Why New Zealand's Building Boom Is Producing So Many Company Failures

New Zealand's construction sector, has a string of serious issues that bedevil the industry.

These problems are not just confined to the major construction companies themselves. They are having a seriously detrimental impact on the fabric of trade suppliers and sub-contractors that bind the industry together.

Underpinned by Auckland and Canterbury’s buoyant growth builders should be comfortable. So, why are increasing numbers of construction companies collapsing and going into receivership, declaring insolvency or being faced with the prospect of liquidation?

A Grim Roll Call

While some firms continue to struggle dealing with leaky building and council compliance regimes, much of this problem can also be sheeted home to New Zealand construction firm’s apparent willingness to take on too much risk despite operating on wafer-thin profit margins. This often places their very survival in the balance.

Just look at the unenviable roll call of deceased construction firms from last year, when over 100 construction-related firms have failed in Christchurch since the February 2011 quakes. Collectively, these failures have squandered $35 million.

Ebert Construction went into receivership, Mainzeal collapsed, Orange-H Group entered receivership, Tribeca, and Valiant homes are no more, while Fletchers suffered $800m in losses on 16 large construction projects.

Auckland liquidation notices make for grim reading these days.

Much of this turbulence comes from the industry’s desperate desire to outsource the risk associated with major construction projects, leaving New Zealand’s commercial construction firms balancing large amounts of risk.

This is a game of pass the parcel, where no one wants to be left holding the parcel when the music stops.

Risky Business

A significant amount of this commercial carnage stems from the companies own shortsighted behaviour. Some firms tender in the hope they will get away with screwing their price down to win the work. They submit a bid and simply cross their fingers they will be able to progress the project without incurring any cost escalations either in materials or labour or timing.

At its heart, the New Zealand construction industry as a whole needs a fundamental change in its approach to bidding and operating. If the head contractor incurs a price rise, they simply pass it down the chain, amplifying the impact across a network of subcontractors and trade suppliers.

The industry trend has been toward a growing number of parties and levels in the construction chain and often each of the parties in the chain working on a fixed price. The lead contractor is often not building, but is relying on subbies and outsiders to do the work. In that structure the higher you up the chain the more likely you are to be managing/administering and not building.

And for each level or party in the chain there are additional costs to be covered and also a margin that they charge, (which those further up the chain sometimes also charge a margin on), and that ultimately means a total build cost that is higher than it would be if, for example, a lead contractor was also the single builder achieving its margin.

Plus while that provides some cost certainty for those further up the chain it leaves everyone exposed to the impact and costs of time delays, and unbudgeted events, such as consenting events and finance constraints.

Many of these subcontractors are insufficiently capitalised to cope with cost blowouts. The ripple effect is enormous. Trade suppliers and labourers bear a huge risk.

How risk is allocated on a project is creating a very real a problem not just for a project team but for the wider construction industry as a whole. It’s an industry-wide issue that is yet to be successfully dealt with.

Busy Work Syndrome

Construction firms often find winning work straightforward. What is substantially trickier is to make project work for them financially.

Winning is simple. You cut your (or others) margin to the bone. But once they have a project they have to make it pay. Some construction companies are believed to run certain projects on 0 per cent projected profit margins.

Four to five per cent is a prevailing industry norm when 7 or 8 per cent is the target margin for firms to enjoy long-term viability.

This strategy is designed to maintain each firm’s internal capacity. They understandably want to ensure they have a continual flow of work flowing through their pipeline so they can keep their staff employed.

However, they aren’t sure when these projects are going to come on-stream. If a firm wins too much work then human and financial resources become critically stretched. When work comes on stream site managers become overloaded, more administratively focused and less functional.

We have seen instances where key staff like project managers have had 10 to 15 sites to manage when in the past they may have one or two. Quality, efficiency and cost control suffers. Losses arise.

The passing of risk and responsibility down to sub-contractors and below means that site managers have less control, are less effective as the subcontractor possibly takes short cuts, quality suffers, and where these acts are picked up everyone faces rework delays which are uneconomic and unproductive.

This puts tremendous strain on everyone. That can’t be good for the industry.

Short-Term Cost Focus

Studies identified the top three issues confronting construction companies during the current procurement phase were:

1. Clients focus on lowest price (81 per cent)
2. Cut-price bidding by contractors (76 per cent), and
3. Lack of visibility around the potential pipeline of future work (75 per cent).

With a recent Government Policy Statement on Land Transport promising record levels of proposed infrastructure public investment, a greater focus on whole-of-life value for projects is required to deliver a sustainable construction industry and overcome its cultural malaise.

A fragmented multi-layer structure, stretched administrative and project management, declining quality and thin margins result in substantially greater risk for both the public and the construction sector. Obsessively cutting costs inevitably leads to poorer-quality infrastructure.

Moreover, if contractors are continually subjected to a series of bidding wars centred on cost rather than quality outcomes, this will destabilise the broader New Zealand construction industry, which is already operating on chronically scant margins.

Government infrastructure programs are conceived to deliver value for successive generations of New Zealanders. Adopting a lowest-cost provider strategy for these projects simply leads to higher maintenance and remediation costs downstream.

Greater Government Transparency Required

With the construction industry generating 7 per cent of New Zealand’s GDP in 2017, it is little wonder Prime Minister Jacinda Ardern’s government is looking to mitigate some of the issues plaguing the industry.

The current problems affecting the construction industry are not unique to New Zealand. A lack of transparency around the scale and timing of central and local government development plans, a chronic skills shortage, poor-quality builds and an epidemic of construction company collapses are all concerning.

The Prime Minister Jacinda Ardern, together with Peter Reidy, Fletcher's Construction chief executive ,and other notable industry players unveiled their Construction Sector Accord a new joint strategy designed to combat these structural issues.

According to Ardern the Construction Sector Accord will improve the construction sector's culture and reputation, bolster its workforce and deliver safer, more durable and affordable infrastructure buildings and homes.

The Construction Sector Accord acknowledges that past construction industry clients and Government decision-making behaviours have spawned systemic problems that negatively impacted the New Zealand economy and the wellbeing of New Zealanders.

Final Observation

Construction company failures do nothing to enhance the industry or the economy. In a construction boom, it's hard to recruit subcontractors and taking on too much work can produce a flow-on effect, which can quickly snowball.

Taking on risk is fine provided it is priced into your final bid. Failing to price risks correctly is foolish and exposes the firm and the wider industry to greater volatility and that is bad news for the industry as a whole, for employees, subcontractors and ultimately clients and the broader public. Everyone loses.

Stage 1 of the The Construction Sector Accord is a welcome development as it recognises much of the above. Stage 2 is tasked with how those goals will be delivered. In the meantime we have observed that sometimes it is better to be less busy but be paid, rather than be very busy and not end up paid. So we encourage all participants to do their due diligence on the human and financial capabilities of the people and organisations they are considering doing business with, so they are making informed decisions based on where the risks lie.

 

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