Construction Industry - Severe Economic Shock

10 Aug 2020

Construction Industry – Severe Economic Shock

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The Coronavirus has caused a severe economic shock to many parts of the economy and the construction industry has been hit significantly, causing major structural effects on the sector’s supply chain. If the UK’s Office for Budget Responsibility (OBR) analysis turns out to be correct, the construction industry might see a 70% reduction in output this year causing significant cash flow issues for those without significant cash reserves.

The construction sector comprises of many sub-sectors which causes additional challenges and interdependencies. The latest data shows there are 325,000 construction companies in the UK, incredibly only a mere 250 of these are not classed as SMEs.

Analysis carried out for the UK’s Department for Business, Energy and Industrial Strategy showed that for a typical large building project the main contractor is on average responsible for managing around 70 sub-contracts of which a large proportion are given work valued at up to £50,000. These larger ones being mainly in the South East. Research on projects in other parts of the UK showed 70% of sub-contracts were given work below £10,000.

I know from the experience of many of my clients who work in or supply the construction industry that it suffers from low profit margins. Research carried out by the Office for National Statistics and the Institution of Civil Engineers, together with the OBR Coronavirus impact scenario shows that UK construction companies will see a negative impact on turnover. This, together with low profit margins, will lead to many struggling to pay their sub-contractors and other suppliers.

Smaller companies, without cash reserves and strong balance sheets, will face significant challenges. Their ability to access more government support packages will be limited and those who have been given government grants will have probably already used the money. Given the nature of billing in the construction sector, which can involve many types of contracts, including retention payments, there is a possible ‘time bomb’ on the horizon for SME businesses. This will only be exacerbated by clients deciding to withhold or delay payments and the expiration of the Government’s job retention scheme.

It is unlikely that the full impacts of reduced cash flow through supply chains will materialise until later in the year. As businesses re-commence works on their sites, under the existing contract terms, they will not receive any cash for around 50–60 days. At the same time, suppliers will be increasing labour and material purchases as they look to increase output each month.

Recommendations from Mace Group:

1. To ensure that supply chains remain intact with the capacity to deliver, all businesses should try and work constructively and openly with their supply chain to address potential cash flow issues up front. Invoices must be paid on time and private businesses should match the commitment made by the public sector. If clients start to withhold or delay payments it could cause a ‘domino effect’ across the whole industry. Refer to Government and CLC guidelines.

2. Businesses of all types should use the GOV. UK online service which helps identify the most appropriate support schemes for different types of business and approach their banking partners to understand facilities available to them. Trade bodies such as Build UK may also be able to offer advice and practical support.

3. Clients and their suppliers should work collaboratively to maximise the amount of work that can be done now whilst respecting the government’s guidance and plan ahead to see how schemes could be accelerated to make up lost ground once lockdown measures are eased.

4. Prof Richard Rumelt, who wrote the book Good Strategy Bad Strategy and is noted for having made several key contributions to the study of business and corporate strategy, talks about “chain-linked systems”. Construction is a chain-linked system due to its structure and complexity of its many supply-chains. This means that the system is limited by its weakest link. Large projects need to stress-test and review any possible weak link or vulnerable supply chain partners and develop mitigation strategies.

5. We should have empathy with all those we do business with. It is only by behaving more collaboratively will we reduce the economic damage and have a healthy construction industry that can help our country recover. The demise of Carillion demonstrated the significant broader economic and societal impacts of what happens when a large construction business can no longer meet its obligations. Carillion was the largest Liquidation of all time in the UK when it failed in 2018!

My thanks to Mace Group for their reports on the Construction Industry.

Companies involved in the construction industry need to be diligently monitored. To ensure on-time payments, suppliers should proactively scrutinise their customers and those within their supply chain.

1 Response

  1. paul_austin_student

    Great article Steve. Definitely, the weakest point (chain-link logic) in your organisation can wreak havoc on your strategy. Similarly, a strong chain-link system can ensure healthy growth.

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