Rob Driscoll, ECA Director of Legal & Business, explains why open conversations with clients about shared risk have become essential as we attempt to tackle ‘hyperinflation’ head-on.
In May of this year, the Bank of England announced that inflation had surged to 7 percent – its highest level in 30 years. The Bank raised interest rates, with a warning that we should expect 10 percent inflation before the end of the year.
Meanwhile, British Land also announced in May that it expects tender price inflation to reach 10 percent. At the same time, Landsec highlighted that its tier one contractors were raising their tender margins by up to 9 percent on project bids.
However, there are many in our industry who feel that these figures don’t reflect the reality of costing products for construction projects. The latest figures put the inflation rate in the construction industry nearer to 25 percent, which is trending towards ‘hyperinflation’.
Industry concerns
Figures from the latest survey of members of the Electrical Distributors’ Association (EDA) point to rising product costs as one of their top concerns, with price increases compounded by continued shipping delays. The latter has recently become a more severe issue as lockdowns in China continue on top of the squeeze, caused by the invasion of Ukraine by Russia, on the global movement of goods.
Competent staffing is also another area of concern for the electrical contracting sector. Although the JIB National Collective Agreement is in place to help stabilise pay rates, this doesn’t reduce the cost-inflation of hiring agency or self-employed electricians. This is something that more projects are doing as the number of qualified personnel in our field is still tightly squeezed.
However, even without increasing pay rates, employers are facing added NI and professional indemnity insurance (PII) costs as well as reverse charge VAT which impacts cash flow. For owners of all sizes of business, this is a time of unparalleled challenge. Yet because many of our industry’s problems are being felt across the whole economy this, at least, has high level government attention.
Honest and open conversations
Many electrical professionals will be considering what they can do to ride out this wave of hyperinflation. The most important step is to focus on reducing risk. This should begin early, at the bidding stage. If manufacturers and wholesalers are re-fixing prices on a weekly basis, and a contract may be over a period of two-years, then a contractor fixing their rates at or even near today’s prices is taking a significant gamble.
The best approach is to talk openly to your clients. It can be an awkward conversation, but it’s better to say: “We can’t sustain prices fixed today for nine to eighteen months”, than to take a considerable loss in a year’s time.
Sharing the risk with clients when this level of inflation has not been seen for decades is better for both parties, and this is what smart contractors are looking to do already.
There are already options for setting up this form of agreement in the JCT contract, for example. Prices can be index-linked to the Building Costs Information Service from RICS (Royal Institute of Chartered Surveyors). The contract can then account for fluctuations in the cost of products and labour (or even changes in legislation).
Index-linking contracts is normal in the facilities management world, where business relationships tend to be over many years and more strategic than in most mainstream construction. However, there is no outstanding reason why we cannot revive this 1970s and 1980s practice in our sector.
Avoid buying into problems
The most important message for contractors is not to be tempted to buy into problems for the future. The construction industry is currently experiencing a high level of work, with many industry economists saying that we’re above pre-pandemic levels of activity. This means that it’s relatively easy to turn down work for clients who aren’t prepared to engage with the risks of higher prices.
However, when the level of activity slows, it may be tempting to price projects at today’s costs to keep work in the business pipeline. The problem with this approach is that hyperinflation will quickly wipe out any profit margin, or worse.
The governments of Wales, Northern Ireland and the Republic of Ireland have recognised the problem of rapidly rising costs. As large clients of the construction sector, they’ve already issued ‘Share the Risk’ guidance for working with the construction sector. In England the government has yet to adopt such a policy, although the potential impact of rising construction costs on projects such as HS2 has been noted by the Public Accounts Committee.
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