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Why the lowest price isn't sustainable

15 October 2019

Lowest-price tendering is having serious consequences for the construction industry, according to the Institute of Chartered Accountants in England and Wales. Phil Joyce of The Orange Partnership explains.

Why the lowest price isn't sustainable
The stereotype of the hard hat-wearing construction worker needs to be replaced with the image of the architect. Image credit: Daniel McCullough/Unsplash

The Institute of Chartered Accountants in England and Wales (ICAEW) warned in its Audit Insight report into construction earlier this year that the ‘race to the bottom’ in construction contracting could lead to more major firms collapsing. It will also damage their supply chains, forcing more smaller firms out of business.

In preparing its report, ICAEW collaborated with auditors with many years of experience of independently examining and auditing construction firms. These included KPMG, PwC, EY, Deloitte and The Orange Partnership.

The construction sector is a key driver of growth for the UK economy, but it is a fragile one with low margins and high risks.

When construction companies and clients get it right − through project selection based on their ability to deliver, responsible tendering, diligent monitoring, and a proactive attitude to deal with issues such as cost and timetable overruns – they create contracts that are more profitable and provide more enduring value.

The report examines four key areas that need to be addressed by construction firms if they are to run sound, well-managed businesses.

Bidding for lasting value

If construction businesses want to generate sustainable profits, they need to get the price right at the tendering stage.

Some companies have become better at pricing their services realistically to reflect their true cost. But we are also seeing businesses bidding at too low a price for large complex contracts in the expectation that they will improve their profit margins because some aspect of the project will change.

This is a risky strategy as unforeseen changes can quickly turn small profits into losses, and make it difficult to return to profitability.

Delivering for success

In construction it is especially important that financial rigour is applied to key estimates and judgements throughout a project’s life cycle.

Competition is so fierce and margins so thin that reliable financial information and analysis can determine a project’s success. One way to achieve this objective is to form strong delivery teams where project managers work closely with finance and commercial teams. We do not see enough evidence of this in practice and urge firms to remedy any lack of collaboration.

Increasing transparency

The UK construction sector continues to suffer from a reputation that it lacks enough transparency, particularly on cost and performance.

In many cases, poor or unexpected results are caused by a lack of internal transparency.

Executive management and boards need to ensure the tone from the top encourages and supports employees early reporting when problems occur. Without early reporting, projects are less likely to remain on track and management may be unaware of a problem until it becomes significant.

Getting fit for the future

The highly fragmented nature of the sector and lack of training and innovation has been contributing to low productivity. Government can help to build confidence in the construction sector by showing more ambition and urgency in facilitating a committing to a reliable pipeline of major infrastructure projects with guaranteed timings.

Businesses need to form partnerships with their local schools, colleges and universities to educate young men and women about the wide range of career opportunities available, creating a pipeline of future young talent.The stereotype of the hard hat-wearing construction worker needs to be retired and replaced with the image of the planner, architect, surveyor, engineer and skilled trades person.

This article is based on the authors’ briefing article in the latest issue (172 CE4) of the ICE Civil Engineering journal.

  • Phil Joyce, Director, We Are OKO