In recent years the construction market has faced a series of significant challenges, including Brexit, COVID-19, inflation and escalating geopolitical conflicts. These turbulent times have highlighted the critical importance of being prepared for the potential impact of insolvencies within the supply chain. Closely monitoring suppliers’ financial health and cultivating strategic supplier relationships enhances visibility, offering early warning signs and a clear path through challenging periods.
The threat of insolvency looms large over the construction industry, as evidenced by recent data from the Office for National Statistics (ONS) and numerous reports of contractors entering administration due to financial difficulties. The ripple effects of insolvencies within the supply chain can vary significantly by project, but they often lead to unforeseen changes to often publicly stated business case targets relating to major infrastructure milestones and outturn costs affecting overall confidence in the industry.
Given the industry's characteristically tight profit margins, high operating costs and long payment terms, it is imperative for clients to proactively safeguard their interests – and those of their supply chain – against the impact of macroeconomic fluctuations.
This article delves into the importance of implementing a comprehensive supplier risk management strategy. By enhancing visibility and ensuring a resilient supply chain, clients can better protect their projects from the adverse effects of insolvencies. We also examine best practices and strategic measures that can safeguard your projects, providing a robust framework for navigating and mitigating potential disruptions.
“Given the dynamic nature of the built environment, delivering capital projects remains a complex challenge. It is important for organisations to enhance supply chain visibility to enable data-driven decisions that mitigate the risk of supplier insolvencies and reduce uncertainty across the organisation and the supply chain.
A well-managed supply chain is vital for the successful delivery of projects. Developing strong supplier relationships supports growth and development while reducing the risk of reactive issue management. Maintaining a focus on these relationships should be central to an organisation’s supply chain strategy to safeguard against impacts on project tolerances, including time, cost, and scope.”
Nicky Wright, Partner, G&T
External market factors impacting the project environment
Over the past five years, the construction industry has faced significant market disruptions, driven by a range of domestic and global factors, including the war in Ukraine, COVID-19 and changes in the political landscape such as Brexit. With additional geopolitical risks on the horizon, such as ongoing conflicts in the Middle East and the potential for further disruption in the Red Sea, the future stability of the supply chain remains uncertain.
These events have had a profound impact on contractors, threatening the stability of their operations and their risk tolerance when bidding on future projects. As a result, the industry has seen a shift in risk appetite, leading contractors to be more selective about the contracts and risk they accept. Global inflation has squeezed contractors’ profit margins, while high interest rates have increased the cost of borrowing. Many contractors have taken on large debts during and after the COVID-19 pandemic, and the ability of these businesses to survive these economic pressures, many of which are ongoing, is still in question.
Figure 1 shows a sharp increase in construction insolvencies between COVID-19 and the Russia-Ukraine conflict.
There has been a clear trend of rising insolvencies since the middle of 2020 – a trend largely driven by historic cost inflation and slowing construction activity, creating financial pressure on firms. Apr-22 appears to be settling for civil engineering, but in the other areas, specifically specialised construction activities appears to be extremely volatile and on an upward trend looking at the latest results for Jul-24. While insolvency levels are expected to remain elevated for the next 6-12 months, stabilising input costs, improving investor confidence, rising demand and falling borrowing costs may provide relief for clients in a changing environment.
The construction industry continues to face a heightened risk of insolvency, which could undermine project delivery. Clients and their supply chains will need to navigate a volatile market environment for the foreseeable future. This environment, along with uncertainties about the government’s future fiscal policies, may disincentivise construction entrepreneurs from starting new businesses that require personal investment to establish new suppliers in the industry.
Why is it important to manage insolvencies?
Developing open and transparent relationships with the supply chain is crucial for effective collaboration in identifying and addressing early warning signs of financial distress. Supplier insolvencies can severely disrupt projects, causing delays and escalating costs. While the specific impact may differ based on the supplier’s role in delivering the project, the threat for organisations remains the same. Financial monitoring of suppliers, at all tiers of the supply chain will support mitigating the impact to project delivery by identifying suppliers at risk of financial distress
Supply chain insolvencies can affect project delivery, however their impact on lower-tier suppliers could have a significant adverse effect on the supply market. These suppliers may encounter defaulted payments leading to disruptions that ripple across multiple projects which are utilising the same suppliers. Even if clients are not directly contracted with the insolvent entity, their projects can be indirectly impacted, especially when major contractors with extensive supply chains encounter financial difficulties.
