T4 industry familiarisation_book_may_2011

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The Industry Familiarisation Book providing an in-depth analysis of the industry setting for the May 2011 case study. This book helps students develop a sound commercial awareness of the industry, which is an essential element to analysing options and providing recommendations.

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T4 industry familiarisation_book_may_2011

  1. 1. T4 Part B Case Study Examination BeeZed ConstructionServices (BZCS) case Industry Familiarisation March / May 2011
  2. 2. British library cataloguing-in-publication dataA catalogue record for this book is available from the British Library.Published by:Kaplan Publishing UKUnit 2 The Business CentreMolly Millars LaneWokinghamBerkshireRG41 2QZISBN© Kaplan Financial Limited, 2011The text in this material and any others made available by any Kaplan Group company does notamount to advice on a particular matter and should not be taken as such. No reliance should beplaced on the content as the basis for any investment or other decision or in connection with anyadvice given to third parties. Please consult your appropriate professional adviser as necessary.Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to anyperson in respect of any losses or other claims, whether direct, indirect, incidental, consequential orotherwise arising in relation to the use of such materials.Printed and bound in Great Britain.All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, ortransmitted, in any form or by any means, electronic, mechanical, photocopying, recording orotherwise, without the prior written permission of Kaplan Publishing.Kaplan would like to thank Construction News and emap for their contributions to this book.ii KAPLAN PUBLISHING
  3. 3. ContentsIntroductionChapter 1: Background to the industryChapter 2: Construction supply chainChapter 3: Industry sectorsChapter 4: Key playersChapter 5: Risk managementChapter 6: Strategies for growthChapter 7: Corporate and social responsibilityChapter 8: 25 Quotable factsIndustry speaker notesKAPLAN PUBLISHING iii
  4. 4. iv KAPLAN PUBLISHING
  5. 5. IntroductionIntroduction The aim of this booklet is to give you some background to the issues faced by construction companies so you are able to better assess the pre- seen information for the BZCS case. Whilst there may only be 5 diversity marks available for “displaying knowledge of relevant real life situations within the same or similar context as that in which the case is set”, a sound understanding of how the industry operates is essential to passing the Case Study Examination. Without it you will be unable to demonstrate good commercial judgement on the day. Without good judgement, you will be unable to offer sensible and realistic recommendations. This booklet should not therefore be regarded as a quick way to get 5 diversity marks. It is more a key to unlock nearly 50% of the marks on your Case Study paper. For each area, we provide some guidance on how this might be relevant in your exam. In addition, the final chapter contains a list of 25 easy to remember, quotable facts, grouped under topics that may come up in the exam. If you are a Kaplan registered student, you can further develop your understanding of the industry, by watching our “industry expert” podcasts, and by using the discussion forum, both of which are available via Kaplan EN-gage.KAPLAN PUBLISHING 1
  6. 6. Chapter 12 KAPLAN PUBLISHING
  7. 7. Background to the industryChapter 1 – Background to the industry The impact of construction on the wider global economy – and the impact of the economy on construction – cannot be underestimated. According to the UK Contractors Group, which represents 30 leading contractors who together produce some 30 per cent of the UK construction industry’s output, construction contributes around 13 per cent of GDP. Meanwhile, every £1 spent on construction is estimated to generate around £2.84 in economic activity. And around 9 per cent of all workers in Britain are part of construction. This significance is replicated around the world. According to Global Construction Perspectives and Oxford Economic, the global construction market is estimated to be worth around £4.7 trillion, representing around 10 per cent of global GDP. Industry statistics The construction market is very volatile, being closely linked to economic conditions. The rising costs of energy and raw materials, a 6% depreciation of the Euro against the dollar (in 2010) and an increasingly competitive market resulting in falling tender prices are all putting increasing pressure on the industry. With funding being much harder to find in the wake of the global financial crisis, it is of littleKAPLAN PUBLISHING 3
  8. 8. Chapter 1 surprise that the industry as a whole has been in decline for the past two years. According to estimates released by Eurostat, the statistical office of the European Union, construction sector output in November 2010, compared with November 2009, dropped by 6.8% in the euro area and by 1.7% in the EU27. Source: Eurostat Among the Member States for which data are available for November 2010, construction output fell in eight and rose in six. The largest decreases were registered in Spain (-30.2%), Romania (-17.7%) and Slovenia (-16.0%), and the highest increases in4 KAPLAN PUBLISHING
  9. 9. Background to the industry Poland (+14.9%), the United Kingdom (+11.1%) and Sweden (+10.4%). Meanwhile, in the US construction spending increased 0.4% in November 2010 (v 2009) according to the US Census Bureau. However, the figure was still 6.0% lower than that of November 2009. Spending cuts Due to the recent economic conditions, the number of private projects undertaken by private companies has declined meaning that over the past 2 years or so, construction companies have been focusing more on public work. The recent spending cuts in many developed nations are therefore expected to have a considerable impact on the industry. In the UK, perhaps the most high-profile effect of spending cuts has been the axing of the Building Schools for the Future programme, which aimed to refurbish or rebuild every single state school in England by 2023. The cutting of the programme has taken over £36.7 billion worth of work away from contractors, although a government-commissioned task force is currently looking at ways in which to resurrect the concept at a lower cost. Most sectors of the construction industry face challenges on several fronts. While many demand- related indicators are recovering, access to bank finance is still restricted compared with pre-credit crunch levels, and on the supply-side, theKAPLAN PUBLISHING 5
