Razor-thin margins push New Zealand construction firms over the edge

New Zealand construction firms are taking on too much risk, and operating on too fine a profit margin to survive, industry experts say.

Ebert Construction has gone into receivership, with debt in the "tens of millions", the latest in a number of big-name Kiwi firms which have struck trouble in recent years. 

Mainzeal's multi-million dollar collapse had widespread ramifications. Orange-H Group, which was set up to run legacy projects after Hawkins was sold to Downer, was put into receivership in May.Fletcher has suffered about $800 million in loses on 16 big construction projects and said it would leave the "vertical construction" sector.

John Tookey, Professor of Construction Management at AUT, said commercial construction firms were forced to bear large amounts of risk. "Everyone wants to outsource the risk, it's like being in a game of pass the parcel – but no one wants to be left holding the parcel at the end. That's a key problem." 

He said it was very easy for big firms to win business, but then hard for them to make the project financially successful.

"Winning is easy, you cut your margin down to the bare bones. 'Can you build a tower block? Yes, we'll do it for $1'. But when they've got the job they have to make it pay."

He said he heard of organisations that were running construction projects on 0 per cent profit margins.

"It's to do with the capacity of the companies involved. They want to make sure there's a continual flow of work coming through and keeping everyone employed but they don't know when the projects are going to come. Sometimes they have to bid on something they don't want to do."

Sources said many businesses were operating on 4 per cent to 5 per cent profit margins when they should be at 7 per cent or 8 per cent. Labour supply was difficult, construction costs were up and wages were rising. Combined, those factors could quickly erode a 4 per cent margin.

Fletcher had cost over-runs of up to 75 per cent.

A construction industry survey by Teletrac Navman and Civil Contractors NZ showed contractors' clients' focus on lowest prices, cut-price bidding by contractors, and a lack of visibility of future work were all playing a part.

Nine out of 10 respondents from large businesses said a poor procurement process usually affects the entire project adversely.

The top three issues for construction companies in the procurement phase were clients' focus on lowest price (81 per cent said it had high to very high impact), cut price bidding by contractors (76 per cent), and a lack of visibility of future work (75 per cent).

"With record levels of investment proposed in the recent Government Policy Statement on Land Transport, there needs to be more focus on whole-of-life value for projects to ensure a sustainable industry," said Peter Silcock, chief executive at CCNZ.

"Razor-thin margins are risky for both the public and the industry. Cutting costs leads to poor-quality infrastructure, and if contractors are forced into a bidding war on cost as opposed to outcomes, this will destabilise the New Zealand construction industry, which is already operating on slim margins.

"Large-scale builds are intended to serve generations of New Zealanders. Taking a lowest-cost approach to these projects will simply add maintenance and remediation costs down the line."

Jim French, construction industry specialist at Teletrac Navman, said it was not clear whether the cut-price bidding was intentional.

"In some cases, firms may not have an accurate understanding of the contributing costs, so are committing to projects that turn out unprofitable down the line.

"Clients should be looking for contractors that have a thorough understanding of project costs and risks – not just picking proposals based on price alone. Job site and measurement technology can play a large part in understanding the total cost of a project and communicating this to clients. Resilient firms can then develop rich historical data, build accurately priced proposals and stay on track during construction."

French said the problem was sometimes a lack of information supplied from central and local governments about their plans. "They can't see far enough ahead what tenders are coming up."

French said there needed to be an understanding that if the focus continued to be on price, the industry was not building for the next generation. It ran the risk of the company not being able to complete or not being able to take on more work in future.

There was also significant pressure due to a lack of skilled and motivated workers, he said.

It was not unique to New Zealand.

Tookey said customers needed to reassess their expectations, too.

Sudima chief executive Sudesh Jhunjhnuwala said recently the cost of building a hotel in New Zealand could be as much as 40 per cent higher than in Australia.

But Tookey said that was an unfair comparison. New Zealand's construction environment was quite different, with seismic issues and different weather considerations, among other factors.

"No one would blink an eye if you said building in Rarotonga was 40 per cent more expensive, it's a small population, geographically remote with a high cost of transportation and less demand – but in New Zealand, we're a small population, geographically remote with a high cost of transportation and less demand…"

Master Builders chief executive David Kelly said although Ebert's receivership came as a surprise, there had been growing concerns of the industry facing greater challenges in recent years.

"There used to be a lot of transparency in terms of contracts. But now we're seeing lengthy special conditions in contracts. These contractors are taking on liabilities they don't fully understand. For instance if a contractor falls over they're not covered at all.

"In a booming economy it's hard to get subcontractors and if you take on too much work that can have a knock-on effect and snowball very quickly. Take on risk, but price it. If you don't price your risks correctly, then that's foolish."

He said failures were bad news for the whole industry.

"It's bad news for everyone, the employees, subcontractors and clients. Everyone loses out."