Contractors – Growing Profits

Ireland is emerging from a protracted recession, marked by a return to moderate growth and rising international competitiveness. In the not-so-distant aftermath of the economic meltdown of 2008 and now the poor performance of the stock market for YTD 2015, the outlook for 2016 will remain positive but will be significantly challenged by factors that influence the construction and commercial business markets.

Astute contractors have not abandoned the lessons learned in the recent post-recession recovery. Construction firms today are leaner and meaner with a focus on bottom-line results. An overall acceptable profit margin for efforts expended is mandatory. However, owners’ expectations are still in a buyer’s market mode, interest rates are artificially low, fuel and material prices are cheap, technology applications are ever improving and there is a painfully growing worker shortage. Going forward, successful firms will cautiously continue to grow their operations with an eye on “Doing More with Less”.

The sign of a true economic recovery is the return of acceptable profit margins. Although there has been a continuous increase in construction revenues since 2012, the return of project margins has declined significantly during the same time. The “Gross Margin Gap” between revenues and profits is still very high. In addition, construction is a high-risk industry many people outside the industry consider it crazy that contractors would assume such risk compared to the low margins gained.

Colm-McGrathTo add to the complex nature of contracting today’s cash strapped public and private owners are shifting greater risk onto contractors through onerous contract terms with non-traditional project responsibilities. Half of the total construction activity that took place in Ireland in 2015 was carried out on public contracts amounting to a combined value of around €11bn. The Public Procurement contracts under the value for money policy look for cost certainty but shifts the risk to the contractor. The additional risks are evident in the evolution of project delivery systems that have surpassed design-build projects to more challenging methods of integrated project delivery (IPD), gap financing and PPP’s. In these high-breed risk-sharing approaches, attention to the potential expanded and long term exposures to risk must be identified and addressed. Contractors must be alert to new risks, resist or at least address these new risks whenever possible, and keep costs low to stay profitable. The financial consequences of the risk-shifting can hit general contractors and subcontractors hard. Long drawn out disputes are costly to all parties from direct and in-direct costs that strip away the already thin project profit margins.

For project owners, making the right choice to mitigate and manage risk on construction projects by selecting the most suitable contractor who will ensure timely project completion are imperative to a successful project.

In order for contractors to bring a project to a successful conclusion, they need to focus on what they know best – their core competencies. Contractors need to highly discriminate on project selection. New opportunities need to have an acceptable profit margin to risk exposure. Avoidance of unknown project elements, contract terms, partnerships and problematic owners should all be traded for the best opportunity projects that have a high probability to make money and generate positive cash flow.

With all the additional risk a contractor has to carry how does a project owner mitigate the risk of contractor failure? Contract surety bonds offer the optimal solution: they offer outside assurance that the contractor is capable of completing the contract. Mandating the bond requirement not only reduces the likelihood of default, but with a surety bond the project owner has the peace of mind that a sound risk transfer mechanism is in place, the burden of construction risk is shifted from the owner to the surety company.

In 2015 some of the larger surety providers have entered the surety market which has increased capacity and allowed many contractors to secure new and larger contracts. We have also seen new entrants to the market who are taking a more innovative approach in their risk assessment filling a much needed gap in the market. For a contractor to maintain an advantage over its competitors managing a long-term relationship with a surety will be key to winning contracts.

In conclusion, collaboration, communication and driving ‘best practices’ across all operations will bring improved ways to equally improved results. By trading in revenue growth goals for a keen eye on exploiting high margin projects with low risk factors, contractors can realize the long term sustainable business model of simply growing profits.

Colm McGrath is Managing Director of Surety Bonds, Irelands only specialist bond brokerage.