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Industry leaders call for 'fundamental change' to improve margins

Industry leaders have called for “fundamental change” to improve collaboration and risk management after the performance of construction’s biggest firms was laid bare by this year’s CN100.

Senior industry leaders have called on clients and contractors to manage risk on a more collaborative basis after the CN100 revealed the industry’s largest 10 contractors had an average pre-tax margin of -0.5 per cent.

National Infrastructure Commission deputy chairman Sir John Armitt called for a “fundamental change” into how main contractors and clients collaborate together to manage risk on projects.

“The dilemma is [that] there needs to be a fundamental change if you are going to see a reduction in the risk taken on by contractors and that can only come from clients,” he said.

“Clients have got to come to terms with more collaborative form of contract, and they need to recognise that if contractors are going to have a sustainable business, taking work at 2 per cent margins is not sustainable for them or their shareholders.

“It needs clients who understand where risk is best managed and clients who are willing to accept that risk.”

The CN100, which covers financial results from the UK’s largest contractors by turnover, showed the top 100 reported an average pre-tax margin of 2.8 per cent – up from 2.4 per cent in last year’s CN100 and 2.1 per cent in 2015’s CN100. 

However, the largest 10 contractors by turnover – including heavyweights such as Balfour Beatty, Carillion, Kier and Laing O’Rourke – posted a combined turnover of £31.9bn but a combined pre-tax loss of £52.9m, with their average pre-tax profit margin slumping to -0.5 per cent.

“It is totally irrational to separate design from construction; no other industry does it”

Sir John Armitt

This compares with a combined turnover of £30.65bn, total pre-tax profit of £351.5m and an average margin of 1.5 per cent in last year’s CN100 top 10.

However, Lord Adonis, who serves alongside Sir John on the National Infrastructure Commission as its chairman, argued that the industry’s margins were “indefensible” and said the CN100 showed they had been “cut down to size”.

“I think it’s a sign that the public sector is getting a good deal at last,” he added. “Indefensible margins have been cut down to size, I’m not concerned at all.”

Contractor leaders have also responded to the CN100’s findings, with Mace chief executive Mark Reynolds arguing that the government’s approach to procurement needed to change to improve collaboration.

“If the government says it is managing within an overall budget which the main contractor is in charge of controlling, then you open up parameters about very different discussions [versus fixed-price lump-sum tendering],” he said.

Mr Reynolds, who was deputy programme manager for the CH2M / Laing O’Rourke / Mace joint venture on the Olympics, said: “On the Olympic stadium with Sir Robert McAlpine, we had an arm wrestle on certain things but they opened up their cost plan and we worked together to minimise the overall cost, and they walked away with higher returns.

“People came to me and said McAlpine earned a load of money [on the project], and I said that in my eyes they deserve every penny; would you have preferred the stadium to go over budget by £100m and them to lose another £20m?

“It’s about how you set that culture within the contract.”

Sir John also slammed the industry’s “totally irrational” approach to design and construction, with too few projects involving main contractors in building design at an early stage.

“All other industries have integrated design and manufacturing teams and the two need to be integrated in construction from day one, from the day you start conceptualising and thinking about things design and construction should go hand in hand,” he said.

“It is totally irrational to separate design from construction; no other industry does it.”

“Subcontractors have been more successful in managing their input costs and risk transfer than their employers”

Simon Rawlinson, Arcadis

Mr Reynolds agreed that there needed to be “a big change” in approach from clients and contractors for building design and construction.

“Why would you buy a car off someone that’s been designed by different people and put together by different people?” he said.

“[We need to be] looking at the development of the client’s needs and outcomes, and how we take that transition from concept to engineering design.

“I think this would radically take time out of the process, you would have greater efficiencies, you would have the right people doing the work, they would be informed and be able to plan better, and you would have more certainty over cost and programme.”

Simon Rawlinson, head of strategic research at Arcadis and a member of the Construction Leadership Council, said main contractors could learn lessons from the strong performance of specialist contractors this year.

“Specialists’ increasing profitability also suggests subcontractors that are actually delivering the work on site have been more successful in managing their input costs and risk transfer than their employers,” he said.

“Given the trades’ improved results and main contractors’ need to improve their own financial performance, it doesn’t look as if prices charged to clients are likely to fall unless there is a slump in demand.”

Specialist contractors’ performance was markedly stronger than main contractors’ this year, with the leading 70 firms in the 2017 CN Specialists Index posting an average pre-tax margin of 4.5 per cent, compared with the CN100’s average of 2.8 per cent.

Mr Rawlinson added that although prices and demand were at “unsustainably high levels”, it was “a good time for specialists to invest” to improve the industry’s performance.

“The increased profit pool generated by specialist contractors in the past year is worth over £50m,” he said. “If even half of that was committed to R&D, innovation and training, not only would the industry be more productive, but in the long term, it would be more profitable too.”

Co-chair of the Construction Leadership Council Andrew Wolstenholme added that while subcontractors were making impressive margins, ”the wider construction sector has not invested sufficiently in new technologies and skills”.

”The key to increasing margins within the sector is to improve productivity and to eliminate waste,” he said.

”The level of productivity improvements in the construction sector have consistently been a third or a half those of other sectors; this productivity gap costs the UK an estimated £15bn each year.

“Through adopting digital technologies and new construction techniques, significant improvements in productivity are possible, which will increase profit margins.”

A spokeswoman for the Department for Business, Energy and Industrial Strategy said: “Construction is a cyclical and highly competitive industry and it is not unusual for businesses in the sector to operate on very tight margins.

“Improving productivity is key to ensuring more sustainable profit levels in the industry. As part of our modern Industrial Strategy the government is working with the sector, through the Construction Leadership Council, to design a package of measures to boost productivity.”

 

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