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The Cost of Construction

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Architects are using a calculator to estimate the cost of house plans, house plans, safety helmet and office equipment placed on the desk.

Recent history has shown that construction firms are not too big to fail even though they may have annual revenues ranging from millions, hundreds of millions to several billions of Euro. The industry has regularly witnessed smart leaders making what appear to be the same fatal mistakes others have made before them. Frequently cited mistakes are; unrealistic growth, over expansion, unfamiliar new markets or entry into new types of construction, volume obsession and bad contracts or poor project selection.

While helpful, this list of mistakes provides insufficient clarity regarding the causal roots of failure, more often it is a combination of factors. The way work is procured is partly to blame, in large the construction industry is different from the way most businesses work. The developer/employer wants a building and wants to know exactly how much it is going to cost before the project is built. Increasing complexity of projects, fluctuating materials costs and labour concerns all conspire to make this a dangerous get-work practice for contractors. While the predominance of this method is changing with new delivery methods, it is easy to see how contractors still get into trouble.

Throw in the mix of Brexit, Covid, labour shortage, shipping/container shortages and competing global demand and contractors face the perfect storm. While there are many in the industry who would deem these inflationary costs as temporary my own feeling is that they will last for the next several years before they start to plateau towards the end of 2023 or early 2024. According to the SCSI the national annual commercial construction inflation is now rising at the rate of 8.3% that is double pre-Covid levels. 

What is the impact for contractors; the first is squeezed profit margins or even losses on existing live contracts, the second issue is supply shortages are resulting in significant delays which further hit the bottom line when penalties such as liquidated damages kick in. Finally the big question is whether contractors can stand over prices they have issued on tenders over the last three to twelve months, in most cases the answer is a resounding no.

To add to the complex nature of contracting public and private owners are shifting greater risk onto contractors through onerous contract terms with non-traditional project responsibilities. Public Procurement contracts under the value for money policy look for cost certainty but shifts the risk to the contractor. The additional risks are evident in the evolution of project delivery systems that have surpassed design-build projects to more challenging methods of integrated project delivery (IPD), gap financing and PPP’s. In these hybrid risk-sharing approaches, attention to the potential expanded and long-term exposures to risk must be identified and addressed. Contractors must be alert to new risks, resist or at least address these new risks whenever possible, and keep costs low to stay profitable. The financial consequences of the risk-shifting can hit general contractors and subcontractors hard, particularly in the current environment. 

The need for cost certainty with fixed price contracts will impede the commencement of many Public Procurement projects that were tendered for over the last twelve months. While it is easy for project owners to blame contractors for the delays and additional costs, it is imperative for project owners to make the right choice of contractor in order to mitigate and manage risk on construction projects by selecting the most suitable contractor who will ensure timely project completion even if it means paying a premium to attain completion of a successful project. While cost is a primary factor it should not be lowest price race to the bottom, we need to look at the long-term cost and value of a contract. 

It is my opinion that it is time to change the public procurement rules that dictate construction projects, price should not be the determining factor to winning a successful bid. There are other methodologies that are used in the private sector for example contracts such as “measurement contracts” or “cost reimbursement contracts”, these determine the contract sum by calculation using the contractor’s actual labour, plant and materials costs, to which a previously agreed percentage addition is made to the costs to cover the contractor’s overheads and profit, profit can be a negotiated fixed sum or a percentage of the contract. While this is only a suggestion and many will disagree with me, without change there will either be a significant increase in the cost to carry out future public procurement contracts or as we have seen in 2017/2018 failure by contractors to complete their contracts which adds to overall cost. 

Colm McGrath – Managing Director Surety Bonds