Cool heads and pragmatic procurement
Painful and problematic though it was, the tender price inflation of 2021 was primarily a side effect of UK construction’s rapid post-lockdown expansion.
By contrast 2022’s potential for a sustained, second wave of tender price inflation will not be so easily dismissed as a speed bump on the road to recovery.
In fact, there is a danger it may undermine the recovery entirely. If tender prices continue to rise rapidly, there could come a tipping point at which early-stage projects are put on ice and clients postpone their capital investment decisions in larger numbers than they are presently doing. Rising interest rates may also contribute to cash flow availability and restrict capital flows, impairing investment decisions.
While such caution may be understandable, at scale, it could put the brakes on construction output growth. It may even push the sector back into contraction territory and reverse the impressive post-lockdown recovery.
This is a time for cool heads, pragmatic procurement and a programmatic approach to capital investment that simultaneously addresses the multiple, overlapping challenges the industry faces. There are five areas to focus on:
1. Get the basics right from the start
The current ‘pressure cooker’ environment, in which cost pressures are rising, and contractors are both busy with existing projects and invitations to tender, should not be allowed to erode procurement best practice.
In normal times, tenders typically remain open for 90 days to give qualified contractors time to submit considered and thoroughly costed bids. However, that period is now being rushed and compressed to just a few weeks due to fluctuating market conditions as contracts are signed before prices rise further.
Contracting at the wrong price doesn’t help anyone in the long run. Rushing into contracts is the last thing procurement teams should be doing – instead they must take the time to eliminate any ambiguity prior to agreement, ensuring that contracts are thoroughly road-tested, and include systematic assurance mechanisms and provision for regular performance audits.
2. Be pragmatic about project risk
In the face of elevated cost volatility and potential disruption to the supply of materials, many clients instinctively request fixed price contracts that transfer significant risk onto their supply chain.
Ironically, by seeking to place the two primary project risks – cost and delay – onto their suppliers’ shoulders, clients will incur several less obvious risks.
The first is that they may struggle to attract a suitable contractor at all. Tendering conditions are hot, increasing selective tendering practises, and contractors might not bid for contracts they feel come with too high a risk burden.
Those contractors who do bid low on ‘unfavourable’ contracts may be more likely to have financial skeletons in the closet, and thus at higher risk of insolvency.
Finally, contractor bids for fixed price contracts will be risk adjusted – i.e. significantly more expensive – and thus may be poor value for the client.
In the current climate, fixed price contracts may represent a ‘lose, lose’ deal for both parties. A transition to ‘win, win’ is needed and careful consideration of the commercial model is required to maximise value.
A balanced approach could be for suppliers – who are most closely connected to logistics chains – to shoulder the delay risk, with the client factoring higher levels of cost contingency into its cost planning.
Alternative forms of procurement and contracts should be explored, which apportion risk fairly and incentivise suppliers to maximise value, rather than hit target costs.
3. Map, and mitigate, supply risk
Whilst the UK isn’t reliant upon Russia and Ukraine for many construction materials and components, there is significant indirect exposure and contagion on some key items. With supply of vital products now compromised, there is a growing risk of shortages and lengthening lead times.
As sanctions on Russia ripple through the global supply chain of both raw materials and construction components, clients need to understand which parts of their critical path will be most impacted.
The best way to identify the pinch points is by creating a detailed supply chain map, which will identify any supplier fragility and pinpoint the components which are in high demand from a limited pool of suppliers. This will then enable the project team to secure alternative sources of supply in a timely fashion.
Clients could also consider their packaging strategy and identify any components likely to be at risk of significant price fluctuations and buy those items early. Long lead items can also be procured earlier, and designs amended, to alleviate the need for components where there are significant shortages.
When procuring materials from new and unfamiliar regions, care should be taken to ensure quality and lead times are comparable to those offered by regular suppliers.
The procurement process therefore needs to engage with alternative suppliers early on, testing their resilience upfront and then confirming their ability to deliver consistently through ongoing checks. This early supply chain engagement should not just be at tier one level, but all the way thorough the supply chain to better understand risk positions.
4. Beware of bubbles – advance purchase astutely
Conventional wisdom has it that when material prices are rising rapidly and there’s a danger of supply interruptions, purchasing in advance and stockpiling brings certainty.
Less talked about is the danger that advance purchasing can be self-defeating if it fuels an inflationary cycle and needlessly triggers shortages. – as happened when consumers panic-bought at the start of the UK’s first lockdown.
Advance purchasing is an effective way to manage risk, but it must be used strategically. Arguably it can offer a better hedge against supply shortages than against rising prices, but the distinction is moot as the two risks often intersect.
Either way, in the current context, advance purchasing steel – and metal-based products such as curtain walling and cladding – makes sense because output from two major sources of steel supply, Russia and Ukraine, has been interrupted.
By contrast indiscriminate stockpiling isn’t just expensive – space needs to be found to store all those materials – it also risks creating the kind of inflationary bubbles and limited supplies it seeks to protect against.
5. Plan for the long-term
The fallout from Russia’s invasion of Ukraine may continue long after hostilities end, in the form of shifting geopolitics and a world less open to frictionless international trade.
It is therefore vital for clients to have 360-degree visibility of their supply chain and to build a lasting, strong relationship with it too.
This is an area where large, global real estate teams and large infrastructure programmes have a substantial advantage by virtue of their buying power and programmatic approach. These teams should leverage both to secure long-term deals that offer both competitive pricing and supply certainty.
Procurement teams who lack these inherent advantages can achieve a similar effect through framework agreements, which can secure better costs and allow for greater planning to mitigate risks.
In all cases, it’s important to achieve a balance between building deep relationships with trusted partners who work collaboratively to manage disruptions and becoming over-reliant on individual suppliers.
Clients that diversify and expand their supply chains, while also continuing to work closely with long-term suppliers, can maximise their chances of building an enduringly resilient value chain.
© 2022 Turner & Townsend