  10. 10. Chapter 1 contractors and suppliers are faced with heightened competition for the remaining pool of available work. The continuing government spending cuts will further reduce that pool of available work, and this can have disastrous consequences. Outlook Available public capital funding will be limited over the next few years and in many countries, governments will be keen to secure private sector funding for a growing proportion of work. The prospects for more routine repair and maintenance work, an area that grew strongly over 2009, are bleaker. Such work is typically funded from departments’ and local authorities’ current or revenue budgets and will therefore have to compete directly with front line services for the limited resources available. New construction opportunities remain scarce in many parts of the UK. The values of underlying planning approvals have fallen sharply in most regions over the last two years and there are now far fewer projects in pre-construction planning. Inevitably, this is impacted upon the flow of new projects moving through to the start on site phase across many regions. However, supported by the flow of government funded projects, and latterly the recovery of private sector confidence, the flow of new projects within the UK began to stabilise, albeit at a low level, with a6 KAPLAN PUBLISHING
  11. 11. Background to the industry modest improvement in project starts during 2010 (see Eurostat data above). The outlook for 2011 holds less reason for optimism, especially for those regions that have relied upon government funded projects to support growth. Outside of the UK, many construction markets remain depressed, particularly in Europe and North America. There has also been a clear slowdown in construction specifically in Dubai in light of payment rescheduling for state development conglomerate Dubai World. However, the Middle East retains some firm potential for development, notably in Abu Dhabi where an estimated £17bn will be spent on developing cultural tourism facilities on Saadiyat Island, and also in Qatar, which is likely to spend around £64bn in preparation for the World Cup in 2022. Both India and China are also notable growth markets. China is expected to be the world’s largest construction market by 2020, accounting for 19.1 per cent of global construction output. Meanwhile, India will grow to be the third largest market. Indeed, emerging construction markets in Asia-Pacific are estimated to grow by 125 per cent over the next decade.KAPLAN PUBLISHING 7
  12. 12. Chapter 1 Relevance in the exam An appreciation of the current position of the industry will help you to judge the current performance of BZCS and to benchmark any further information we might be provided with in the exam.8 KAPLAN PUBLISHING
  13. 13. Construction supply chainChapter 2 –Construction supply chain On any construction project, there are a variety of stakeholders with contractual relationships between each other. At the top of the tree is the client, the company or government body that is commissioning the project. It is the client that ultimately funds the project and makes the decisions about which firms are employed to deliver the works. Under a traditional contracting process, the client will commission an architect to design the project according to a supplied briefing. Typically the client will have a budget in mind and the architect will design according to this, which may result in the budget being modified. Once a finalised design is complete and has been approved by the relevant planning authorities, the client then invites main contractors to bid for the work. Some of the top firms operating in the UK are Balfour Beatty, Carillion, Kier and Laing O’Rourke. Contractors will look across their supply chain and provide estimates for the total cost of the works, and the client will select the bid they believe is most appropriate for their project. Clients will all have their own internal criteria for bid selection, with motivations varying between price, quality of build and contractor track record. The bid process is competitive. As a result, contractors are encouraged to minimise theirKAPLAN PUBLISHING 9
  14. 14. Chapter 2 margins on a project. Some contractors can be particularly keen to win a project to the point that they will issue what is colloquially referred to in the industry as a suicidal tender – a proposal that will result in a net loss to the contractor. Doing so can have the benefit of getting the contractor on a client’s supply chain, but the strategy does include an inherent amount of risk and a firm that does this too frequently can find itself facing bankruptcy. Another option is to tender at break-even levels – a survey by KPMG suggests 39 per cent of construction firms are doing this. However, on many projects, while the main contractor will be responsible for delivering the works, they will not be responsible for carrying out all the actual work on site. All main contractors have a supply chain of subcontractors, which tend to be smaller firms that specialise in particular elements of construction. A main contractor will typically have dedicated subcontractors for elements such as mechanical and electrical works, site preparation and demolition. These subcontractors may also competitively tender for work, presenting bids to the main contractor. Although there are several major national subcontractors, typically the sector features a high number of SMEs. Nearly a quarter of all UK SMEs work in construction, generating around £174bn per annum. There are also other varying forms of contract, notably design and build contracts, where the10 KAPLAN PUBLISHING
  15. 15. Construction supply chain contractor will be required to develop a building design and then deliver it. Last year in the UK, around a fifth of all projects were contracted on a design and build basis. Contracts broadly come in three forms. A fixed price contract finalises price for the client (subject to any agreed changes in specification) and so the contractor must deliver the job at a cost lower than the price to retain a profit. Another option is a cost-plus contract, where the arrangement with the client is that the final sum paid to the contractor is the cost of delivering the project plus an agreed percentage profit. When combined with a fixed ceiling price, this is known as a guaranteed maximum price contract. Finally, PFI contracts will include paying the contractor for the construction work plus revenues from facilities management and maintenance. The latter are intended to be long term agreements, lasting for more than 20 years. In the UK, government cuts have had a significant impact in winding down PFIs in several sectors, notably social housing and education. The system is still seen to have some mileage in infrastructure projects, however. Contractors can also join frameworks, where a bank of contractors will be listed by a client as ‘approved’ for works. Some frameworks will maintain an element of competitive tendering, where contractorsKAPLAN PUBLISHING 11
