07.03.2016

Procurement in the current market

Procurement in the current market

Clients, particularly those in the overheated London market, are telling us how viabilities are becoming more difficult in the face of spiralling construction costs.

Projects are frequently delayed as attempts are made to bring reluctant contractors’ prices down. There are instances where projects are put on hold or cancelled or procurement takes significantly longer than intended. Recent construction economic studies report pre-tender estimates from quantity surveyors have been up to 10% below actual construction outturn costs. This is particularly apparent in London where construction inflation of 15-20% has been apparent, three times higher than predicted.

Times are now very different to those experienced during the recession, when both contractors and sub-contractors were prepared to secure work at very low overheads and profit margins just to survive. In economic terms, the upturn in demand for services has exceeded the available supply, with the most extreme price rises being driven by short-term lack of capacity. The skills shortage has been driven by several factors, not least the failure to replace the thousands of workers who left the industry during the downturn.

While it is still possible to obtain competitive tender returns outisde of London, the capital’s market has seen contractors unable to meet the rising demand, resulting in a selective response to tender invitations and an unwillingness to take on risk.

There’s currently enough work out there for subcontractors and suppliers to be selective of their workloads going forward. The lack of capacity has seen contractors unwilling to bid without far higher preliminaries, profit margin, inflation and risk premiums than had been anticipated. It is now a regular occurrence for contractors to turn down tender opportunities, particularly if they involve single stage tendering, incomplete design information or significant risks.

There is a growing shift away from single stage tenders towards more risk averse two-stage tendering. Some commentaries hint because of the risk transfer process, there may be a re-emergence of Management Contracting arrangements. Consultants are advising clients to engage with contractors and the supply chain early and work hard to make projects as attractive as possible to contractors. This means not only a two-stage procurement process, but negotiated contracts, improved quality of information to bidders, and a reassessment of how much risk it will be possible to transfer.

However, very commonly price increases are emerging at the second stage of a two-stage tender process, when prices come back from trade bidders. For quantity surveyors and clients, this often means committing to a protracted period of negotiation and market engagement in an attempt to bring prices down. Value is being found where the tender is set up correctly. Without a long period of market engagement prior to bid, a client could be left with a financially unviable scheme.

However, there is also a danger in tryng to tie down any price too early, with contractors increasingly pricing-in huge inflationary risk premiums, given the experience of the last year. The timing of procurement is the important factor. For those projects already half way through procurement, it is too late for these approaches.

If there’s bad news on a project, it needs to be delivered early so an action plan to mitigate can be formulated and the whole team focused on the solutions. There is no doubt tender price growth in the market has exceeded everyone’s expectations, with some of this down to contractors and specialists seeing an opportunity to exploit a temporary advantage. Moving forward, we have to become more flexible when allowing for inflation in contracts and devise more innovative methods of managing it, including more open book accounting. This includes understanding main contractor attitudes to sub-contractors and more collaboration with supply chains.

For more information, please contact, Dale Arden, on 01689 888 222 or darden@calfordseaden.com