Input Costs

Key Inflationary Drivers

Following COVID-19 and the war in Ukraine, double digit rises in materials prices in both 2021 (+19.8%) and 2022 (10.9%) drove the inflationary spiral. Relatively speaking, labour costs were a less important factor over this period, rising by 2% in 2021 and 4.8% in 2022. However, in 2023, the cost-of-living crisis, high demand and reduced contractor capacity meant that labour became the most prominent input cost driver, rising by 7.1%.

Still, wages in construction have not risen as much as previously feared. Indeed, construction earnings growth has lagged that of other sectors this year, while falling vacancy rates suggest that wage pressures will gradually recede in 2024. When considered alongside falling material prices, softer demand for construction projects and an increased appetite to win work, it is unsurprising that industry forecasters generally anticipate lower levels of tender price inflation in 2024 and beyond.

Deflationary drivers are not likely to completely win out though. Above trend workload levels, a shrinking supply chain, labour pressures and contractor concerns about taking on too much risk will ensure tender price inflation continues to be positive for the foreseeable future.

Materials Trends

Since July 2022, construction material price inflation has collectively stabilised and, for several materials, fallen significantly. Stagnating demand, lower wholesale energy prices and improvements in product availability following a series of supply chain disruptions have helped soften material prices.

According to the BEIS All-Work index – a basket of goods that tracks price movements for construction materials – prices in October 2023 were 2.6% lower than they were one year ago. Additionally, October marked the fifth consecutive month-on-month contraction of the index.

The decline in the index was driven by a handful of key materials; namely structural steel, rebar, and imported timber – some of the most heavily inflated materials in 2021-2022. Prices for a small number of product categories are still experiencing marginal increases (eg insulation, concrete/cement and electrical components), but there has been a clear tapering off in the rate of inflation in recent months.

The slowdown in the speculative new-build sector caused a drop in demand for heavy materials such as steel, bricks and timber. This allowed manufacturers to rebuild inventory/stock levels for these products, improving the supply-demand balance. This may generate short-term discounting and favourable buying windows but further hikes are still possible. Some suppliers have simply deferred scheduled price increases as demand has slowed, while ongoing volatility in the energy markets presents a significant upside risk to production costs and future price movements.

Labour Trends

Weaker new order growth and uncertainty over the longer-term business outlook has limited appetite for additional hiring, dampening employment and recruitment activity over the past year.

According to ONS data, labour cost pressures have eased in recent months. In October 2023, average weekly construction earnings in the UK were 4% higher than a year ago (on a three-month average basis). Although still higher than the industry’s long-term average annual growth rate of 3.1%, this represents a significant cooling and is far below earnings growth in the economy as a whole at 7.2%.

Construction workers have taken a larger pay cut in real terms compared to other sectors. Easing demand for construction activity and improved capacity have led industry vacancy levels to fall from their peak in Aug-Oct 2022. Lower consumer price inflation will also help to alleviate some of the pressure on earnings growth.

Against a background of falling new orders, the tight labour market may experience some relief. The latest earnings data offers some reassurance that wage growth has now passed its peak. However, we expect earnings will only ease gradually from here towards more typical growth, rather than seeing a substantial rebasing.

On Costs

While Main Contractors are perhaps becoming keener to secure work, most respondents don’t expect to see any notable changes to preliminaries costs and overheads and profit (OH&P) over the next 12 months.

Staff and skilled management costs will continue to maintain or, as one third of survey respondents anticipate, increase preliminaries costs. Increased levels of tendering competitiveness will naturally drive a review of preliminaries, but with the current labour pressures, costs are unlikely to come down significantly until the second half of 2024.

OH&P has remained broadly consistent over the past quarter as contractors have priced work prudently, with appropriate allowances for profit and risk. Over the next 12 months, if new orders continue to decline and construction activity stalls, contractors will have to compete more heavily on price and may lower their returns to secure work.

As contractors try and strike the balance between maintaining competitiveness and margin, the rising number of supply chain insolvencies is a significant risk. A return to aggressive competition on pricing, as is typical in market downturns, is therefore unlikely. Many contractors will naturally look to mitigate insolvency risk by building in higher risk allowance provisions and increasing on costs with the objective of maintaining a stable and successful business.