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Construction industry heads towards deflation

21 Jul 20 Two months after the prime minister sent the UK construction industry back to work and ended its lockdown, it looks like recovery may take longer than initially thought.

The risk of disruption remains, with delayed project starts and completions, and increased fixed costs threatening to weaken the industry.

That is the gloomy prognosis from construction economists at consulting firm Arcadis

As a result, Arcadis has downgraded its tender price forecast for 2020 to minus 4% in London and minus 3% in the regions, with the risk of further deflation into 2021.

The analysis is published in Arcadis’ summer 2020 market view report, Great Expectations?

This quarterly analysis of the UK construction market looks across sectors and regions and delivers a tender price forecast to facilitate financial decision making for projects and programmes.

It sets out a worst case  scenario in which a second Covid-19 outbreak makes it simply impossible to price jobs since the risks become unquantifiable.  In such circumstances, Arcadis suggests, any projects not scrapped would probably have to be on an open book accounting basis.

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Now that most construction sites are operational, productivity has recovered better than expected, ranging from between 70-90% depending on the sector and the stage of the project. This has contributed to the lowering of prices, edging the balance of the industry closer towards deflation and offsetting some of the initial inflationary pressures from extended programmes and different ways of working.

The industry is now at a turning point, Arcadis says. Prices have been rising since 2014, but profitability across the sector has barely recovered. With further disruption associated with Brexit and changes to labour markets ahead, Arcadis expects that contractors and their supply chain will continue to take a risk-averse approach to business development – focused on quality work rather than work at any cost. However, this presents an opportunity for clients who are ready and able to work with their project teams to bring forward de-risked and deliverable projects.

While the mid-term outlook is pessimistic, Arcadis retains a more optimistic longer-term view. Tender price inflation has been forecast at 5% for 2024/25, reflecting not only the size of the potential pipeline, but also the long-term contraction of the UK labour force. Despite this, the path to recovery will not be straightforward, it says, and new projects will be exposed to an increased level of risk, not just from potential new waves of infection but also new risks associated with health and safety, productivity, viability, and supply chain stability.

This increased sensitivity to risk will determine how many projects will proceed, and how quickly they will start.  This in turn will influence the shape of recovery and future market conditions.

Simon Rawlinson, head of strategic research at Arcadis, said: “Clients are reconsidering their business needs, with risks around lower productivity, future Covid-19 disruption to works, and supply chain resilience all having the potential to cause delays and increases in costs. We need a different approach, not just to make sure that projects succeed, but also to ensure the long-term health of the sector.

“Looking at the wider industry, a successful rebound will depend on urgent, short-term actions - such as longer site operating hours, extended planning consents and prompt payments – combined with strategic longer-term thinking. Small steps will enable gradual progress towards ‘bigger’ tasks such as rebooting apprenticeships, embedding digital technologies, or exploring more collaborative business models and contractual terms. We have a real opportunity here to strengthen the collaborative spirit of the industry as well as enhance procurement. This will have the benefit of increasing transparency as well as embedding some pragmatic thinking into contracts to increase overall project resiliency.”

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