The opportunities and challenges inherent within New Zealand’s construction sector have always been amplified by its cyclical nature. With the high demand construction firms are currently experiencing in both the commercial and residential sectors, we are seeing the industry take fresh approaches as it responds to market challenges such as procurement of materials and delays due to supply shortages as well as mitigating financial risk with changes to negotiating and pricing of contracts due to inflation and market pressures. These key challenges will provide the footing for those within the industry who will continue to thrive and those who may fall victim to their own lack of forward planning.
Supply chain challenges
While non-availability of construction products and materials arising from disruption to production and shipping was an expected consequence of the global pandemic, supply chain challenges have progressively worsened over the past 12 months, evolving into the major challenge it is today. 56% of respondents to BDO’s latest Construction Sector report indicated that they had experienced project delays directly linked to receiving materials later than originally planned and 32% of these experienced delays exceeding two months.
The sector has been quick to rethink and apply new strategies to mitigate this situation, such as procurement teams tracking individual shipping movements to know exactly where their materials are. They are identifying alternative suppliers in case their historical supplier can’t deliver and where possible materials are being ordered and stored well before they are needed. Forward planning on projects has allowed some companies to keep a strong profit margin on a number of jobs by adopting these methods. Those who have also been able to strategically pass on additional costs incurred by these methods directly to the client, have fared best of all.
Inflation is underway
Builders and construction companies are receiving supplier emails advising of price increases weekly. Often, price increases exceed the gross margin of many companies. The issue is not restricted to materials; the acute shortage of labour in the sector is significantly forcing up labour costs too. We have been through a prolonged period of low inflation and most building contracts have a fixed price.
Initially builders and subcontractors were being forced to absorb the price increases. This is not sustainable, and practices need to quickly change. Inflation is not a risk that the construction industry has capacity to absorb. It is a risk that needs to be passed on to those best equipped to absorb it; the clients. Most construction firms expect significantly higher costs to flow onto clients, but acknowledge that contracts will need to change to allow for this.
Determining a projected final contract price will be challenging as each subcontractor and each materials supplier will want the ability to pass on increases that are more than modest. The head contractor/builder must collate these into a winning bid when quoting for projects, a very challenging task. Clients won’t be able to easily select a builder based on price alone moving forward and non-price attributes will become a greater factor in builder selection.
A distinct trend is developing in respect to financial sector performance and outlook. The majority of large head contractor firms are seeing their gross margins grow, while gross margins decline for small head contractor firms and the subcontractors category. Should this trend continue for the sector, we risk seeing smaller companies battle each other on low margins in a period of high risk which will inevitably result in casualties. Organisations need to decide whether they will turn down some forward work – staying at existing activity levels and within the capacity of their staff and suppliers to manage. If they take on additional projects, they run the risk of being unable to successfully manage and perform on those projects, resulting in losses.