In this chapter we review:
With the advent of globalisation construction has become quite a big ‘export’ market, e.g. Chinese, Japanese, and Korean construction companies have really spread their wings and readily compete in many developing nations with companies from the US, Canada, Brazil, UK, Europe, Australia, South Africa, etc. The ‘client countries’ are spread across many regions, in Africa, South and Central America, the Middle East, Central Asia and Asia Pacific. These international contractors are also providing healthy competition, or entering into joint venture contracts, in the home markets of their competitors, often introducing new methods.
Construction industry cycles are often global and always interesting. The global financial crisis of 2007–2008 exposed the residential market, with notable boom–busts in North America, Ireland, Spain, Dubai, and Malaysia, amongst others. The outcome was that dozens of property developers collapsed, and their banks, contractors, and supply chains followed, or were badly hurt. In these countries, and others, the governments had to set up special bail‐out entities to sort out the mess, which has taken a few years. Not so in Australia, where there has been an ongoing residential boom market since the mid‐1990s.
We have also had mining, oil and gas, and heavy industry construction booms. Brazil, Chile, and Australia rode high on the mining boom from 2003 to 2014 with their massive export markets and even with the drop in prices that occurred mining is still big business for these countries.
The mining and oil and gas boom cycles have been good for engineering contractors, because these industries have been geared to EPC contracting (engineering, procurement, and construction), which in many cases amounted to ‘cost‐plus’ contracts, with the clients having deep pockets when the oil, gas, and mineral prices were booming and they wanted their projects delivered as fast as possible. However, the demand tightened considerably when the drop came in commodity prices, with contract terms and pricing tightening at the same time.
At the time of publishing of this book, we are witnessing what we can call the ‘infrastructure’ cycle because there is an insatiable worldwide demand for new infrastructures of all types. It is predicted to keep growing at a fast pace, so as with most ‘booms’ people are rushing in to get part of the action,
A new trend in business models and contracting formats has emerged with the advent of ‘soft loan’ financing of projects by individual contractors in order to procure projects. Chinese and Japanese companies are prominent in this sort of project financing. This is in addition to the traditional financing in developing countries that is provided by the World Bank, the Asian Development Bank and the African Development Bank, amongst others, together with a relatively new entrant in this field, the Asian Infrastructure Investment Bank, an initiative of the Chinese Government that commenced operations in December 2015.
PPPs (Public Private Partnerships) add a further dimension by privately financing infrastructure developments, and they are spreading rapidly in developing nations as well as being well established in developed countries.
Another noticeable trend in the last two decades has been that many major construction companies have diversified into being asset owners and having their own services divisions to operate and maintain their asset portfolios, such as the case of ACS/Hochtief/CIMIC, Ferrovial, and Balfour Beatty in Europe. In South East Asia there are similar large conglomerates such as the Kuok Group and CK Hutchison Holdings, while the Macquarie Group has its tentacles all over the world. There are many other such conglomerates in India, China, Japan, North, and South America, and new ones are emerging throughout Africa.
With this vertical integration, these large groups finance, design, construct, own, and operate these assets.
Advances in technology are occurring rapidly and can greatly assist in improving efficiency and margins. In Chapter 20, Rob Horne provides us with a really interesting update and overview of Contech (technology to manage construction risk) and, in Chapters and , Graham Thomson and Professor Noha Saleeb expand on IDF (intelligent document format) and BIM (building information modelling).
Use of these latest technologies is expected to grow rapidly and will surely define the difference between progressive and innovative managers and ‘the old school’.
An increase in the sharing of risk on major projects has been another significant trend, such as with HS2 in the UK and the Gautrain High Speed Rail between Pretoria and Johannesburg in South Africa, completed in 2012. This is not only confined to high speed rail projects, but also to industrial facilities, cultural centres and multi‐structure complexes such as in Doha for the 2022 FIFA World Cup.
