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The 2019 BDO Construction Survey has found that the industry remains concerned about staff issues, bureaucracy and future workflow

‘Marginally better’ – but still a race to the bottom – By James MacQueen

The 2019 BDO Construction Survey is complete and the resultant report identifies some positive developments and concerning trends.

Positive trends include an improvement in gross profit margins. The 2018 survey showed that 54% of head contractors were missing out on winning projects at margins 6% and below which is not sustainable for those companies. Those winning projects at those low margin levels have now dropped to 35% of companies, which is still too many. For them, the race to the bottom seems to be continuing. The proportion achieving margins over 8% has increased from 28% to 42%.

The improvement has flowed through to subcontractors too, with those earning a margin below 20% reducing from 78% to 53%. This trend is reassuring from the perspective of survival of the sub-trades, as one of the greatest challenges for everyone is the availability of companies and people to do the physical work. The improved margins should help everyone stay in business, but some will not survive and may take other casualties with them.

Significant constraints

Unsurprisingly, managing cashflow is becoming a greater challenge for a third of the sector. Bank performance bond security and the retentions regime are tying up additional cash resources that the industry needs. One in five found getting paid on time was a big issue for them. Margins are insufficient to quickly resolve these challenges.

Encouragingly, only 7% ‘prefer not to confirm’ they are complying with the retentions regime compared to 28% last year, but of those few that actually inspect that their retentions are being held in trust, nearly a half found instances of non-compliance.

As expected, the ability to provide performance bonds is a significant constraint to growth, with only 53% of those that provide bonds having capacity to issue new bonds before existing bonds are released. This and other factors are separating the industry into two segments: the good operators with robust businesses, and those that are fragile and susceptible to failure through bonding, cash, resources and other significant constraints.

Risk management

Arising from the recent high-profile collapses, we asked questions around what businesses are doing to protect themselves from those risks. Most respondents said that these insolvencies have had a noticeable effect on their businesses and the way they run them. A number of the actions being taken to protect businesses from these risks are outlined in the BDO Construction Survey 2019 report.

In the context of the Mainzeal case against the directors, we asked several questions around directors’ and officers’ insurance. Whilst that insurance has become more expensive and more difficult to obtain, many are uninsured and even more likely under-insured. Given the more litigious path New Zealand is going down and increasing legal costs, consideration should be given to reviewing these policies and increasing the limits.

One of the findings of the Mainzeal case was that the directors continued trading in an insolvent state for much longer than they should have. The lesson for directors of distressed or struggling businesses is the importance of taking appropriate financial and legal advice and acting on that advice appropriately.

Sustainability and succession planning

With more focus on sustainability, we asked questions focused on that and found an overwhelming response that clients wanted it but were not prepared to pay for it. It is a misunderstood concept as there is still huge inefficiency in the sector, and seriously addressing inefficiency will have a massive impact on sustainability.

Succession planning remains a huge risk to industry participants. Only half of those surveyed that were over 50 had made progress on a succession or exit plan. All those in that age group know people who have had a serious medical diagnosis. Not only does a good succession plan allow for an orderly exit from the business with a cheque, but it can avoid the stress of a spouse suddenly having responsibility for a business when they have neither the time nor expertise to run it. Good succession plans take time and they are a journey rather than an event. The BDO construction team have a lot of experience in developing and implementing succession and exit plans in the construction sector.

Accurate reporting and forward planning

We remain concerned that 43% of survey respondents find their management reporting to be limited or lacking. Given the pressures on margins and cashflow, accurate reporting is a fundamental prerequisite to a sound business. Our experience with new clients reflects a similar issue, and we spend a lot of time correcting incorrect accounting and setting up systems so that margins are properly measured and understood.

There are mixed messages in relation to forward work. While the industry as a whole is forecast to continue to grow, our analysis indicates that overall there is less forward work than a year ago. It seems to be feast or famine, with the South Island showing greater signs of weakness.

Whilst there has always been a bit of try-on and push-back with responsibility for risk and costs of variations and extras, for the first time the survey asked questions around the frequency and cost of unreasonable disputes and the cost of unreasonable transfer of contractual risk. For those unfamiliar with big claims, the results are alarming.

Lowest cost

The sector as a whole continues to grow, and forecasts of future projects support the opportunity for further growth. However, in addition to the issues identified above, there are other significant industry-wide challenges, with respondents particularly concerned about staff issues, bureaucracy, the economy and future workflow.

At many levels and ways there is still too much pressure on lowest cost, irrespective of the consequences. It is apparent that more people now realise the folly of this, but there always seems to be someone desperate enough to go lower than is sensible and take risks others avoid in the mistaken belief they can stay in business indefinitely.

James MacQueen is an advisory partner and the national leader of construction and real estate for BDO New Zealand; to read the 2019 BDO Construction Survey Report, visit bdo.nz/2019constructionresults

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