Construction leaders must collaborate to avoid financial failure

Construction leaders must collaborate to avoid financial failure
Time to evolve: Construction outfits must improve their business practices to avoid failure
Published: 3 February 2018 - 5:52 a.m.
By: CW Guest Columnist

Predatory pricing is another challenge to look out for. In a business where contractors often operate on single-digit margins, one would not expect to see double-digit variances in tender prices from competing construction firms. This is often the case, however, and in extreme cases, the lowest bidder has been 20-30% below the competition.

While some great progress has been made through value engineering and construction efficiency, such variances are often either symptomatic of the contractor having mispriced the project – meaning that they will struggle to deliver to the required quality and programme as they attempt to mitigate losses as construction progresses – or it could mean that the contractor has deliberately priced very low to secure the project and boost their reported order book, or to receive the mobilisation cash advance to satisfy creditors that may be knocking on their door.

These actions in competitive tendering have resulted in predatory pricing, where all too often on construction tenders, there is at least one firm submitting a price at a negative margin, which in turn drags prices down throughout the sector.

This practice is not isolated to the main contractor either – it cascades through to sub-contractors, and is also evident in the consultancy sector. This has created a sort of race to the bottom for the industry, and needs to be addressed, otherwise we will continue to see projects – as well as the firms delivering those projects – fail.

Moreover, it is common place for clients to assign a main contractor or consultant the liability for the full extent of the design or construction of a project. Essentially, the client assigns risk to the party best equipped to manage that risk. In turn, to protect their liability, the main contractor or consultant will seek to make their sub-contractors and sub-trades legally responsible to the full extent for their elements of work, which is perfectly reasonable.

The issue arises, however, in the application of back-to-back clauses to payments – also referred to as ‘pay when paid’ – whereby the main contractor is not liable to pay sub-contractors until they are in turn paid by the employer. While main contractors have a need to manage the risk of non-payment or delayed payment by the employer, such clauses can often result in significant challenges for the supply chain and, in turn, the project.

The risk of non-payment is borne by the entire supply chain, despite the majority of the supply chain not being in a contractual position to manage that risk.

Take, for instance, a drywall contractor. It will be responsible for only a small portion of the project, but is exposed to the full risk associated with the main contractor not being paid, which may be as a result of failures of other parties in the project and have nothing to do with the unfortunate drywall contractor’s own actions.

This has created a contractual risk arrangement, whereby parties that may be responsible for less than 1% of the project scope will take on the payment liability for the entirety of the project. Not only is this arrangement somewhat inequitable, but it also demotivates the better performing sub-contractors, as they see their payments being withheld for matters outside their control.

Additionally, less scrupulous contractors have been found to use the guise and lack of transparency associated with back-to-back payment clauses to manage their own cash flow by not paying sub-contractors, or making only partial payments, even though they have been paid in full.

Back-to-back payment clauses have directly resulted in a number of very good sub-contractors in the Middle East market going out of business, which, in turn, impacts the market and the ability to deliver innovation and quality.

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