Opinion: Construction industry woes – when competition turns bad?

The collapse of Ebert Construction has come close on the heels of the much-publicised troubles of Fletcher Construction, and there are rumours of more collapses on the way. Receiverships like Ebert also have a domino effect on their many sub-contractors, who in some ways bear the ultimate cost. Expect sub-contractors to strike financial difficulties as well. And of course, it is ultimately the client who is hung out to dry with nothing to show for their investment.

The conundrum is how this can be when the construction business is going through boom times with promises of a lot more construction work to come, eg from the Government’s Kiwi build programme.

There are a number of factors at play here but I think some key factors are that:

• The construction business is very competitive so that margins typically get squeezed in order to get work. This impact is made worse by fringe players who lack competence and are unrealistic about costs and thus margins.
• The construction business is basically about creating infrastructure and the need for infrastructure work is notoriously unreliable and cyclical, so there is pressure on construction companies to keep the order books as full as possible, even if this means cutting margins.
• The construction business is very integrated involving developers, contractors, sub-contractors and regulators in complex arrangements, so there are multiple points at which the process can break down.

The situation has not been helped by the continuing escalation in the cost of materials and the lack of construction workers, but in principle, it should be possible to take factors like this into account when bidding for work and writing contracts.

In theory competition in the market should sort issues like this out, but sometimes competition can have the opposite effect. If companies become too desperate for work and cut their margins too thin, they not only set the scene for their own demise but deny work to other companies who may have more realistic margins. The result can be a domino effect which catches the good with the bad. So simply leaving it to the market to sort it out is potentially a recipe for disaster.

So, what can be done to get a done to get a better functioning construction sector? I think a number of factors need to be looked at, ie there is not one magic bullet which will solve all the problems. First and foremost the construction sector should sort itself out, even if it means less work for some because of more realistic margins. However, that will be hard going as it will probably mean loss of work to less scrupulous contractors and a limited ability to grow – at least for a while. However, the end game has to be companies left in the business who have a reputation for performing or producing good quality work and on budget.

However, there is an equal responsibility on clients or developers who contract the work. Clients need to be more sensitive to the overall qualities of bids and not automatically go for the lowest bid. In retrospect, for example, it is hard to believe that Ebert succeeded in winning contracts when it turns out to have had a murky history. Examples abound of work going to companies with dubious records and histories. Clients need to be more thorough in carrying out due diligence on bidders and have a mindset of going for the best bid, not necessarily the cheapest. There is also scope for pre-qualifying acceptable bidders through a rigorous due diligence process.

Contracts also need to be realistic so that the cost implications of factors outside of the control of the contractors are shared rather than dumped on the contractor (and then on subcontractors).

I don’t think more regulation is part of the answer. We already have regulations and it arguably causes problems of its own as well as increasing timelines and costs.

The Government has a key role to play in all of this – not as a regulator but as a developer. If Government started getting more selective and demanding, this would have a significant roll-on effect on the industry given the huge significance of the Government’s building programme. Doing so would create stresses because higher standards would undoubtedly slow the building programme down – at least for a while – which would further cripple the Government’s target of 10,000 new houses in 10 years. However, I believe this is a responsibility that the Government should accept and in which it needs to show leadership.

By Bas Walker

This is another of Bas Walker’s posts on GrownUps.  Please look out for his articles, containing his Beachside Ponderings.