There are some very large and very complex prestige projects being undertaken in several countries with adventurous geometric architecture, including cultural centres, scientific research facilities, space‐age commercial premises, complex industrial plants, international airports, and so on.
One of the author's favourite new buildings is the Louis Vuitton Art Museum and Cultural Center in Paris that opened in 2014, an extraordinarily complex design by the architect Frank Gehry that was able to be built because of innovative digital architecture and engineering on a common web‐hosted 3D digital model.
The introduction of new technologies and skill sets that come with these international joint ventures is a very beneficial outcome. A good example of this was with the Mersey Gateway Bridge in the UK that opened for traffic in October 2017; three international contractors in a joint venture were appointed for the main contract, Kier from the UK, FPP from Spain and Samsung from Korea, and with specialist subcontractors for the cable‐stay towers and the toll systems from Italy and France. A truly international and very successful project!
However, no matter how large, magnificent, and complex a new building, industrial or transport project may be, clients will always want to know the costs in advance and as accurately as possible. The rest of our book states how that should happen.
At the same time we must not lose sight of the fact that every‐day basic construction is, and will continue to be, a very large component of the global construction industry, with housing and factories, schools and medical centres, and roads and bridges. The residential sector is actually the largest single sector in the industry.
The construction of these every‐day basic necessities creates a huge employment base and is a fundamental component of the GDP in every country. The issues we are raising are essentially the same for all these sections of the industry
Just one interesting example of this employment base is that in Europe there are currently 180 000 people employed in the manufacture and placement of asphalt for roads, with many of the companies undertaking cross‐border contracts. This is not surprising because there are five million kilometres of asphalt roads.
In the Middle East cultural practices have proven difficult for international contractors and construction consultants that have entered that market. Contract and payment terms are often ignored by government and private clients until final notices are issued. It is also common for contractors to have to put up performance bonds, of say 5–10%, that are all too easily redeemable for breaches of contract as interpreted by the client, which may include stopping work due to non‐payment. Add retentions to the performance bonds and you are setting the scene for real financial difficulties on a project, especially if the client turns out to be a bad payer. On top of this you also may well be at the mercy of the local courts if you end up in litigation with contract disputes. You might ask who in their right mind would enter into a contract like that. Plenty of over‐eager international contractors have in the past, but they are now becoming far more careful.
The Asia Pacific region, including India and China, has the largest volume of construction in the world.
China's infrastructure development has been really amazing in recent years. Just one recent high profile project is the Hong Kong–Zhuhai–Macau Bridge across the Pearl River Delta, which was opened in May 2018. Spanning 34 miles (55 km), this US$20 billion bridge is the world's longest sea‐crossing bridge and is a monumental engineering achievement for China.
China also has the highest number of PPPs in the pipeline of any country and Indian PPPs are also gathering pace, with plans announced in 2018 for multi‐billion US dollar rail and road PPPs.
When ‘western’ companies venture into these markets, which many have done successfully, it is really important that they understand the different cultures and practices between countries, because they vary considerably. Joint ventures, i.e. partnering, is a widely accepted business practice in this region on the basis that it should be a ‘win–win’ for both parties; the foreigner brings expertise and new techniques, and the local partner manages the domestic side of things and looks after the foreigner. Supply of funding is no longer an issue in most areas. Contractors, consultants, and suppliers who try to do it alone can fall into traps.
In Africa there is a huge future market, and major projects are being undertaken across the continent, but in some countries the levels of corruption are scaring away international investors and contractors who have to comply with the laws of their home countries, and non‐compliance can attract heavy penalties. Development banks are having difficulty coping with the way their infrastructure funding is being misused.
In Central and South America there is continuing demand for mining, and oil and gas facilities, but apart from a few major projects such as the Panama Canal widening, there is not as large a demand for projects as in most other regions.
North America is experiencing a major push on infrastructures, with PPPs really taking off.
