Key inflationary and deflationary pressures
Based on our observations of the market, survey feedback and our extensive discussions with the supply chain, we have established that a number of inflationary and deflationary pressures are likely to impact tender pricing.
In the year to February 2021, the Department for Business, Energy & Industrial Strategy (BEIS) reported that their ‘All Work’ construction material prices index rose by 7%, accelerating sharply since October 2020. A handful of key materials have driven material price inflation and year-on-year fabricated structural steel prices have risen by 16.4% while rebar prices were 18.2% higher. Timber prices have also rocketed with imported sawn or planed wood prices rising by 12.3% and imported plywood by 30.4% over the period.
Some have suggested that we are witnessing the start of a commodities supercycle (ie a prolonged period in which commodities trade above their long-term price trend). Commodity prices have already risen substantially over the past few months which has put upward pressure on construction materials costs.
Rebar price rises are pushing up frame costs and trades using metal materials are experiencing significantly higher trade package inflation (eg MEP). Cold Rolled Steel is also proving tricky to get hold of which is causing delays to some schemes. Some materials such as plaster, plasterboard, bricks and mortar are in high demand but their supply is still being affected by the pandemic. Roofing costs have also increased substantially due to shortages of material and labour and shortages of insulation have been reported from within the supply chain which is increasing lead times.
Recent PMI surveys have revealed that higher demand for construction products and materials has contributed to longer wait times for deliveries by suppliers. In March, 41% of the survey panel reported longer delivery times compared to the previous month (only 1% saw an improvement) which were accompanied by steep inflationary rises. In fact, purchase prices of construction products and materials in March rose the fastest since August 2008 at the height of the last commodity price cycle. Supply constraints/underperformance and logistics issues were commonly reported by construction firms, especially for imported items.
Whilst rising raw material prices are putting upward pressure on tender price inflation, we cannot forget that higher shipping costs are also having an impact. British businesses are experiencing higher container charges with logistics company Freightos reporting that the average cost of shipping a 40-foot container rose by as much as 380% between October 2020 and mid-February 2021. Pre-Brexit stockpiling, a pandemic-fuelled shortage of containers and, more recently, the six-day blockage of the Suez Canal have resulted in delays surcharges being imposed by shipping companies on shipments to congested UK ports. The increased shipping costs are unsustainable ad infinitum and costs are likely to be passed up the supply chain until shipping capacity eases as the world enters the post-COVID era.
Prices are likely to continue to increase for many construction products and materials as contractors fight for limited supplies. Prices will arguably peak and begin to ease once global restrictions come to an end supply chain capacity normalises. Until then, certain materials will be affected by upward cost pressure and longer lead in times.
Official data from the ONS shows that in the year to February 2021 average weekly earnings for construction rose by 1.7% on a seasonally adjusted basis. The recovery has been impressive but not unexpected. Wages fell to a low-point in May 2020 – just two months after construction hit its furlough peak (with 723,600 employments furloughed on 14 April 2020) – but as sites reopened after temporary shutdowns and pauses, construction wages recovered sharply.
Forthcoming new project starts have spurred a solid rise in employment numbers according to March’s PMI survey data with job creation rates in the sector hitting a two-year high. If the market becomes increasingly busy some are concerned that the limited pool of contractors and labour will not be able to meet demand which could push up labour rates and project cost. However, it’s possible that labour rate rises will slow down and return to pre-COVID levels when lockdown restrictions are eased and European labour can return back to the UK.
A lack of skilled labour continues to be an ongoing theme in the industry but not to the extent that it’s having a major effect on projects. Shortages of labour are more pronounced in certain trades and stem from long-term underinvestment in training and apprenticeships and more investment will be needed in the coming years to win the war on talent.
Labour rates tend to closely track changes in construction output and capacity. If output growth continues to remain strong amid buoyant demand whilst capacity is largely stagnant, labour costs will tick up. The labour force in the construction industry fell by 140,000 in 2020 (ie 7-8% of the 2.3 million construction workers in the UK) according to the RCIS. It will take time to rebuild the UK’s construction capacity to pre-pandemic levels and there are some signs that demand for projects (in the form of new orders) is returning rapidly in certain sectors.
