Sector - Finance & Legislation
How construction companies can mitigate the risks posed by economic instability
In challenging times, the companies most likely to prosper are those which understand the market in which they operate and the challenges which they face and those which take proactive steps to mitigate the pressures they find themselves under.
Whilst the economic forecast has improved since H2 2022 and a recession on the scale of 2008/9 looks increasingly unlikely, these are, without doubt, difficult times for the industry, particularly in such proximity to the Covid-19 pandemic. Louise Elmes, construction partner at Keystone Law, explore the challenges and opportunities for businesses.
Challenges facing the construction industry
The challenges the industry is facing are wide-ranging. These challenges include those in general – a predicted recession, increased borrowing costs and a slowing housing market – and those particular to the industry itself:
- increases in the price of materials (particularly energy, steel and timber), labour and imports, resulting in supply chain pressures and shortages of materials and labour;
- increases in the cost of fuel, resulting in the increased cost of operating fuel dependent plant and transporting materials and labour to site;
- greater difficulty in obtaining funding for projects, particularly in relation to projects which are high in value, complex or which have a long build time, and increased costs of doing so; and,
- coverage issues, particularly in securing coverage, given a perceived increased risk profile as a result of price inflation. Contractors may also find themselves underinsured as a result of price inflation where coverage is linked to the estimated contract price, for example in all risk policies.
Taken together, these challenges result in a narrowing of competition in the market and a landscape with a greater risk of insolvency.
What steps can parties take to mitigate the challenges?
These challenges impact on current and future projects. In both circumstances, the parties should be looking to manage the risks of price inflation over the lifetime of the project in a manner that is fair and proportionate to all parties involved.
In respect of current projects, it is important to carry out a comprehensive risk analysis of the life of the project. This risk profile will aid in identifying the particular challenges the parties face – including the forecast recession, continued high borrowing costs and the predicted ongoing fall in the housing and wider property markets – and will assist the parties in setting a collaborative path. Where companies may, in better times, have taken a ‘chance’ on a particular project, now is not the time to do so. The next step is to consider the terms of the relevant contracts. If the contract contains fluctuation provisions, the parties should ensure that these provisions are operated properly and fully. If the contract does not contain fluctuation provisions and price inflation is having a detrimental effect on the project, the parties should manage the challenges proactively and collaboratively. These steps will include mitigating price increases and supply problems and considering whether it is prudent to reach a deal to re-allocate the risk of price inflation in whole or in part to a party better placed to absorb the additional or increased cost.
In respect of future projects, there are several steps which will hold parties in good stead:
- carrying out an early and comprehensive risk assessment;
- carrying out early and comprehensive financial planning, including funding and insurance (including in respect of the monetisation of contingent assets) and economic forecasts;
- planning for early and comprehensive set-up of the project, paying particular attention to the forms of contract, the design and coordination of the project and the methods of construction;
- planning for the early sourcing of materials and payment thereof; and,
- thorough consideration of the allocation of risk of price fluctuations. The allocation of risk of price fluctuations can be achieved by several methods and it is imperative to select the method most appropriate for the particular project and the particular challenges that project is likely to face.
Whilst the challenges facing the already struggling sector are significant and widely felt, any party to a construction project would be wise to take proactive steps to mitigate the challenges faced by focusing on prudent risk and financial management of both current and future projects: if the risk of a particular project is fully understood and planned for, the project is likely to be a success.
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