2% and 3%. Two numbers that should send shivers down the spine of those leading the UK’s construction sector.
2% was the average net profit made by the top 150 construction companies in the UK in 2018, according to a report released by Building magazine.
As a colleague of mine said: you can (almost) get more in the bank. As Ian Marson from EY said at the event where the report was launched, this is why there’s a shortage of investment funds available to the sector. With many firms also living on debt, when interest rates rise we could see more Carillions. (For those outside the UK this was a massive outsourcing and construction firm that went bust in 2018 – said to be the largest ever trading liquidation in the UK – with huge consequences.)
Equally shocking is a statistic quoted in a Kreo blog citing a recent UK study from the University of Reading: that construction firms spend 3% of their turnover on bidding. According to the blog, most of this is written off as they lose most bids – but it means they’re spending 50% more on bidding than they make in net profit.
Not only is this unsustainable for the contractors, it doesn’t serve the buyer. My own conversations with buyers suggest that they often get failed bids. Even more common are contracts which go way over budget at the delivery stage because the bidder won through a low figure and either deliberately recouped profit through variations or legitimately had to charge more because the bid process was so flawed. There was insufficient information to provide a firm price – and, guess what, the world changes anyway and so delivery has to flex too.
There has to be a better way
A report from PwC in 2017 nailed the issue:
“Higher margins in the UK construction sector tend to come from long-term relationships, such as five-year service contracts, rather than one-off building contracts. These long-term arrangements, such as for civil work, tend to be driven by organisations where establishing a relationship is key to accessing a pipeline of contracts.”
The critical issue is the win/lose nature of so much construction tendering. Firms whose whole business development process is based on RFPs inevitably get into a response focused on capability and price. That’s a recipe for driving down margins, because lots of firms can credibly do the work, many can reach the quality threshold, and so the differentiator in a fixed procurement process becomes cost.
The answer for construction firms is clear: there needs to be a focus on building trusted relationships geared towards the long term co-creation of mutual value with key clients. This is what most sensible clients want: a partner who can be relied upon both to deliver and respond collaboratively in developing better solutions as part of a wider team. When things go wrong – and they of course will – trust becomes the critical currency of effectiveness.
The quid pro quo is that the buyer needs to be trustworthy as a long term partner – one who understands and embraces the idea of mutual value, realising that healthy margins for the supplier results in a more secure and committed relationship. This can actually save lots of money, because an open conversation between partners focused on developing great solutions can lead to better projects that are more effective and go wrong less often. If both sides are focused on deepening the trusted relationship, not winning short term battles, then this creates long term mutual value.
There are a number of keys to this.
Firstly, there needs to be a clearly articulated story of Mutual Value, shared with the buyer and used as a framework for engagement. In an ideal world, this is co-created by both buyer and seller. This then becomes a key driver of the relationship, and can be included in bids as a clear differentiator for the supplier.
Secondly, the behaviours of the vendor’s people need to reflect this commitment. At all touch points it should be clear to the buyer’s team that this is how the vendor does business, and there is an explicit and clear intention to build a long term partnerial relationship focused on better outcomes for the client.
Thirdly, innovation now needs to become a key part of the vendor’s narrative, rooted in the reality of a firm which is genuinely seeking better ways to do things. This is part of the trust equation: a buyer who develops a long term relationship with a construction firm needs to know that they are partnering a company that will always seek to bring to the table the best of what can be done. That means they are never complacent.
A McKinsey report published in 2017, Reinventing construction through a productivity revolution, said that globally, labour-productivity growth in construction has averaged only 1% a year over the past two decades, compared with growth of 2.8% for the total world economy and 3.6% in the case of manufacturing.
It added: “The building trade is worth $10trn each year, or 13% of world output. If its productivity growth had matched that of manufacturing in the past 20 years, the world would be $1.6trn better off each year.”
The construction industry needs to get much better at this and show its clients that it is also thinking of ways to reduce their costs and be more effective while making reasonable margins. That’s true win/win thinking – creating Mutual Value.
Character is as important as capability
Whatever the tender says, buyer research shows that when given a choice, they select firms that display the right character. This can be defined in terms of cultural match, a team that seems to work well together – and a group of people that, as a buyer, you want to work with because you trust them. This makes sense: most projects will change and develop over time, and all work is done as a collaboration between client and supplier, so this is a critical part of effective delivery.
Understanding that, articulating that and focusing on it as a core part of the proposition is a powerful way for construction firms to differentiate themselves, radically increase their margins because price is not the central issue, and also provide clients with a much better service. This creates Mutual Value and a far superior working relationship.
At Mutual Value we work with organisations who want to be more ambitious about that they can achieve with their customers, suppliers and partners. This is based on a changed mindset, a new skillset and a toolset we have developed, and deliver through consultancy, training and coaching programmes.
If you would like to set up a call to discuss this please email firstname.lastname@example.org