In the UK and Europe the industry continues to be very competitive, margins are very low, maintaining a positive cash flow is a real challenge and the supply chain is suffering at the hands of contractors. Structural changes in the industry are happening, but quite slowly. This is despite three UK government sponsored reports being published in the last two decades against a backdrop of deep concern in the industry and amongst its clients, of which the government is a major one. They have been the 1994 Latham Report, with one of its recommendations being fair payment; the 1998 Egan Report, which delved into all the major concerns and included the City's view that the construction industry was a poor investment; and the 2016 Farmer Report Modernise or Die, which basically covered the same ground as the two previous ones.
Professor Rudi Klein elaborates on these reports in Chapter 5.
However, here we are, 24 years after the Latham Report, with sectors of the UK industry still struggling with out‐of‐date contracting models and living from day to day on very tight margins and cash flows, with the supply chain also suffering as a consequence.
While there are clearly too many inefficiencies, and too much debt is being incurred to stay afloat, it is not a realistic solution to ask senior company management to say ‘no, enough is enough and we won't bid any more on those terms’. They are too busy running their companies.
Real structural change needs the joint efforts of industry groups in collaboration with the government. As we go to print it is encouraging to see that this might be finally happening in a meaningful way, with legislation being proposed to have retentions placed in trust accounts and ‘bad payers’ be excluded from government contracts. This is certainly a step in the right direction.
What changes have taken place since 1996? We have all seen headlines such as the one below in 2003 reporting on project failures:
Never mind a West Coast upgrade – the route is off track
It is difficult to tell which project, the new Scottish Parliament building or the upgrading of the West Coast Line, is more tragic in terms of delay, cost‐overruns and bungled management.
(Scotsman Newspaper July 2003)
Are these headlines a thing of the past? Unfortunately not!
In early 2018, the collapse of Carillion in the UK made global headlines. The extent of the fall‐out and consequences extended beyond the UK to the Middle East, Canada, and Europe, and the publicity was widespread over the printed and broadcast media. The effects went far beyond the company; it affected ordinary people's lives ranging from the Carillion employees and its supply chain through to local communities depending on the assets Carillion were delivering, such as hospitals. It also extended to investors and in‐house pension funds.
The extent of the consequences resulted in a parliamentary enquiry being launched in January 2018: ‘Works and Pensions and BEIS committees into Carillion's collapse leaving a mountain of debt, potential job losses of thousands, a giant pension deficit and hundreds of millions of pounds of unfinished contracts with vast on‐going costs to the UK taxpayer’. The Committees investigated ‘how a company that was signed off by KPMG as a going concern in spring 2017 could crash into liquidation with a reported £5 billion of liabilities and just £29 million left in cash less than a year later’. www.parliament.uk – Work and Pensions Committee Carillion Joint Enquiry.
And quite rightly so. When you look at the ongoing situation, with contractors in many countries continuing to get into financial trouble due to low margins and project losses, often their problems are self‐inflicted by incompetent management entering into inappropriate contracts and then compounding the problem by managing them badly.
Carillion is not the only contractor to get into difficulties in 2017–2018, with several other large ones in Australia, New Zealand, Brazil, South Africa, and the UK either collapsing or announcing heavy project losses.
Just look at some more of the evidence:
The above are just some random samples, but bad news seems endemic in the construction world and we are constantly reading about contractors getting into difficulties in the different regions, from Brazil to the Middle East, from South Africa to Asia.
Investors have become quite sceptical about over‐optimistic pronouncements by companies in regard to their state of financial health. Typical of this was a statement in early 2018 by the CEO of a major contractor in which he referred to their improved underlying profit of £165 m and to their financial soundness with cautious optimism (quite correctly), but he did not highlight that it represented a margin of only 2% before tax on their annual turnover of £8.2bn. A couple of good project losses could wipe that out in the blink of an eye! The result was a considerable improvement on previous years, which just shows how fragile the margins are.
Is it any wonder that investors and shareholders get very concerned about the whole situation.
Why are corporate and project failures continuing to occur?
Where is the overall planning and implementation going wrong?
