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Brexit clauses and aggressive pricing hit contractors' forecasts

With more uncertainty on the horizon, contractors will need to look closely at risk profiles and contracts in what will be an increasingly competitive market.

The construction industry may be tired of asking for certainty – but the current business climate looks set to continue for for the foreseeable future.

Last week’s High Court ruling that the UK government must consult MPs before triggering Article 50 has not helped what has been a turbulent few months, making it all the more difficult for firms to plan for the future.

That sentiment is reflected in the October Industry Barometer from consultants Leading Edge, which surveyed more than 80 senior-level respondents across construction, including contractors, consultants and product managers. The data points to an industry that is determined to get back to business as usual, in spite of economic and political uncertainty, but also one that recognises political and contractual risks.

Six-month slowdown

One stand-out finding of the latest barometer reflects what many other industry surveys and official datasets are telling us: construction has seen a definite slowdown in the last six months, with the pace of growth coming off the boil.

Data from the Office for National Statistics showing construction output declined in August compared with July sits alongside industry surveys pointing to a slowdown in sales growth, including those from the Royal Institution of Chartered Surveyors, the Civil Engineering Contractors Association, the Construction Products Association and Markit / CIPS.

CECA’s survey suggested that civil engineering firms had seen sales grow at their slowest rate for three years in Q3, while surveyor respondents to RICS’ Q3 Construction Market survey reported only a modest increase in sales quarter on quarter.

Respondents to the Leading Edge barometer reported that sales in their business grew by just 1.6 per cent in the six months to October – the lowest rate since April 2013, when growth stood at just 0.9 per cent. This represents a significant decline on the previous period, where firms saw average sales growth of 6.3 per cent, the third-highest level on record.

Leading Edge managing director Mel Budd says the sales figures reflect a step back for the industry, which had maintained momentum since October 2013, when average sales growth hit 5 per cent. However, he is quick to add that sales are still growing, and that the lower growth rate follows a period of strong increases.

That sentiment is reflected in respondents’ sales outlooks, which, while dampened, still paint a relatively positive picture for the coming six months.

A net balance of 14 per cent of respondents expected sales to rise in the next six months – lower than April’s survey (38 per cent) and comfortably below October 2015 (50 per cent). While the positive outlooks still outweigh the negative, this marks the lowest net balance since October 2011, when only 4 per cent of firms, on balance, expected sales to rise, reflecting the unease that pervades the industry.

Brexit contract clauses

Respondents pointed to a number of key factors that had led to changes in the way they do business in the last six months – not least the atmosphere of uncertainty bleeding into contracts, and particularly in terms of risk on projects.

Contractors mentioned having to add “Brexit clauses” into contracts to account for wild fluctuations in sterling, which have had knock-on effects to materials and import costs ever since the vote to leave the EU.

One senior construction lawyer added that, while he had not seen specific ‘Brexit clauses’ as yet, it was likely that allowances for currency fluctuations and tax rises will begin to creep into short and medium-term contracts.

“It’s much easier to take a law away than to create it”

Chris Hallam, Nabarro

He said that while clauses that cater for foreign exchange rate fluctuation are normally part of longer term contracts, it isn’t normally the case that they would be included on short-term jobs, lasting up to a year. But with contractors pointing to those clauses already starting to emerge, they are now likely to become common if turbulence persists.

The lawyer added that such clauses will be “all about who takes the risk” when costs and economic impacts are so hard to predict.

In addition, more ‘change in law’ clauses are starting to creep into shorter-term contracts, according to Chris Hallam, partner at law firm Nabarro.

Changing the law

The clause typically deals with who takes the risk when laws change; they are typical in longer-term PFI contracts, and are much more commonplace overseas than they are in the UK, he explains.

“If the contract is under a year or sometimes under a couple of years, the contractor will take the risk of [a change in law],” he says.

“In the UK we tend to have a lot of transparency over what’s going to happen with the law; things are detailed and documented well in advance.”

He adds that the lack of clarity around how the process of leaving the EU will work – not helped by last week’s High Court judgement – makes it difficult to manage any change in law clauses.

“So much law is European law,” he says. “[The government] has said they will adopt all of it from day one and bits will be repealed as and when, but quite what the process for doing that is, nobody really knows. That could happen more quickly. It’s much easier to take a law away than to create it.”

As a result, contractors will be looking to pass as much risk as they can back on to the client. “For things like cost fluctuations, foreign exchange risk, change-in-law risk, contractors have been reasonably comfortable to take a reasonable level of that risk on,” Mr Hallam says.

“But with the uncertainty and the margins that contractors work on, they can’t afford to take a hit on the change of law [clause].”

Aggressive pricing

Increased risk profiles will also be coupled with a more competitive market, with more and more firms expecting aggressive pricing from competitors to increase in the coming months.

According to the barometer, 74 per cent of firms named aggressive pricing from their competitors as the top barrier to winning work over the next 12 months, up from 62 per cent in April’s survey, showing that the problem is getting worse, not better.

Mr Budd says that while this factor is always one of the survey’s top issues for firms, the data shows that it is becoming even more of an issue as projects are put on hold or cancelled.

“Everything from truck drivers to labourers to skilled trades is in short supply”

Mel Budd, Leading Edge

Lack of resource to meet demand from the market has slipped back as a barrier to work, with 28 per cent of firms citing it as a key concern, down from 44 per cent in April’s survey.

But Mr Budd says that construction clients have still pointed to a wide range of trades in short supply – “everything from truck drivers to labourers to skilled trades”.

Mr Hallam adds that many of these issues are only being made worse by the political situation.

“In some respects it’s the same old issues that tend to come up on construction contracts, they’re just much more heightened at the moment because of the level of uncertainty in the market,” he says.

And with doubt over freedom of movement threatening to exacerbate the skills shortage, alongside an increasingly competitive market, contractors will face a battle to maintain sales growth and profitability.

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