  16. 16. Chapter 2 on the frameworks will be invited to bid for projects. Others will allocate contractors by region or project type. Major frameworks currently in operation include the Department of Health’s Procure 21+ and Ofwat’s AMP5 framework for water utilities. Getting on a framework can result in near guaranteed work for several years. Timescales Timescales associated with tendering vary dramatically according to the scale and complexity of the project, and also whether the project faces any planning challenges. However, strict regulations govern the advertising of public sector contracts for works worth more than £3.9m within the EU. Such projects are covered by the EC Procurement Directive and must be advertised in the Official Journal of the European Union (OJEU). The minimum amount of time a project has to remain open for tender can vary according to the bidding procedure, from as little as 10 days to 52 days. Cost drivers Costs in construction can be strongly driven by material costs, particularly those of steel, copper, cement and aluminium. Contractors need to anticipate these costs in advance when bidding for projects, working from predicted prices, or ensure they already have the materials required within their supply chain. Subcontractors will often assume responsibility for both materials and labour relevant12 KAPLAN PUBLISHING
  17. 17. Construction supply chain to their role on a project, and Infrastructure UK suggests that costs can be reduced by around 15 per cent through making efficiency savings in the supply chain. The cost to a main contractor is also affected by the cost of employing their subcontractors. Good relationships with the supply chain can help bring down costs for main contractors, although larger firms need to be cautious as it isn’t unknown for a subcontractor to charge a higher price under the impression the larger firm can afford it. Sectors and regions are also subject to the laws of supply and demand and if a particular region or sector has a small number of projects open for tender, this can lead to contractors trying to cut their prices in the hope of winning business. Sustainability can also create costs for projects, partly as a result of changes to building regulations which came into force in 2010. Generally, buildings aiming for certification under a green building rating scheme as the US Green Building Council’s LEED system or the UK’s BREEAM system can expect to come at a cost premium because of the added expenses involved in sourcing adequate materials and testing. Meanwhile, new building regulations have placed onerous demands on projects which may require the use of additional mechanical and electrical features such as ground-source heat pumps or mechanical ventilation and heat recovery.KAPLAN PUBLISHING 13
  18. 18. Chapter 2 Raw material costs Year-on-year, the majority of materials used within construction have increased in cost as a generalised slowdown in construction has had a knock-on effect on the rate of production. Significant variations have been seen in metal prices, which have surged by 20% - 40% since June 2010. Other variations include: Material Year-on-Year Last price Updated movement Cement -1.04% 14/01/2011 Bricks 1.11% 14/01/2011 Pre-Cast Concrete -0.42% 07/01/2011 Builders’ Woodwork 5.91% 07/01/2011 Sand and Gravel 13.55% 07/01/2011 Ready Mix Concrete 2.59% 07/01/2011 Relevance in the exam As well as providing some good general background for the way in which the industry operates, an understanding of the supply chain will help you appreciate the power exerted by different stakeholders. It will also help you identify potential risks for contractors.14 KAPLAN PUBLISHING
  19. 19. Industry sectorsChapter 3 – Industry sectors Offices Office construction was one of the fastest expanding areas of construction activity over the three years to 2007 and a key driver of industry growth, with office construction output in the UK rising by more than 50 per cent between 2004 and 2007. However, the crisis in global financial markets and the subsequent downturn in the many economies have hit the sector especially hard as developers have fretted over the implications for occupier demand, and securing project funding has become more difficult and expensive. The central London office market dominates the UK sector, with the capital typically accounting for 40per cent of new office projects. The previous boom in new office projects was underpinned by rising demand for office space, in part from a buoyant financial services sector which, at its peak, had taken on an additional 210,000 people since 2004. Whilst the flow of new office projects remains extremely weak, market conditions have moved off the low point reached in the first half of 2009. The take-up of central London office space improved considerably during the final six months of 2009 as occupier confidence strengthened, with theKAPLAN PUBLISHING 15
  20. 20. Chapter 3 turnaround most noticeable in the City. Construction project database Glenigan predicts there to be a large 41 per cent rise in office projects during 2011. Such an upturn would still leave the value of project starts some 50 per cent adrift of 2007 levels. Furthermore, if there is a renewed weakening in economic conditions, the downside risks for the sector will increase. Sports facilities The UK’s plans for the next sporting decade are positive for the sporting construction sector. Aside from the 2012 Olympics, Britain will also host the Rugby Union World Cup in 2015, the Rugby League World Cup in 2013 and Glasgow will be hosting the 2014 Commonwealth Games. As a result sports clubs have been preparing expansion plans in a bid to get involved in the action. Many of the projects include bolt-on developments such as hotels, conferencing or community facilities, with sports clubs wary of the need to generate revenue outside of match days. However, currently there is around £2bn worth of stadium projects on hold and the failure for England to secure the 2018 World Cup is also likely to have an impact on the number of projects coming to fruition.16 KAPLAN PUBLISHING