The ramifications of corporate and project failure are widespread and include:
It is important to recognise that there has been some real progress in the following areas:
Nevertheless it can still be argued that some of these contract formats do not yet offer enough protection to subcontractors and suppliers, or that the supply chain is still not able to enter into contracts on a level playing field and have to accept modified contracts, often with onerous terms, if they want the project. This means that legislative support is required in areas such as retentions, payment timing and security of payment.
In the UK the government has introduced some worthwhile initiatives that are a good start toward improving the efficiency of the construction industry including:
The Institution of Civil Engineers (ICE) and the Infrastructure Client Group (ICG) launched Project 13 in May 2018, supported by leading Government and private sector organisations. Project 13 is an industry‐led initiative to improve the way high performance infrastructure is delivered, after organisations from all levels of the supply chain agreed that the infrastructure industry's current operating model was broken. Too often projects have been delivered over budget, past deadline and below par.
The Major Projects Leadership Academy ( MPLA ) for senior government managers, which has three simply stated objectives:
(Note: We believe senior corporate management should put a lot more time and effort into this sort of approach).
At the time of publishing this book the UK government is proposing legislation to provide security for retentions and this will be really welcomed by the broader supply chain.
In June 2018 Network Rail took the lead and pledged to reform prompt payment practices and to abolish the use of retentions in its contracts. This is a very positive step in the right direction.
In 2017 the UK Government adopted the principal of collaborative working and published ISO 4401 (based on BS11000), entitled ‘Collaborative business relationship management systems – requirements and framework’, which includes weighted tender analysis towards non‐confrontational company policies.
In regard to terms of payment and the maintenance of healthy cash flows, it is certainly worthwhile to keep a close eye on what is happening in other countries, e.g. in Australia the Security of Payment legislation that has been in place in all states and territories for some years that allows for the rapid determination of disputed progress claims under building contracts and contracts for the supply of goods or services in the building industry. This legislation was designed specifically to ensure continuing cash flow to these businesses.
There is now a good range of different contracting formats available so it should be possible for contractors and clients, including government procurement agencies, to negotiate terms in an appropriate form of contract that will safeguard the interests of both parties, provided they both accept the importance of collaboration and then manage their responsibilities efficiently.
These formats include Alliancing; ECI (early contractor involvement); EPC (engineering, procurement, and construction); IPI (integrated project insurance); penalty bonus (as distinct from liquidated damages and generally related to the completion time). These formats are supported by new forms of contract documents such as NEC4 and the FIDIC Suite, which can be used in the traditional form or amended to fit one of the above ‘share the gain and pain’ formats.
The use of these contracting business models is becoming more widespread as clients in both the public and private sectors recognise that it is in their best interest if they enter into construction contracts that are fair and reasonable to both sides, and which contain terms that effectively acknowledge that contractors and their supply chain need to be financially sound and must have positive cash flows.
The issues raised in this chapter highlight the need to have a healthy and robust global construction industry because funding institutions, trading banks and clients certainly do not want to be picking up the pieces and unexpected additional costs when a contractor goes bust or terminates a contract.
As previously stated, our primary focus in this book is on the qualifications, performance and accountability of CEOs, directors and senior managers in both the public and private sectors.
The reason for this is obvious. It is because ‘the buck stops there’ when it comes to running a successful and financially sound contracting or supply business, and for government and private clients in managing their end efficiently in the creation of successful projects.
This senior management group control and direct policies and strategies, finance, risk management, processes, personnel behaviours and cultures. So their skills and competence are paramount, because everything else flows from them.
With this in mind, it is necessary to ask some searching questions:
Managers also have to ask themselves ‘have their risk management processes adapted sufficiently to safeguard their interests’ ; probably not in many situations.
When you look at the projects that we have reviewed in Chapter 4 and the common causes that we have identified, it is clear that the planning and risk management processes have failed badly in those examples. And the projects quoted were all in countries regarded as having robust checks and balances.
