Friday, 28 October 2011

Hard times

A friend of mine asked me to write something about the impact of the current financial crisis on the construction sector. What follows are my personal impressions about the threats and opportunities currently confronting the sector.

Since the beginning of the financial crisis, things have panned out in a somewhat strange way. First, the impact on the construction sector was a long time coming. There were many public sector projects already in progress, which was part of the government's problem at the time. They had continued to spend on major public sector projects at considerable rate, and all those major projects in the pipeline kept construction companies in work, though at a more relaxed rate until well after the labour government was unseated in a coalition of conservatives and liberal democrats, when there was no outright majority in the 2010 general election. The new government soon discovered that the adventurous public spending by the previous administration had all but exhausted the countries reserves, so a comprehensive public spending review soon put paid to many planned construction projects. As work for the construction sector finally dried up, new major projects were announced, and the tap of public sector investment was quickly turned on again, to try to avoid too many insolvencies and consequent redundancies. Thus, while there is not a lot of work about, the public sector investment programme has maintained a low level of work that seems to have provided a buffer. But the private sector has slowed significanctly, largely through the disappearance of capital markets. Once  the full impact started to hit the construction sector, insolvencies were seen to rise much higher in the construction sector than in others, with a 20% increase in some quarters, compared with the previous year. But most of the time we seem to be seeing insolvencies running at about 10-15% higher than the previous year. Of course, these headline figures are increases, not the proportion of companies disappearing. Headline grabbers are great for creating disquiet. Normally, I would expect construction insolvencies to run at the same rate as all business sectors (contrary to popular belief). But construction insolvencies are always slightly higher in recessionary periods, as they are now. But, still,the vast majority of businesses are continuing to trade, although they would prefer to be busier.

Few developers can raise capital from banks, because the banks do not have any. Clearly, this is a very lean period for the construction sector.  Construction workers are being laid off and a proportion of business are disappearing. Since most work is sub-contracted, the sector is very resilient. Those contractors and suppliers with workflow are now in an odd situation, becaue if they are making profits, there is a real problem in terms of what to do with their reserves. Contractors typically manage their projects so that there is a positive cash flow, ensuring that payments out are always some weeks behind payments received. Few people seem to notice that this means contractors do not need to invest in projects; their clients do. This positive cash flow means that contractors with projects have surplus cash to invest, typically in developments of their own. But in such an austere period, the markets into which they sell their own developments are somewhat moribund. Since this is often quite lucrative, times are hard. Moreover, trade contractors who design and manufacture the things that they install are reliant on investment in their processes, in a way that others in the sector may not be. And they are also hit with the double problem of very competitive pricing levels and nowhere to invest surpluses. Since the banks are not lending, there is not much happening in the private sector capital markets. So those with surpluses appear to be  shepherding their money for now, to see them through continuing lean patches. What development there is, is relying on capital, rather than debt financing. 

In the longer term, locally and globally, I feel that there is chance the construction sector might be able to finally move away from being a cash cow. If we are to make this into a 21st century business sector, it is essential that we abandon the Victorian business models and ideals that have served us so well throughout the 20th century. I sense that there is an opportunity for businesses to take more of a stake in the things that they are producing. If we can get contractors and trade contractors to invest in the things that they make, and take a greater proportion of their payment after completion, then we shall see greater incentives and rewards for innovative (and, perhaps, sustainable) products and practices. And what better time than now to enable large, successful companies to pump-prime their clients' developments with cash? Many more contractors are establishing capital arms to invest in their own and their clients' projects. This is interesting. If it continues, we could see the end of a business sector based on large volumes of cash being pumped around construction sites, and the growth of significant investment-driven construction companies which will be able to weather financial storms as successfully as any other business sector.

So, who knows what will happen? Even in this difficult time, there are great opportunities. One thing is for sure, as someone once said, "if you always do what you have always done, you'll always get what you've always got".


Lorna Josiah said...

I guess the idiom "cash is King" would need to be unlearned, in an industry that is entrenched in it. Getting paid at the end of the project would work for more established companies, some Mom and Pop companies that I've dealt with rely on the Cash inflow to manage their supply chain. It would go a long way in managing the process if all parties thought lean construction, innovative construction, that as a result is an advantage not only to the contractor but also to the client. It's an interesting concept with potential but is the ship for turning?

Sitsabo said...

I cannot agree more with the view that what has worked in the past for construction firms can no longer be expected to apply going forward. Construction firms are comfortable with operating under tried and tested norms and traditions. Faced with the reality that we can no longer continue as in the past, firms that fail to accept this and seek change have no place in the 21st century.

The role of the knowledge economy does not seem to have been fully understood and integrated with practice. Lots of important research has been undertaken in construction by a multitude of respected academics, but how many of those valuable pieces of works are being put to use in practice? How well are these wise men and women in the knowledge economy being utilised to advise on such important matters? God says my people perish because of lake of knowledge, but in construction, firms perish because of ignorance.

Will Hughes said...

Now you can read my contribution in the context of the whole article in AJCEB

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