A number of contractors have faced significant financial challenges in recent years, resulting in insolvency. These financial difficulties have caused contractors to accumulate substantial debts, often owing billions of pounds to their supply chains. As these contractors fail to meet their financial obligations, suppliers, subcontractors, and other stakeholders within the supply chain are significantly impacted, further increasing uncertainty in the market
Clients must acknowledge these risks and adopt effective mitigation strategies through financial monitoring and best practice supplier relationship management.
The impact of insolvencies on organisations’ delivery programme
- Delay in delivery: Supplier insolvencies can lead to immediate disruptions to the critical path. The sudden stoppage of supplies, materials or services can cause delays to the project timeline, further impacting progress down the supply chain. Further delays are expected where clients will be required to re-procure works packages in the event of an insolvency.
- Cost overruns: The financial repercussions of a supplier insolvency can be substantial. Clients may face additional costs associated with finding replacement suppliers, renegotiating contracts or expediting alternative solutions to mitigate project delays. In addition, clients that do not have the appropriate vesting arrangements in place with their incumbent supplier may be required to pay for materials again if they have not been delivered prior to insolvency. Further retendering of construction work packages may be necessary if a supplier encounters insolvency during the delivery phase of the project.
- Reputational damage: Project delays and complications resulting from supplier insolvency can also impact the reputation of a client. A client may be viewed by the market as not delivering best practice Supply Chain Management.
- Further supply chain disruptions: Supplier insolvencies can create widespread disruptions throughout the entire supply chain. Sub-contractors and other suppliers linked to the insolvent entity may face challenges where creditors are owed, further exacerbating the issues.
Common warning signs of financial distress
There are various leading indicators, both financial and non-financial, that can signal an impending insolvency. It is important that organisations are cognisant of the warning signs, allowing them to take proactive measures before the impact of supplier failure is felt.
- Poor operational performance – A contractor’s poor performance during project delivery may serve as a sign that financial constraints are impacting the quality of delivery. This can manifest in various ways including late deliveries or poor sub-contractor performance, signalling poor payment practices to the supply chain. Further compromises to the quality of materials and/or labour may suggest ‘cost cutting’ by adopting cheaper alternatives, ultimately impacting quality.
- Delayed filing financial accounts – A delay in the filing of financial accounts can indicate a reluctance to disclose a contractor’s financial position, suggesting the possibility of financial difficulty. The delay may suggest that a contractor is facing challenges and is buying time to prepare or mitigate against the impact.
- Debt management – Financial instability can occur from an inability to service debt repayments. High debt to equity ratios may indicate more debt than liquidity and poor credit ratings may be a sign of poor profitability (with an inability to meet repayments). Softer signs experienced through engagement may include upfront or early payment requests.
- Change in engagement with contracting authority – Alterations in a contractor's behaviour, particularly if they previously demonstrated openness to collaborative discussions regarding management insights, may signify apprehension regarding sharing sensitive data that could affect relationships. Similarly, shifts in demeanour, including negative tone, a change in tone, decline in attitude and low morale may indicate heightened pressure and stressful working conditions, which are often associated with organisations facing financial strain.
- Further financial metrics – Financial indicators such as decreasing revenue and low profitability, or even losses, can signal financial strain within an organisation. As these metrics worsen, contractors may encounter challenges in meeting their financial obligations, including covering costs and overhead expenses. Moreover, their ability to secure new projects and retain existing clients could be compromised, exacerbating the financial pressures they face.
- High staff turnover or management restructure – contractors facing financial challenges may witness a downturn in morale, encounter challenging working environments and experience failures within mid-level management, potentially leading to high staff turnover rates across the organisation. Restructuring at the higher management level may signal either cost cutting efforts and/or change in strategic direction to support financial improvements.
In June 2023, the Government Commercial Function released a guidance note outlining key warning signs of financial distress for an organisation. This guidance provides a comprehensive list of financial and non-financial indicators that can be used to assess and better understand potential risks.
A best practice Strategy and Solution: G&T Methodology
The publication of the public and private sector construction playbooks for sourcing and contracting infrastructure works underscores the critical importance of transparency, understanding of supply chain health and capability, and focusing on outcomes that are best for the project. The scale and longevity of major infrastructure and construction works presents a unique opportunity to develop a sustainable, reliable, resilient and robust supply chain for clients. This is achieved through a commitment to transparency, intelligence, innovation, efficiency and collaboration.