  21. 21. Industry sectors Further afield, both Russia and Qatar will see an increase in the number of stadium projects and related infrastructure after their successful wins of the 2018 and 2022 World Cups. Brazil, already a growth market, is also likely to see further growth as a result of it hosting the 2014 World Cup and the 2016 Olympic Games. Infrastructure Infrastructure, more than other sectors, relies on major project spending. The sector saw the value of underlying planning approvals in the UK fall significantly during 2008, finishing 69 per cent down on the previous year. In addition, whilst the value of underlying project starts during 2009 was 3 per cent up on the previous year, major schemes—including the £275 million Blackfriars Station redevelopment and the £6.3 billion M25 widening contract—almost trebled the overall value of project starts. Again, these large projects will boost sector activity over the next two years. Major projects (schemes of £100 million or more) account for a significant proportion of overall sector workload. A clutch of major projects starts will help boost overall sector activity over the next two years. Several large road contracts started on site in September and October 2010 and these, combined with more recent scheme starts such as the M80KAPLAN PUBLISHING 17
  22. 22. Chapter 3 upgrade and the £6.5 billion M25 motorway widening, will help lift sector output. Preparations for the London Olympics will also stimulate transport infrastructure construction starts in the Capital. In addition, rail will be a key sub- sector over the next year, with preparatory works for the £16 billion Crossrail scheme recently starting on site and work continuing on Thameslink. However, there are significant downside risks to this positive outlook for the sector. The greater concentration of sector activity upon a selection of large, high profile schemes has implications for contractors and suppliers operating in the sector. The emphasis on large schemes favours major contractor groups who are best placed to win such projects, but also means the potential risk of feast or famine hangs on securing these same projects. Rail projects in particular seem set to grow in the Middle East and Asia. The UAE plans to build a £7bn railway network with the first trains scheduled for running in 2013, and the project is likely to plug into a larger Persian Gulf network which is predicted to cost around £15.7bn.18 KAPLAN PUBLISHING
  23. 23. Industry sectors Community projects In the UK, the NHS has seen capital expenditure grow by 148 per cent since 2000/01, with PFI funded projects boosting investment further. Against this background, health-related construction output (in current prices) more than doubled between 2000 and 2007. Similarly, education had been one of the strongest performing construction sectors over the last two years. The sector was buoyed by a strong government investment programme centred on the now-cancelled Building Schools for the Future (BSF). Looking ahead, the prospects for continued growth in the education sector are remote. Although education received a slight increase in its overall budget from October’s Spending Review, its capital spending budget was cut by 60 per cent. In 2011- 12, the capital budget will fall by 36 per cent with 14 per cent and 21 per cent drops to follow in subsequent years. Overall, capital spending in education will be just £23.4 billion during the five years to 2014-15, with 2010-11 seeing a spend of £7.6bn decreasing to just £3.4bn in 2014-15. Heathcare projects are still in a difficult position too. The coalition government has announced that a shake-up of the NHS is to take place, with GPs handed more control over funds. While the Health Service has avoided the spending cuts that most other departments have had to endure, funds haveKAPLAN PUBLISHING 19
  24. 24. Chapter 3 been channelled away from construction projects to ‘frontline’ services. The NHS will see its capital spending budget cut by 14 per cent in 2011/12 following October’s Spending Review. However, capital spending will be stable in subsequent years totalling £17.8bn. Planned redevelopments of St. Helier, Royal Oldham, and West Cumberland hospitals will go ahead. The spending reductions mean that while the outlook is not as bleak as other sectors of the industry, project starts are still likely to take a hit over 2011. Energy The energy sector grew strongly during 2009, with the value of underlying construction starts in the UK rising by 17 per cent year-on-year. The rise was driven by several mid-sized construction projects in the renewable energy sub-sector. In particular, Wales benefitted from the strong interest in wind farms (and other renewable energy options). Other parts of the UK have also seen growth, with Scotland seeing work start on site on a £2 billion biomass CHP project and several offshore wind farms. However, the fallout from the credit crunch is hampering some clients’ access to capital funding,20 KAPLAN PUBLISHING
  25. 25. Industry sectors albeit to a lesser extent than faced by developers and housebuilders, delaying some project starts. Nevertheless the sector, which tends to have longer lead times, is now benefitting from a relatively strong pre-construction pipeline. For instance, several wind farm projects are scheduled to start on site over the next twelve months; although, it should be added that such projects are politically sensitive and vulnerable to delay. October’s Spending Review was relatively kind to the sector as capital spending is budgeted to increase by more than 40 per cent over the next 5 years. In particular, government spending will continue to focus on renewable energy including £200 million for offshore wind technology and manufacturing at port sites and up to £1 billion of investment to create one of the world’s first commercial scale carbon capture and storage (CCS) demonstration plants. Environmental Both the water utilities and several major UK ports are pressing forward with strong investment programmes. Having risen 17 per cent in 2010, underlying projects starts are expected to grow by 14per cent this year. The new five-year capital expenditure programme agreed with Ofwat, the industry regulator for water companies in England & Wales, started last April. Historically, the first year of these programmes (2010 is the first year of theKAPLAN PUBLISHING 21