PROFITABILITY AND PROCUREMENT
OH&P and Preliminaries
Overheads and profits (OH&P) from main contractor tender returns to G&T (across all sectors) averaged around 6% in 2020 but the range of OH&P levels widened significantly. At the lower end of the range, OH&P levels didn’t dip much below 2% but at the upper range one or two outliers achieved OH&P exceeding 10%. Again, this is evidence of a two-tier tendering environment emerging where sectors experiencing high market activity and an abundance of schemes are resulting in less competitive tendering and higher pricing levels. Interestingly, some survey respondents indicated that a number of contractors are now seeking 7-8% OH&P in their tender returns, indicating that in some sectors at least margins are healthy.
An example of this two-tier tendering market was revealed in our 2020 tender returns data, where the residential sector achieved a higher OH&P average (6.9%) than the office fit-out sector (2.9%). This is perhaps unsurprising given the higher volume of work and new orders in the residential sector during the year. Increased competition for work in certain sectors has forced contractors to reduce margins to win work and help them secure repeat business in the future. However, across all projects and sectors the vast majority of survey respondents (72%) saw little change to OH&P in Q1 2021, suggesting that the tendering market is stabilising.
Main contractor preliminary costs edged higher last year (from an average of 13.5% in 2019 to an average of 15.3% in 2020) as contractors sought to recover some of the ongoing operational costs associated with imposing COVID-related measures and complying with CLC SOPs on site. However, preliminaries in the first three months of 2021 saw little change. While some preliminary increases have been offset by greater competition in the market, we have also seen a number tender returns where preliminaries were higher than expected in our pre-tender estimate. In some instances at least, this was a result of contractors looking to incorporate head office costs into project preliminaries.
Most survey respondents (53.8%) forecast that preliminaries are likely to remain above pre-COVID levels in the short-term and will only abate once site restrictions, measures and protocols are either eased or removed. However, there was a growing proportion of respondents who believe the preliminaries will rise further over the course of the next year. Some 38% believe that preliminaries will rise (compared to 13.2% in our Q1 2021 TPI) but acknowledged that rises are likely to be confined to a handful of key sectors.
Similarly, for OH&P forecasts most surveyed respondents (around 60%) believe that OH&P will remain broadly unchanged over the next 12 months but a growing number (30%) think OH&P will rise. Again, respondents anticipate that contractors will have greater headroom to raise OH&P in a handful of key sectors while competitive market forces in other sectors will leave contractors with very little room to increase margins. However, contractors sharpening their pencils with their own OH&P calculations will perhaps look to make savings on package re-tenders to make up for this drop. The net result may be that across all sectors both OH&P and preliminaries will remain relatively static over the next 12 month period.
There have been no surprising changes with regard to the most favoured project procurement routes over the past three months. D&B two-stage was once again the most favoured route overall in Q1 2021 according to 36.1% of the respondents. However, this was closely followed by the D&B single-stage procurement route according to 32.4% of those surveyed.
While two-stage tendering remains preferred by tier one contractors on major projects, contractors looking to secure work have clearly been more willing to take on additional risk and procure using a single stage route since the pandemic hit the UK. Clients also desire to benefit from the contractor taking on all the risk by fixing costs under a single stage tender and unsurprisingly have been pushing for this route more often. However, respondents noted that some contractors are electing not to tender on a single-stage route if the project is large/high value or is otherwise particularly complex or challenging. Whether contractors become less willing to accept single-stage procurement as the year progresses and certain sectors become less competitive remains to be seen.
Favoured procurement route is, of course, project-specific but with more public/civic projects expected in the coming years we’re likely to see more frameworks being used that advocate early contractor involvement (effectively two-stage with design transfer to the contractor) and also traditional competitive procurement processes.
*Average Weekly Earnings (Total Pay), Y-on-Y three-month average to Feb 2021