Building sustainability into construction and infrastructure01.06.23
The construction industry is crucial to the Australian economy, responsible for delivering the diverse infrastructure which lays the foundations for our communities.
A recent report by the Australian Constructors Association (ACA) found the industry directly contributes approximately $150 billion in value to the economy annually while creating a further $300 billion in value throughout the construction supply chain.
However, it also has an insolvency rate well above the rest of the economy, with businesses entering administration at a rate more than twice that of other industries. Perhaps one of the most concerning datapoints is from credit rating agency Equifax, which revealed more than half of all large builders are now carrying current liabilities which exceed current assets — the technical definition of insolvency.
The good news is there are several ways we can strengthen the sustainability of one of the largest and most important sectors of our national economy and improve our productivity to deliver the infrastructure required for our nation to prosper.
These include the equitable sharing of risk and improving liquidity to unlock investment in innovation to enable faster, safer and more efficient construction.
Fair and shared allocation of risk
Using early contractor involvement (ECI) during procurement and promoting collaborative behaviours are some examples of how we can achieve better project outcomes through fair and shared allocation of risk. This can help drive the parties towards better project and value for money outcomes.
In July 2022, the ACA released a report titled: Construction Cost Inflation: Ways to Address an Escalating Issue. Laing O’Rourke contributed to this report, which outlines some of the challenges and practical solutions to address the current risks fairly for all parties.
The report found greater collaboration between clients, contractors and the supply chain will ensure risk is assigned to the party most capable of controlling, quantifying and managing that risk. This is not possible without open, honest conversations and forums between all parties.
Investing in innovation
By improving liquidity and profitability within the construction industry, we also pave the way to allow greater investment in innovation for the future, improving productivity significantly.
Redefining value for money
This investment starts with the definition of ‘value for money’. To deliver on industry commitments and support sustainable outcomes, value for money considerations should adapt to current conditions and avoid the mentality of lowest price necessarily equalling best value for money.
In November 2022, the Construction Industry Leadership Forum released a Practice Note on Assessing Value for Money in Procurement. Laing O’Rourke, through the ACA, contributed to this practice note, which proposes a standard definition of value for money: “Value for money is an assessment of outcomes that weighs the cost of procuring infrastructure against the value it provides. In doing so, it balances the whole of life costs against a range of outcomes, including the suitability and quality of infrastructure, financial benefits, risk exposure, timeliness of outcomes and social, environmental and industry outcomes.”
Few other industries are expected to finance such large amounts of work undertaken on behalf of a third party in the way the construction industry does.
Improving the liquidity of the sector through advance payment arrangements assists with site mobilisation costs and the early ordering and storage of price sensitive materials. It also frees up capital which can be invested into research, development, and new technologies to improve productivity.
Liquidity can also be influenced by frequency and timely payments throughout the whole supply chain.
Poor cashflow is largely fuelled by the industry norm of paying contractors progressively following completion of certain work or milestones. This requires contractors to hold excess liquidity in the form of cash or bank facilities to manage large working capital. This detracts from the financial stability of the industry and stifles the ability to invest in innovation technology and growth.
Instead, we must move towards more frequent payment terms which allow head contractors to meet their payment responsibilities to the supply chain, improve business cashflow and minimise the financial burden on head contractors.
Improving cashflow on projects would result in micro and macroeconomic benefits to the industry.
Additionally, the excessive requirements for bonding and the tight capacity within the surety market is restricting the ability of some contractors to obtain bonding, requiring them to provide cash collateral or resulting in cash retentions from contractor claim.
For better industry and project outcomes, we recommend removing or reducing the requirement for bonding, particularly where a Parent Company Guarantee is required.
Cost reimbursable contracts, where the overall profit margin is linked to the project outcome, drives better value for money outcomes. On the other hand, fixed price contracts tend to lead to contractors having to price in unnecessary risk or not pricing it correctly.
Incentivising cost savings and providing other performance incentives encourages better contractor performance and client outcomes. We have seen this not only when incentivising program or quality, but across social inclusion, gender, and Indigenous participation. Incentivising innovation and providing contractors with opportunity to test new ideas in live environments would no doubt drive productivity forward and yield positive results for government, contractors, and community alike.
A profitable construction industry is in everyone’s interests. By adopting fair and shared risk allocation, improving liquidity, incentivisation and improving value for money considerations, we can strengthen the long-term sustainability of the industry.
Annabel Crookes is the Director - Legal, Risk and Delivery for Laing O'Rourke in Australia and the President of the Australian Constructors Association.