  26. 26. Chapter 3 current five year investment programme) have seen sharp falls in project starts as the companies finalise their new investment plans. However, the timing of planned major projects will remain an important influence upon the overall value of project starts in the sector. Several large projects (that is, projects greater than £100 million) in pre-construction planning are also expected to boost the flow of utilities-related project starts. Major expansions at many of the UK’s largest ports will generate high value construction work over the next 12 months. For instance, a £400 million project at London Gateway and £200 million project at Felixstowe started on site late in 2008. In addition, major port developments are also planned for Middlesbrough and Belfast and these could see construction work starting on site within the next 18 months. Additional environmental factors are also affecting upcoming projects. The UK has a target to reduce carbon emissions to 80 per cent of 1990 levels by 2050, which is driving a retrofit challenge across the country. Other initiatives include plans for all new build homes to be zero carbon by 2016.22 KAPLAN PUBLISHING
  27. 27. Industry sectors Relevance in the exam Although much of above reflects the position of these sectors in the UK market, this provides a good barometer of how each sector is performing in many developed countries. This awareness will help when considering the prospects for each of BZCS’s divisions, particularly if re-structuring options were being considered.KAPLAN PUBLISHING 23
  28. 28. Chapter 424 KAPLAN PUBLISHING
  29. 29. Key playersChapter 4: Key players There are a number of key players in the market. Detailed below are a few of the ones that have many similarities with BZCS. Balfour Beatty is an international infrastructure services business. They operate across the infrastructure lifecycle with four businesses in professional services, construction services, support services and infrastructure investments. They deliver services essential to the creation and care of infrastructure assets including investment, project design, financing and management, engineering and construction, and facilities management services. They work for customers principally in the UK, Europe, the US, South-East Asia, Australia and the Middle East and aim to differentiate themselves based on the highest levels of quality, safety and technical expertise. Total revenue for the y/e 31 December 2009 was £8.95bn.KAPLAN PUBLISHING 25
  30. 30. Chapter 4 Based on their interim accounts to 26 June 2010, key financial indicators include: Company Industry Sales (5 year 20.74% 4.24% growth) Net profit 2.44% 1.75% margin Return on equity 29.97% 4.95% Current ratio 0.87 1.89 Debt to equity 0.37 0.52 In 2009, 59.9% of revenue comes from the UK, 31.7% from the US and 8.4% from the rest of the world. In addition to their strong financial position, other strengths of the business include: - A strong order book. In the y/e 31 December 2009, the company reported a 10% increase in the size of their order book (year-on-year) to £14.1bn, 1.6 times the revenue earned in 2009. - Diversified revenue stream which helps to reduce exposure to any one particular market sector. However, weaknesses of the business include a limited presence in emerging markets and a weak liquidity position.26 KAPLAN PUBLISHING
  31. 31. Key players Kier Group is a construction, development and service group specialising in building and civil engineering, support services, public and private house building, property development and the Private Finance Initiative (PFI). The Group employs over 11,000 people worldwide and has annual revenue of £2.1bn, of which £1.5bn came from the construction and services division. Based on their financial accounts for the year to 30 June 2010, key financial indicators include: Company Industry Sales (5 year 5.5% 4.24% growth) Net profit 1.97% 1.75% margin Return on equity 41.35% 4.95% Current ratio 1.15 1.89 Debt to equity 0.29 0.52 Similar to Balfour Beatty, Kier has a strong order book and a well diversified revenue stream. Additionally, its profitability ratios are increasing, primarily because of its low cost operating model. However, it has limited exposure to differentKAPLAN PUBLISHING 27
  32. 32. Chapter 4 geographical areas and suffered a fall in revenue of £55.9m from 2009. Carillion plc is another support services and construction company, employing around 50,000 people. They have annual revenue of around £5bn and operations across Britain and in Europe, Canada, the Middle East, North Africa and Caribbean. They have a portfolio of work in areas such as health, education and regeneration, road, rail, defence and commercial property. A key strength of the business is its brand reputation. The company has won awards in recognition of its services from sustainability and community engagement to technical innovations and safety. Revenue in the year ended 31 December 2009 was 4% higher than the previous year, with operations in the Middle East expanding by 19.2% to just over 10% of total revenue. Carillion also has a history of value added acquisitions, including Carillion JM Ltd (formerly Mowlem Ltd) and Alfred McAlpine. Both of these acquisitions yielded significantly higher cost savings than had originally been expected.28 KAPLAN PUBLISHING
  33. 33. Key players On the downside, the value of Carillion’s order book at 31 December 2009 decreased by 13% from the previous year to £17.7bn. Relevance to the Exam An awareness of the strengths and weaknesses of other key players in the market will allow you better assess the position of BZCS and evaluate how significant their own strengths and weaknesses might be.KAPLAN PUBLISHING 29
  34. 34. Chapter 530 KAPLAN PUBLISHING
  35. 35. Risk managementChapter 5 – Risk management Risk is an inevitable part of the construction industry – as indeed it is part of any profitable industry. As a result, contractors need to plan carefully to mitigate these risks Successful risk management requires a commitment from senior management and the creation of a corporate culture that constructively avoids apportioning blame. The success of any construction project is partly down to the attitude taken to risk. A positive attitude where the goal is to succeed will generally encourage staff to be more innovative, take more risk when appropriate and work harder to manage risks. Meanwhile, a negative attitude where the goal is to avoid failure will discourage such activities. Risk management in construction projects involves identifying and assessing the risks in terms of impact and probability, and establishing and maintaining a joint risk register agreed by the integrated project team Insolvency Construction has traditionally been a high risk industry for insolvency. This was borne out in Q4 2010, when construction firms accounted for around 15 per cent of all insolvencies, the single largest sector affected. There is little guidance for subcontractors facing an insolvent main contractor.KAPLAN PUBLISHING 31