Clients must implement preventative controls within their organisation and the supply chains to create an environment and culture which minimises supply chain failures on major projects. By gaining visibility into all tiers of the supply chain, clients can ensure that commercial incentives flow down to contractors who are critical to project success, not just the Tier 1 providers.
The G&T Procurement and Supply Chain Team has developed a comprehensive risk management approach, successfully implemented across a range of public and private sector infrastructure projects in sectors such as Aviation, Roads, Rail, Nuclear, Healthcare & Utilities. The approach encompasses key principles prescribed by the Association for Project Management (APM) on risk and issue management within the project environment and follows best practice outlined in both the public and private sector playbooks.
The steps taken by clients to mitigate supplier insolvencies follow the below:
Map your supply chain - Establishing visibility of the supply chain is essential for identifying pinch points within critical categories of spend, especially where a client has a programme or portfolio of projects to manage. By increasing visibility across the supply chain, clients can bolster resilience, limit the possibility of reactive issue management, and instead adopt a proactive risk management strategy.
Monitor your supply chain - Construction contractors operate in highly volatile markets, where material prices are influenced by both domestic and international factors. Fluctuations in core commodity prices can significantly impact contractor costs, squeezing profit margins. To mitigate these risks, it is crucial to continuously monitor and understand the financial health of your contractors, allowing for early identification of potential issues and better risk management.
Manage your supply chain - It is important to develop good supplier relationships through collaboration, especially when supporting contractors in their delivery and in their recovery if financial difficulties arise. Even well-established contractors can encounter financial challenges in uncertain times, making it essential for clients to understand the implications of their reliance on these contractors.
Conclusion
The risk of insolvency will continue to pose a significant threat to clients in the construction sector. To mitigate this, organisations must adopt a comprehensive supplier risk management strategy that detects early warning signs and encourages collaborative, proactive measures with the supply chain. Enhanced visibility is crucial, as it enables a deep understanding of strategic suppliers across a project or programme. Regular financial monitoring of these suppliers will provide a level of assurance to the client that the supply chain remains resilient and capable of delivering essential work. Moreover, cultivating strategic supplier relationships will foster stronger collaboration, establishing a two-way communication channel, helping both contractors and projects navigate challenging times.
Explore G&T's comprehensive Supply Chain Management services to learn how we can support your organisation. Download our brochure here.
Disclaimer
The content of this article is for informational purposes only and is based on publicly available data and sources. While we make every effort to ensure the accuracy of the information presented, Gardiner and Theobald LLP are not financial analysts, accountants, or legal advisors.
References
Insolvency Service: The Insolvency Service - GOV.UK (www.gov.uk)
Insolvency Graph: https://www.gov.uk/government/statistics/company-insolvency-statistics-july-2024
Corporate Financial Distress: 20230615 Corporate Financial Distress (publishing.service.gov.uk)
Public sector playbook: The Construction Playbook – September 2022 (publishing.service.gov.uk)
Private sector playbook: 5195_Construction_Brochure_SinglePgs.pdf (bethebusiness.com)
Insolvency Articles:
Construction insolvencies up 7% (theconstructionindex.co.uk) (Jan 24)
A dozen construction firms going bust every day | Construction Enquirer News (Jan 24)
Michael J Lonsdale supply chain unlikely to see £65m owed | Construction News (May 24)
Construction worst-hit sector for insolvencies | Construction News (Jun 24)
ARJ owed £12.5m to supply chain at time of collapse | Construction News (Jun 24)
Creditors await outcome of extended Henry administration | Construction News (Jul 24)
Facade specialist goes under after 120 years | Construction News (Jul 24)
Blenheim House applies for administration | Construction News (Jul 24)
Willmott Dixon reports loss after supplier collapse cost £13m | Construction News (Jul 24)
Insolvencies to remain high as sector awaits action, experts warn | Construction News (Jul 24)
London builders merchant goes into administration | Construction Enquirer News (Jul 24)
Beck Interior collapsed owing £38m to trade creditors | Construction Enquirer News (Sep 24)
ISG supply chain facing £700m+ hit | Construction Enquirer News (Sep 24)
Cladding panel maker does down | Construction Enquirer News (Sep 24)
