With construction industry output forecast to decline in the first three quarters of the year and supply chain the leading cause of turmoil, the outlook is at best bumpy. Neil Fleming UK underwriting manager, Construction & Engineering, QBE examines the risk horizon, and charts a course through the disruption ahead.
This is is a time of great innovation and opportunity in the UK construction sector. The global construction industry is forecast to grow 70 per cent by 2025, while the UK’s target to reduce emissions to 20 per cent of 1990 levels by 2050 is creating huge opportunities for companies that design and build greener buildings and structures.
However, the sector is not without its challenges. With uncertainty in the aftermath of Brexit, a growing skills shortage and quality control climbing the agenda, construction firms need to ensure that they are monitoring and actively managing their risks. The outlook for the industry will be as bumpy as 2022, with output forecast to decline in the first three quarters of the year.
Supply chain disruption is the leading cause of anticipated mid-air turbulence. Geopolitics and domestic developments far from the UK will continue to affect access to materials and their price.The reopening of China’s economy following the end of the zero Covid strategy and the ongoing conflict in Ukraine are two key international drivers of potential disruption. The post-Brexit realignment of UK-EU relations appears to be largely heading in a positive direction, but that could quickly change if the issue of Northern Ireland’s customs status is not resolved.
Meanwhile, domestically, demand for the work of the construction sector – particularly in relation to large infrastructure projects, but also smaller projects and homebuilding – remains affected by political vacillating and high demands on public spending. Although elections are unlikely before 2024, 2023 is the year in which the government and opposition will essentially go into campaign mode. Expect big promises on investment in building infrastructure to “level up” the country, which create potential opportunities in the coming years.
Since the first pandemic lockdown, a shortage of material inputs has been the largest factor constraining construction activity in the UK. Scarcity of inputs was cited by an average of 78 per cent of construction firms as a brake on output across the four RICS Construction Market Surveys conducted in 2022, compared with 74 per cent for shortages of labour and 56 per cent for the firms’ financial position.
This is the highest percentage balance since the question was first asked more than a decade eago. According to the Office for National Statistics survey evidence released in December, 39 per cent of construction firms attributed this to global production shortages, 21 per cent to the pandemic, nine per cent to increased cost inflation, and six per cent to transport issues.
Looking forward, the construction industry’s supply chain is particularly vulnerable when it is reliant on inputs which are not produced domestically and supplies from abroad are sourced from a single or only a few countries. Examples of imported inputs where supply is heavily dependent on particular overseas countries are: bitumen and asphalt (68 per cent of which is imported from the Netherlands), road rollers and tamping machines (68 per cent from Germany) and oriented strand board (38 per cent from Latvia).
There are broader indicators of supply chain concentration risk. Around 18 per cent of total construction material imports are sourced from China, which might be vulnerable to Covid lockdowns or geopolitical risk. While trade data suggests 57 per cent of construction material imports arrive by sea, where issues with ports may be a potential problem.
Profitable turning unprofitable
Research commissioned by QBE shows that three in five (59%) UK
construction companies that have been hit by supply chain issues over the past year have seen once profitable projects turning unprofi table. In a February 2023 survey of senior leaders in the construction industry, 83 per cent of respondents said they had experienced an issue with their supply chain over the past 12 months, while 85 per cent said that they expected supply chain issues to pose a challenge in the next 12 months.
Some 85 per cent of respondents went on to say that the cost of importing construction materials had increased at a rate higher than inflation over the past year. Nine out of 10 (89%) of those impacted by supply chain issues also said that they were currently experiencing a shortage of materials. Many of the construction firms surveyed said they are taking steps such as diversifying supply chains (42%), holding greater stocks of strategically important materials (31%), establishing robust monitoring systems of stocks and suppliers (23%) and nearshoring (17%). However the survey found nearly one fifth of firms (18%) have not taken any action.
4 ways to lower supply chain risk
The decision to transfer, or retain and manage risk, is a subjective one for most organisations, based on their risk appetite and various other factors. A key element of this choice, though, is having a clear and accurate picture of one’s risk profile and an effective
risk management plan.
As part of the plan, there are four strategies that firms can adopt to lower the risk:
1. The first is to shift from the ‘just in time’ supply chain that was finessed during the period ofeconomic stability around the turn of the century, towards a ‘just in case’ supply chain to help insure against a period of economic instability that firms are currently facing. The old school methods of boosting stock levels and ordering further in advance than normal still have a place. Albeit, they come at the cost of absorbing capital and storage space, which may require additional external finance to pay for stocks, restore liquidity, or rent warehouses.
2. Secondly, for larger firms, technology can also play a role by automatically ordering supplies when stock levels go below a certain point. Where firms feel they may be left short, a smart move is to invest resources in gaining market intelligence about a wide range of potential suppliers.
3. Thirdly, diversifying procurement to build relationships with a number of suppliers is wise. This diversification can potentially occur across modes of transport or hubs (for example, different ports) suppliers use and the geographical location of suppliers’ supply chain to avoid overdependence on production facilities in the same part of the world. Scenario planning for plausible disruption, transport or logistical problems and geopolitical issues is also advisable.
4. Finally, where higher input prices are the likely fallout from supply chain disruption, construction companies could also consider adding a cost escalation clause to future contracts – that allows for an automatic increase in agreed-upon prices if certain conditions change – to provide the option of sharing expenses if they rise uncontrollably
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