In this article, first published by Practical Law, we discuss why, while the impact of the pandemic on the construction industry has been substantial, it also presents an opportunity to reassess, plan and build resilience for the future. Moving to a point where low productivity levels, low predictability and low margins are a thing of the past will, however, require input from participants across the industry, and some new approaches.
Challenges facing the industry
The impact of the Covid-19 pandemic on the construction industry in the UK has been substantial. Major disruption to supply chains, and labour resourcing and other issues meant that output dropped significantly from March 2020. While there has been some bounce back in terms of growth and productivity from the nadir of the first lockdown, hopes of a "V-shaped" recovery have faded as the ongoing tiered restrictions, Brexit uncertainty and then a third lockdown have stifled site activity, supply chains and business confidence.
In a sense, the macro challenges to the construction industry posed by Covid-19 are nothing new. Issues such as low productivity levels, low predictability, low margins, financial fragility and a shrinking labour pool all sound like they are features associated with the fallout of the pandemic, when in fact they were all listed as barriers to overcome well before the pandemic became an issue (for example, see the Farmer Review of the UK Construction Leadership Council in 2016). The reality is that the unprecedented set of circumstances presented by the pandemic has exacerbated pre-existing and well-known problems within the industry.
However, that is not to understate the impact of the pandemic on construction businesses themselves. Results from an ONS survey in November 2020 showed that the construction industry had the second highest percentage of businesses with only between zero and three months' cash reserves. Just as was witnessed in the aftermath of the financial crises in 2008/9, the ultimate consequences of this level of cash reserve erosion can be stark: insolvencies and job losses.
Nevertheless, there is a silver lining. The nature of the external pressures exerted by the pandemic has meant that the industry has been forced to work differently. Businesses have been adopting remote working, embracing new technology to help productivity, ensuring work is carried out in accordance with evolving health and safety rules, or reviewing contracts to better understand and manage the risks posed by unforeseen events. Although 2020 was one of the most challenging years in living memory, it has presented opportunities for the construction industry to not only survive the current challenges, but to improve in the long-term and overcome its historic barriers.
How has the construction industry responded?
During the initial phase of the pandemic, we saw a surge in businesses seeking to protect their position and it was common to see parties issuing notices in relation to change in law and force majeure provisions. This was not universal though; the approach has varied across different parts of the industry. Particularly in the energy and utilities segment, many businesses were seen to be more willing to collaborate and acknowledge the unique circumstances of the pandemic. In some other areas, parties have placed more reliance on a strict contractual (and adversarial) approach. This has, at times, resulted in a protectionist stance from paying parties that are keen to retain cash and leverage the circumstances to exact payment abuse. It remains to be seen whether the latter approach is sustainable, given that some key pain points posed by the pandemic are likely to continue further into 2021 and beyond, meaning that collaboration could come to be seen as unavoidable.
One issue that is likely to endure is reduced labour resources and access to sites. This will affect certain parts of the industry more than others. For businesses undertaking indoor construction works, such as those on commercial premises, it is foreseeable that sites in the UK will be subject to ongoing restrictions or limits, even post lockdown or rollout of the vaccine. Outdoor works such as rail or highways are unlikely to be constrained to an equivalent degree.
Another key issue is supply chain capacity. In the construction industry, this needs to be considered from a global perspective. The UK-EU trade deal has brought some measure of reassurance for what had looked like a compounded issue (a large proportion of construction materials currently being imported from the EU). Nevertheless, the variable progress of vaccination programmes in different countries means that the supply of materials and parts is likely to continue to be disrupted.
Further changes we might expect to see are:
Examples of collaboration to address challenges posed by the pandemic have been seen since last March, in the form of fruitful "without prejudice" conversations and short-term deals (see above). However, it remains to be seen whether the momentum acquired in this regard triggers a more permanent shift in the construction industry, from the traditionally adversarial approach to a more collaborative model. Time will tell, once construction output returns to something resembling pre-pandemic levels and when temporary restrictions (such as the ban on statutory demands and winding up petitions where non-payment is Covid-19 related) are relaxed.
Certainly, the pandemic has demonstrated the need for more balanced contractual risk allocation in the future, whereby the risks and consequences associated with unforeseen events are apportioned more equally between parties to construction contracts. This can facilitate continued progress to projects or programmes without recourse to formal dispute resolution.