  36. 36. Chapter 5 For example, although now out of date, the JCT form of contract, one of the two forms most commonly used in UK construction, only has a practice note for employers in the event of the insolvency of the contractor. With weekly stories of developers being put into administration, there will be numerous contractors considering their next move. Dundas & Wilson senior associate Claire Donnelly says that under a standard JCT 2005 contract The contractor should prepare an account setting out: - the total value of work completed at termination - loss and expense claims - removal costs - costs of materials or goods paid for or on which payment is due; and - direct loss and/or damage suffered because of termination. In reality, the contractor is unlikely to receive what he is owed and will join the list of unsecured creditors. Even if money does become available, he may only receive a proportion of what he is owed. Before signing a new deal, contractors should remember the administrator is only an agent of the employer, and not personally liable for the32 KAPLAN PUBLISHING
  37. 37. Risk management employer’s obligations, therefore contractors should prioritise financial protection. The contractor should consider negotiating a combination of payment guarantees, advance payments, and payment on delivery of goods. Cash flow Cash flow management can be the biggest headache a small company boss faces, especially with payment dates of 60 days or longer. Now that large clients prefer to bundle up work and award it to main contractors rather than deal directly with local firms, the headache can become a migraine. Cash should be thought about from the outset, rather than when problems occur. When tendering for a job, contractors should consider not just how much it is worth but how it will be funded. SME contractors should not be afraid to ask for funding information from their potential customers, whether they are clients or main contractors. Even if a subcontractor can’t get access to a client’s or main contractor’s funding bank, they can do a credit check on them and continue to monitor their business, noting project wins and growth. Contractors may consider other parts of a tender such as its worth, materials and their own suppliers but not about funding the contract until it is won. Alternatively, credit insurance will pay out when aKAPLAN PUBLISHING 33
  38. 38. Chapter 5 customer goes bust or is unable to pay for work. While it doesn’t manage cash flow directly, it can give a company security and more bargaining power. If a company is seriously overdue in payment then the contractor should have some systems and procedures in place which might culminate in taking staff offsite and stopping work. Safety risks All construction projects that will last longer than 30 days or 500 man hours must be notified to the Health and Safety Executive (HSE) as per the Construction (Design and Management) (CDM) Regulations 2007. Contractors must check that the client is aware of their duties, check that a CDM co-ordinator has been appointed and ensure that HSE has been notified before the work starts They should also co-operate with the principal contractor in planning and managing work, including reasonable directions and site rules and provide details to the principal contractor of any contractor engaged in connection with carrying out work. Contractors must provide any information needed for the health and safety file and inform the principal contractor of any problems with the plan, or of any reportable accidents, diseases and dangerous occurrences.34 KAPLAN PUBLISHING
  39. 39. Risk management Construction remains one of the most dangerous industries in which to work. In 2009/10 there were 42 fatalities, giving a rate of 2.2 per 100,000 workers. However, this still represents a massive decrease on previous years, with fatalities dropping by 72 per cent since 2001. Prosecutions by the HSE can be costly, with total fines last year coming to £2.7m, or just over £10,000 per firm fined. Relevance in the exam These are all risks which BZCS must be aware of and have plans to mitigate.KAPLAN PUBLISHING 35
  40. 40. Chapter 636 KAPLAN PUBLISHING
  41. 41. Strategies for growthChapter 6 – Strategies for growth Successful businesses can’t afford to stand still, and this is particularly true for the construction sector. Market development – entering new countries Britain is home to some major industry talent and as a result, British firms can compete for construction contracts across the world. How a contractor can get into another country depends on the local legislation. For instance, many Middle Eastern countries such as Saudi Arabia or the UAE require that foreign firms enter in joint ventures with local companies. However, in countries where wages are typically lower than in the UK, construction firms may find themselves operating in a slightly different way. For general construction services, some firms partner with a local contractor as it can be hard for British companies to compete on price otherwise. Some contractors may also find their expertise has value in putting them in a position beyond basic contracting duties. For instance, Mace, which is working as a main contractor on the Shard in London, operates in a project management capacity in Qatar. Product development - changing sectors Although large contractors will work across the whole gamut of sectors, some firms will tend to focus on particular areas. Diversifying the project portfolio can help reduce the impact of a decline in a particular sector but comes with its own set of challenges.KAPLAN PUBLISHING 37
  42. 42. Chapter 6 Broadly, a contractor doesn’t need to set up a new division to enter a new sector, although some firms will acquire and incorporate smaller contractors who may already have a presence. Acquiring smaller firms that already have expertise in specific sectors can be quicker and cheaper than developing entirely new departments. One example is main contractor Kier’s acquisition of solar panel installer Beco in December 2010. The company has become the delivery arm of a new unit, Kier Energy Innovations, which is likely to take advantage of the Green Deal, a forthcoming government programme that could unlock up to £170bn for energy-efficiency upgrades to the UK housing stock. Certain sectors will require contractors to contain specific elements. For instance, most sporting stadium projects will require a contractor with a strong in-house design department. What is crucial for all sectors, however, is that the contractor can demonstrate its supply chain is geared up to meet the demand for a sector. Therefore it is possible for a main contractor to expand into a new sector without the need for new divisions or joint ventures provided the supply chain base already has the necessary experience. Other expansion plans Given that PFI and PPP contracts tend to incorporate a maintenance or support services element, any contractor looking to enter into these agreements will38 KAPLAN PUBLISHING