It is a real concern that these project disasters and corporate collapses have continued to occur all over the world on a regular basis and we want to get to the bottom of why this is so when we have advanced management training, many efficient risk management systems available, and much more awareness of the importance of communications and collaboration.
Even a big balance sheet won't help companies if they adopt the wrong strategies and/or employ incompetent new management.
Investors, lenders, and other stakeholders are fed up with hearing all the excuses and promises of CEOs that ‘We have put into place rigorous processes to ensure a more disciplined approach towards project selection’, blah, blah, blah (a recent comment by the CEO of a large contractor when announcing a big write‐off). We have been hearing this in much the same terms on a regular basis for the last 40 years, but the buck does stop at the top and these processes should have been in place long before.
Investors are also fed up with construction companies that embark on over‐ambitious expansion strategies, increasing their debt to prop up businesses in which they have no expertise or into new countries where they have no idea how to do business, especially if they attempt this without entering into a joint venture with an experienced local partner.
So beware of contractors whose debts are continually rising as they over‐borrow to support their chase for low margin contracts and expansion plans, yet do not invest anywhere near sufficiently in training, technology, and R & D because there is no cash left for this; again just further examples of CEO and Board incompetence.
It is important to understand the different cultural practices between countries.
Many prudent international operators enter into a joint venture with a credible, successful, and influential local partner in order to try and safeguard their position. Even so, it can take two years or more to really understand how things work, based on the author's experience of working in several countries.
Some contractors and suppliers who have tried to go it alone in new countries have compounded their risks by entering into inadequate contracts, with insufficient due diligence and risk assessment. Even worse, some of them then proceed to appoint inexperienced ‘expat’ managers who run these contracts inefficiently, with poor administration of such things as variations, extensions of time (EOT's) and loss and expense claims. This in turn loses the respect of their clients, who then see it as an opportunity to take further advantage of them.
Is this scenario being unfair to contractors? Absolutely not, the author has witnessed this sort of bad management in several countries.
The safest way in a new region, as with any contract, is to spend the necessary extra time on detailed planning, precise specifications and on ensuring that the terms of contract and the payment procedures in particular are clear and unambiguous, fair and reasonable, and clearly understood by both parties when the contract is signed. It is not all that difficult for experienced lawyers and commercial managers to write contract terms that include the necessary safeguards.
If foreign clients will not agree to fair and reasonable contract terms and payment conditions, then you are better off without the business. Builders are builders, not bankers!
It should also be remembered that in every country it is important in negotiations to be respectful and polite, and to be careful not to cause loss of dignity or embarrassment, commonly referred to as ‘loss of face’.
It seems to be taking a long time for the above messages to sink in. Clearly, new procurement methods and business models will only emerge if there is a concerted effort by industry institutions representing contractors and the supply chain working in conjunction with governments.
The opposite side of this debate on the financial health of the industry is to ask why should clients be able to demand performance guarantees and retentions, often followed by the arbitrary withholding of payment for concocted reasons, but not put up guarantees of their own in respect of milestone progress payments and final completion payments.
Contractors are not banks and they should be entitled to negotiate payment terms and guarantees that protect their financial position provided they perform the contract efficiently. The old idiom ‘a fair days pay for a fair days work’ should always be applicable!
And clients cannot complain if they take on contractual responsibilities for which they are not best positioned or equipped to deliver, or do not clearly define the scope of the contract, or badly underestimate the costs in the first place.
Clients, including government authorities, have an equal responsibility to be competent and professional, and this does apply with the majority of clients. Those that are not have to bear the extra costs and a lot of publicity when their projects run off the rails.
On the positive side, it should be noted that there are efficient contractors in every country who are operating profitably in the current regime, but in any over‐competitive market they really have to maintain that efficiency to survive, and invest in training, technology, and R&D.
The future is bright for construction contractors that are managed really professionally at all levels, but not so for ‘old style’ companies whose managers persist with traditional and unprofitable methods and who do not embrace change.