December 2, 2022

Power is shifting to subcontractors

With suppliers in a better position to call the shots on contract terms, the industry must recalibrate its approach to risk management.

The construction industry is immersed in a storm of circumstances impacting the viability of projects across the UK. Employers and investors that have previously expected contractors to accept contract terms fully wrapping all the risks on construction projects for an all-in lump-sum price are now finding this approach unrealistic. The industry is witnessing the cumulative effect of an ongoing shortage of skilled labour, rising inflation rates, residual covid-19 impacts, rising energy prices, a slow planning system and a hardening professional indemnity insurance market.

Main contractors are already struggling to deliver current projects procured on lump-sum contracts that do not allow for recovery of rising inflation costs. The prevailing contract approach previously adopted was for contractors to be held to existing lump-sum pricing arrangements in their upstream contracts, without any allowance for fluctuations. This is a particular concern for contractors that are yet to secure certain packages on current projects. Subcontractors are not only changing their prices but also demanding more favourable contractual terms.

Wider economic shifts are leading to tangible changes in the risk allocation that contractors and suppliers can accept. Reliable contractors with access to the required goods and materials and to skilled labour in the right geographical location can more than fill their order books. As a result, the industry is seeing successful contractors and subcontractors choose which clients to work for – namely those with a strong financial track record, which will pay them fairly and work in a truly collaborative way. Advance payments and shorter payment cycles may be required, and the timing of materials availability might have to dictate the entire project programme.

Another issue is the increasing cost of professional indemnity insurance. Contractors and suppliers seeking commercially viable cover are also finding that insurers’ requirements and the extent of the policy limitations or exclusions are becoming more restrictive. This is affecting contract negotiations. Given the volatility in the industry, employers should arguably be seeking greater ancillary financial security from contractors – for example, performance and advance payment bonds, and a parent company guarantee. But either the additional upfront costs to the employer of the contractor obtaining this security are prohibitive, or the contractor is unable or unwilling to obtain this security.

Depending on the nature and location of a project, the number of contractors that have succumbed to insolvency or restructured their business can exacerbate the “pick and choose” approach of the remaining contractors. This means tendering processes may not provide employers and investors with any meaningful contractor competitiveness, in terms of pricing, programming and obtaining best value. In addition, contractors and suppliers are turning the tables and requiring employers to provide them with increased financial security before they undertake any works – for example, payment guarantees and the use of project bank accounts.

Today’s economic landscape paints a very different picture to that of only a few years ago. To avoid crippling their own businesses, contractors and suppliers along the supply chain are stipulating revised pricing, payment and programming structures while also trying to unlock developments and facilitate long-planned construction projects starting on site. There remains a reluctance, however, for some employers and their investors to appreciate the reality of the unprecedented economic situation contractors and suppliers are operating in across the construction industry.

It is for the industry to recalibrate and take a commercially pragmatic approach to risk management and work collaboratively throughout the supply chain to ride out this perfect storm. If the last few years have taught us anything, it is that we are unable to predict the impact of future world events. It is of paramount importance all stakeholders involved in construction projects concentrate on maintaining good working relationships with each other and proactively navigate risks collaboratively to unlock successful project delivery.

This article originally appeared in Building.

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