  43. 43. Strategies for growth need to have expertise beyond the element of constructing. Joint ventures can be a common way of bringing these expertise to the table and a contractor will submit a bid in conjunction with a facilities management firm. Some firms, however, prefer to keep the work in house. For instance, Balfour Beatty’s works are carried out by Balfour Beatty Workplace. The firm originally started life as independent firm Haden Building Management, but was acquired by BB in 1986 and subsequently rebranded in 2008. Mergers and acquisitions 2010 saw several major mergers and acquisitions, notably as a result of the collapse of contractors Connaught and Rok. Connaught, which worked primarily in property maintenance for the public sector and providing affordable housing, went into administration in September 2010 with debts of £220m. Rok, meanwhile, called in the receivers in November and worked mostly in providing building services to the public sector So for example, Morgan Sindall subsidiary Lovell bought a number of maintenance contracts and assets from Connaught’s administrators for £28 million in September and Balfour Beatty subsidiary Mansell bought the majority of Rok’s remaining business in November for £7 million.KAPLAN PUBLISHING 39
  44. 44. Chapter 6 But acquisitions aren’t just as a result of company collapse. As this book goes to print there are some significant hostile bids in the offing including Costain’s approach for Mouchel and ACS’s attempted takeover of Hochtief. Keep an eye out for how things progress. Relevance in the exam These all represent opportunities for BZCS to expand. Key to the discussion of any of these options is to address the risk involved.40 KAPLAN PUBLISHING
  45. 45. Corporate and social responsibilityChapter 7 – Corporate and social responsibility With such an impact on the global economy, there are several CSR issues that face the construction industry – and the industry itself may also be crucial to helping other firms meet their CSR requirements. Sustainability Given the carbon generated by actual construction work, and the impact buildings have on the country’s carbon footprint, sustainability needs to be high on the agenda for all construction contractors. Construction companies must look at the carbon footprint of their own businesses and integrate across the supply chain if they are to meet the legal obligation to cut carbon emissions by 80 per cent by 2050 according to the government’s chief construction adviser Paul Morell. Additionally, the Waste and Resources Action Programme (WRAP) has a voluntary agreement commitment to halve the amount of construction waste going to landfill in the UK by 2012. Since the programme’s launch in 2008, over 400 contractors have signed up. Contractors looking to participate within the agreement need to set a target for reducing waste to landfill and assign a team member with responsibility for delivery, embed the target within corporate policy and processes, set requirements in project procurement processes andKAPLAN PUBLISHING 41
  46. 46. Chapter 7 engage with the supply chain, measure performance at a project level relative to a corporate baseline, and report annually on overall corporate performance. Imperial College in London used off site construction for the first phase of their £100m Riverside scheme and, together with clever on site segregation, ended up only sending four skips per month to landfill instead of as many as 80 skips. Health and safety The nature of work within the construction industry means a high priority must be placed on health and safety. Companies must do all that they can to ensure their staff return home safely each day from work. Furthermore, the duty of care can stretch far beyond the working day as contractors need to be mindful of their staff’s exposure to materials such as asbestos when working on refurbishment projects. Despite the dangers in construction, the situation is improving. In December 2010, the National Specialist Contractors’ Council’s (NSCC) Accident Survey, covering 157,000 workers, showed injury rates were at their lowest levels since the survey began in 2003/2004. The major injury rate was down 47 per cent compared with last year alone. Over half of all accidents resulted from either handling, lifting and carrying or slip and trips. The NSCC said this was consistent with all industries in the UK and the construction sector as a whole.42 KAPLAN PUBLISHING
  47. 47. Corporate and social responsibility Taking a proactive approach to safety is vital. Mansell safety, health, environment and quality director, Janice McCann, states “It’s a mandatory condition that everyone on a Mansell site holds a Construction Skills Certification Scheme card [a card which demonstrates a worker has achieved a measureable level of competency]. We don’t have anyone on site who doesn’t know how to use the tools. We’re confident of the competence level of people arriving,” she says. Following on from this basic training are site inductions, where method statements are put together, outlining which tool should be used for a specific job. “The requirement to use the right tool and not improvise is covered in the site induction. Even subcontractors need to supply a method statement which is evaluated by site management,” says Ms McCann. The tool operative then just needs to comply with that particular method statement. Cutting back on the health and safety budget can have wider impacts on quality. A main contractor that doesn’t make sure its subcontractors aren’t keeping up runs the risk of paying for substandard work.KAPLAN PUBLISHING 43
  48. 48. Chapter 7 Bid rigging September 2009 saw the Office of Fair Trading fine 103 construction companies a total of £129.5 million after they were found to have colluded on building contracts. The firms were each fined an average of £1.26 million – or 1.14 per cent of their annual worldwide turnover. The decision followed what was one of the OFTs largest ever Competition Act investigations. The breaches affected a series of building projects across England, including schools, hospitals and residential schemes, worth a total of more than £200 million. Since the fines, the OFT has hailed significant improvements in contractors’ awareness of illegal business practices since it delivered the results of its investigation into bid-rigging in the construction industry in England last September. The primary method for bid rigging targeted by the investigation has been cover pricing. Through this method, contractors have in the past been able to inflate the costs of their contracts. Cover pricing is when a contractor bids for a job with no intention of winning the tender. Often, a contractor will be on a client’s supply chain, and usually will wish to stay on that list, but they may not have an interest in working on a particular project.44 KAPLAN PUBLISHING
