Thought Leadership

How to mitigate inflation risks in the construction industry

Most contracts in the construction sector are fixed price; only the public sector contracts sometimes have variation clauses in them to reflect inflationary pressures, although this is usually focused only towards material costs, not equipment and labour.

The producer price index (PPI) report from the U.S. Bureau of Labor Statistics (BLS) reveals record increases for material costs in 2021. From December 2020 to December 2021, price inputs to new non-residential construction jumped 19.6%—up from a 4.4% gain in 2020 and a 1.8% rise in 2019.

The cost of nearly everything soared, with the PPI for steel mill products (127.2%), plastic construction products (34%), and aluminum mill shapes (29.8%) all posting large year-over-year increases. The PPI for diesel fuel skyrocketed 54.9%, and the retail price in the U.S. hit a record of $5.557 per gallon in mid-May 2022.

So, and here’s the big question, how can companies operating in the construction sector still make a profit when margins were low to begin with and now there’s increasing financial pressures from inflation? And I’ve not included the ecological position of using renewable resources; however, these come at an increased cost as well.

One of the largest brick manufacturers in the UK mentioned to me recently that they can’t even supply all of the material needs of their long term customers. They’ve increased their prices substantially to reflect the energy and material costs, but that hasn’t changed demand at all. Something has to give!

Preparing your business for inflation

As most work in the western world is sub-contracted, the main contractors are not suffering across the entire build; however they’re still suffering. The sub-contractors are really struggling – most are not enormous companies so absorbing the extra cost caused by inflation can push them too far over the breakeven point.

You can’t control the rate of inflation, but you can mitigate the impacts by making changes that help proactively manage inflationary pressures. These two areas are especially important for the construction industry:

1) Supporting the entire supply chain

Working as a homogeneous team (main contractor, sub-contractors and suppliers), is critical in times like these – it’s always important to have clear and concise communications throughout the build. When that exists, it can be an incredible support network during difficult times. You don’t want to find out too late and then your sub-contractor can’t deliver on time, or worse still at all.

At Proudfoot, we have developed excellent communication models. We implement them with all stakeholders, and the gains are useful for everyone. Work is planned more effectively; procurement is more focused and work on site is far more productive.

The caution; however, is not to rush to employ all of your previous employees. Instead of bringing everyone back; you should first develop new working practices with clear standards and targets that allow you to hold your teams responsible for their actions.

More importantly, new or improved operating practices that reflect the needs of today, allow you to recognise when work is falling behind, take corrective action before the problem becomes too large to manage, or even allow you to identify constraints even before they happen.

2) Reducing costs

This is an easy thing to write as I reflect on projects with clients in the construction sector; yet it may seem a difficult thing to attain for many. Cost management is manageable if done right.

Typically, waste on a site is high, projects don’t share resources and work on a isn’t planned in enough detail or rolled out with all stakeholders correctly – all of it leading to waste in things like space constraints, people waiting around, unscheduled stoppages, and the list goes on. I’m sure you will recognise these points.

Do we learn from our mistakes or just repeat the same practice? What’s critical to recognize is that project plans need not only to be detailed enough, but they also need to be revisited on a continuous cycle to ensure that any deviations for the original plan are taken into account at all levels and new plans are developed for the new realities and constraints. And while this is a critical step, probably more important is the need to communicate and review that plan with all stakeholders involved in the operation.

Finding new material mixes is another key to lowering costs. With the price of materials and components rising at different rates, it’s critical to make sourcing strategy adjustments as needed. Additionally, sourcing locally is now an environmental ‘must’, but it can also save you money, if it is planned and delivered at the corporate level. Don’t just assume that the supplier is small and this project is remote – they may have relationships that go further than you realised.

Local sourcing can also reduce transport costs, and with fuel prices not showing any signs of falling, this can also aid in managing costs.For your cost strategy, you may want to work with a partner, like Proudfoot, who specialize in looking at all of the data within your organization, removing all complexity around that data to truly understand where your biggest cost drivers are, and develop and implement an agile plan that minimizes the impact all of external costs, as well as improve your internal procedures and processes for an operatin that is fit for today’s world and propels you into the construction company of the future.

Nothing moves until people move

Increasing productivity, through communication and best practice planning techniques, and reducing costs, through less waste and shared resources, are smart ways to address inflation, but to impact business performance, your people must embrace these changes.

A continuous cycle of coaching on the floor and improving leadership empowers people to become owners of the new way of work. In the construction industry, that means upskilling your people on not just technical skills but also soft skills like customer service and communication.

When people see how they’re helping improve operations themselves, companies are more likely to create lasting results. That’s why Proudfoot works alongside our clients’ people to help organizations achieve sustainable transformation and make changes at scale that stick.

Book a meeting with Proudfoot to analyze your construction business and get personalized support for combating inflation

 

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