In the 12 months leading up to March 2023, 4165 construction firms collapsed. Experts warn that this could trigger a domino effect across the supply chain due to the tight profit margins in the industry, firms owing large amounts of money upon bankruptcy, and that many products used in construction are manufactured using a 'just-in-time' approach.
38 construction firms entered administration in March, the most since the pandemic began, and the trend looks set to continue. Two significant insolvencies from this year are Tolent and Metnor Construction. Tolent collapsed into administration with a £43m outstanding debt after losses on its £85.5m Milburngate development and tightening credit conditions. Metnor Construction went into administration owing creditors £10m at the time of its collapse.
There are many challenges in the construction sector that are exacerbating the number of insolvencies:
- Rising inflation
- Covid loan repayments
- High energy costs
- Shortages and rising costs of equipment and materials
- Longer lead times, schedules and cost overruns
Not to mention the ever-present issues of labour shortages and slow digital adoption. There are concerns that, unless major changes take place, the current rate of insolvencies will continue, posing a danger to the entire supply chain.
Why The ‘Race to The Bottom’ In Construction Tendering Needs to Be Reversed
There is now a culture of 'race to the bottom' tendering in the UK construction industry, where contractors compete to offer the lowest price possible to win a contract without considering risks, price rises, or rework. This 'commoditisation trap' results in extremely tight margins and profit loss across the sector.
The 'race to the bottom' has come about through clients prioritising price over other factors such as quality, social value, net zero, and end-user engagement. Tender evaluations that favour price in the procurement process leads bidders to provide the lowest price possible to secure a project.
This low-cost model has several negative consequences:
- Poor quality materials and overall construction projects
- Lack of trust and transparency leading to disputes
- Lack of investment in technology or cultural change
- Poor site conditions, safety and employee wellbeing
- Inadequate payment terms for contractors
- Fictitious pricing that significantly differs from actual cost
To address this issue, there needs to be a fundamental shift away from prioritising lowest cost in the procurement process and rank factors such as quality, experience, and financial stability higher.
Clients need to be engaged from the start and adopt a more comprehensive 'should-cost' model where they are aware of the risks and costs in the project. With a range of what the 'right' price should look like to achieve their goal, they will be able to rule out anything that is not sensible.
On the contractor side, highlighting specialisms and expertise, and focusing on building relationships with clients, will go a long way. A realistic price, efficient contract management and an overall better client-contractor relationship should ensure successful project delivery.
Avoiding Bad Debt in Construction
Entering 2023 there was roughly £300m in bad debt in the UK construction industry, financial experts predicted this could rise to £1bn by the start of 2024 because of the domino effect caused by large insolvencies.
The construction supply chain is under a lot of pressure following Covid loans, inflation and rising interest rates, which is being compounded by outstanding debts and stretched payment terms.
No company is immune to the effects of bad debt, as was shown by Carillion's collapse in 2018, which had a huge impact on the sector. Carillion collapsed under £1.3bn of debt causing a domino effect across the industry. Research found there was a 20% spike in insolvencies following the collapse which especially affected smaller firms. Thousands lost work or money owed to them which made it difficult to pay their own suppliers, staff and bills. The main reasons behind Carillion's snowballing debt were:
- Large loans and 'borrowing' money by taking a long time to pay invoices
- Little investment into long-term assets
- Overly optimistic profit forecasts
- Dividends based on expected profits
The main learnings to take from this is that cash is king, being strict with invoicing, credit control and choosing suppliers or clients will go a long way in ensuring you can weather what has been coined 'the perfect storm' in construction.
Following the seven key pillars for avoiding bad debt should keep money in the bank:
- Clear and lawful contracts with correct payment terms and conditions for late payment
- Send invoices on time and promptly record payments
- Set up a credit control policy
- Be consistent with the credit control policy
- Say goodbye to customers that don't pay
- Always know your current cash position and cash flow forecast
- Have full and accurate visibility of data
To see a more comprehensive version of this list, download our free bad debt e-book>
Future-Proofing Construction Through Digital Transformation
The construction industry has a notorious reputation for slow technology adoption and reluctance to digitalisation. Slow digital adoption has led to construction businesses being seen as an easy target by cyber criminals, according to the UK National Cyber Security Centre.
Digital transformation in construction is essential for businesses to become more productive, to speed up processes and increase overall quality of projects. A report by the National Federation of Builders found that 64.3% of contractors experience sustainable business improvements from digital transformation, and 57.6% say the main motivation for digital transformation is to gain competitive advantage.
Industry 4.0 evolutions, such as cloud computing and automation, are on the rise. Construction is recognising the need to invest in processes that improve data quality and encourage collaboration across teams. 66% of construction businesses are using cloud applications, which is less than the national average, but this number is rising.
Cloud computing gives businesses the ability to access and store data from anywhere, anytime, which is helpful when teams are remote workers or at various sites. It also improves security of data, preventing costly cyber breaches.
There is a wide range of software that can help control and increase profit margins. The main one being construction ERP software which can simplify complex financial reporting, giving an accurate view of a business’s cash position. Implementing ERP software will help:
- Control budgets and ensure projects stay profitable
- Locate the right resources at the right time through procurement tools
- Improve data management by providing a 'single source of truth' for all project data
- Identify and mitigate risks and rework