  49. 49. Corporate and social responsibility By submitting an artificially high bid, the contractor avoids the risk of winning the job but maintains its place on the tender list. Where this infringes competition is when the contractor trying to avoid winning the job contacts another contractor who is attempting to get the contract and asks for a cover price. The second contractor then supplies a price around 10 per cent higher than its own bid. This higher cost can then be submitted by the first contractor as a bid. It is the collusion between two bidders that infringes the law – and of course, if an arrangement is made where both contractors will benefit at the expense of the client through cover pricing, this ultimately drives up the cost of construction. A report published by the OFT has uncovered increasing awareness and understanding of competition law and business behaviour in a number of areas including: - Nearly 75 per cent of contractors are aware of the OFT’s decision on bid rigging in the construction industry. In 2008, fewer than a third were aware of earlier infringement decisions in the construction sector - Nine in 10 construction firms now recognise that bid rigging, including cover pricing, is a serious breach of competition law with associated penaltiesKAPLAN PUBLISHING 45
  50. 50. Chapter 7 - Three-quarters of contractors are aware of fines as a penalty for cover-pricing, compared to less than half in 2008 - Approximately two in three procurers have introduced a new mechanism in the last two years to detect or prevent anti-competitive practices. From firms surveyed by Construction News, most respondents confirmed their procurement teams have begun their own investigations into the matter. When asked what measures they would be taking to safeguard themselves against anti-competitive activities, many said new controls were “under discussion”. One said: “We revised our ‘invitation to tender’ documents, making it clear that if we become aware of any anti-competitive behaviour such as cover pricing, the firms concerned will be struck off our approved list and we will report them to the OFT or the police, or both.” More than half the officials said both cover pricing and bid rigging distorted competition and were as bad as each other. A further 16 per cent also said they still did not understand the difference between cover pricing and bid rigging. More than 90 per cent also said the inquiry had damaged the reputation of the industry. “This has46 KAPLAN PUBLISHING
  51. 51. Corporate and social responsibility made us review our procurement policies and will ensure we now review large differentials in pricing,” one senior manager said. Relevance in the exam Ethical issues are high on the agendas of many of the real life construction companies. BZCS needs to maintain its heavy investment in its CSR policies to compete. The cost of non compliance and potential damage to the brand has increased. The potential list of ethical issues that could arise in the exam is lengthy. You should ensure you are aware of the strategies adopted in real life to help you identify potential solutions and provide sound, commercial recommendations.KAPLAN PUBLISHING 47
  52. 52. Chapter 848 KAPLAN PUBLISHING
  53. 53. 25 Quotable factsChapter 8 – 25 Quotable facts - Every £1 spent on construction in the UK is estimated to generate around £2.84 in economic activity. - Around 9 per cent of Britain’s workforce is in the construction industry. - Nearly a quarter of all UK SMEs work in construction, generating around £174bn. - In the UK, the construction value chain accounts for 13% of GDP. - The global construction market is estimated to be worth around £4.7 trillion, representing around 10% of global GDP. - Construction sector output in November 2010, compared with November 2009, dropped by 6.8% in the euro area and by 1.7% in the EU27 (Eurostat) - US construction spending increased 0.4% in November 2010 (v 2009) according to the US Census Bureau. However, the figure was still 6.0% lower than that of November 2009. - In the UK over £34 billion worth of construction projects started on site in 2010. - The number of office projects in the UK is expected to rise by 41 per cent in 2011, compared to 2010.KAPLAN PUBLISHING 49
  54. 54. Chapter 8 - The Construction Products Association estimates that the industry will grow by 5.8 per cent between 2009 and 2014. - China is expected to be the world’s largest construction market by 2020, accounting for 19.1 per cent of global construction output. - Emerging construction markets in Asia-Pacific are estimated to grow by 125% over the next decade. - Balfour Beatty is Britain’s largest contractor in terms of turnover and profit, at £8.9bn and £282m respectively. - Over 2010, the average turnover for the top 100 contractors increased by 3.8 per cent. - Jarvis, Connaught and Rok were three of the major contractors which went into administration during 2010. - In Q4 2010, construction firms accounted for around 15 per cent of all insolvencies, the single largest sector affected. - Average tender prices have risen by 6 per cent over the last year. - The average increase in price for commonly used construction materials is around 6 per cent over the last year. - Metal prices have surged by 20% - 40% since June 2010.50 KAPLAN PUBLISHING
  55. 55. 25 Quotable facts - 39% of construction firms are tendering at break-even levels according to a survey by KPMG. - The minimum amount of time a project has to remain open for tender can vary according to the bidding procedure, from as little as 10 days to 52 days. - Fines issued by the Health and Safety Executive cost the UK construction industry £2.7m over the last year. - Major injuries in the construction sector were down 47 per cent in 2010, compared to 2009. - Bid rigging fines cost the UK construction industry £129.5 million in 2009. - The number of fines equates on average to each fined firm losing over 1 per cent of its turnover.KAPLAN PUBLISHING 51
  56. 56. Industry speaker notesIndustry speaker notes52 KAPLAN PUBLISHING
  57. 57. Industry speaker notesKAPLAN PUBLISHING 53
  58. 58. Industry speaker notes54 KAPLAN PUBLISHING

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