A boom in disputes
In truth, it is likely that any shift towards a collaborative construction industry would be tempered by the reality of financial pressures exerted by the pandemic. Low cash reserves may force companies to demonstrate that they are profitable and realistic going concerns, with insolvency the consequence for those that cannot reach that threshold.
In the short to medium term (up to the summer of 2021, when the rollout of the vaccine is expected to be largely completed in the UK), it is foreseeable that there will be an increase in the number of adjudications as companies try to drive more cash back into businesses to demonstrate viability and to stave off insolvency and job losses.
Similarly, a large number of retrospective claims are expected, with a rise in defect identification during this period, where there may have been less focus on quality and less opportunity for site reviews due to Covid-19 restrictions. An increase in defects claims through insurers (and the resulting greater pressure on insurers) may create a much tighter and tougher – and more expensive, possibly impenetrable – insurance market.
It is reasonable to assume that, since the beginning of the pandemic, businesses within the industry have been stockpiling problems that may come to the fore on completion or in final account discussions. In 2020 and early 2021, many companies will have been focussing on surviving and short-term "firefighting" but, in future, once the industry has reverted to more normal levels, these companies can be expected to turn to the issue of contractual entitlement.
What support has the industry received – and is it enough?
It has been reassuring to see the government's reaction to the challenges being faced by the industry. In November 2020, the government announced a "once in generation" commitment to infrastructure investment, pledging £100 billion to capital spending in 2021 (£27 billion more than in 2020). This includes a £7.1 billion National Home Building fund and a £4.4 billion "levelling up" fund for local authorities to finance local projects, which are expected to include new roads, libraries, museums and galleries and upgrades to railway stations, improvements to high streets and town centres. This followed on from the prime minister's "build, build, build" message in June 2020, when a £5 billion "New Deal" for the building of homes and infrastructure was announced as a means to counter the economic fallout of the pandemic, accompanied by the "most radical" changes to the planning system seen since World War II.
There has been a broadly warm reception to the government's recognition of infrastructure and construction’s vital role as a catalyst for a wider recovery, and the inevitable employment and procurement opportunities that increased investment would create. Inevitably though, doubts remain in the industry as to whether these lofty ambitions will translate into tangible actions. In the same vein, the government's emphasis on building has been seen to be somewhat misplaced; it has been suggested instead that the focus should be on improved project and programme delivery – something which will be impossible without business confidence.
Overcoming these challenges and building resilience against future crises (be they pandemics, natural disasters, recessions/depressions or so on) requires more than an injection of cash. A more holistic approach is required.
What are the longer-term opportunities and resiliency measures for the construction industry?
Whether couched in terms of building business resilience or seizing future opportunities, the challenge is the same: businesses need to adapt to industry and market developments or risk being left behind (resulting, potentially, in a two-speed industry). The difficulty is breaking a cyclical issue - without being a robust business with healthy cash reserves, a company will be unable to afford the capital expenditure often necessary to facilitate investment into new technology or working practices. But without that investment into and adoption of innovative, more efficient practices, it becomes very difficult for the business to remain up-to-speed in its industry, to win work and to generate the cash to stay afloat.
A potential solution to this problem might be to reform the public procurement system, with greater emphasis placed on innovation and efficiency, rather than just price. The government's recently-published green paper indicates that change is coming, with contracting authorities set to be encouraged to take a broader view of what constitutes value for money, such as social value. Unless this also includes an emphasis on innovation, critics have warned that businesses will be reluctant to commit the vast research and development investment necessary to create more efficient, innovative engineering solutions.
In a similar vein, the use of government frameworks can be seen as an important way for contractors to avoid a hand-to-mouth existence, providing businesses with the breathing space and confidence to invest in innovation and capitalise on the learnings and new practices from the pandemic. The public procurement green paper also suggests reform to frameworks, involving new "open" eight-year framework agreements, which are closed for an initial three-year period, then continually reopened over the next five years to allow new suppliers to join.
Another possible, but seemingly readily viable route to companies retaining more cash would be a mandate for project bank accounts (PBAs) in government construction contracts. PBAs have, rightly, long been heralded as a mechanism for improved cash flow along the supply chain on projects, since they ensure not only that the project team is paid, but that payment is timely, with the risk of payment abuse nullified. Is there now finally enough will within the industry to see their widespread use?
However it is achieved, more money in pockets means that businesses can better afford to invest in technology and innovative ways of working, which can improve productivity and efficiency and ultimately result in more profitable businesses with greater cash reserve – which will be more resilient to future crises.
The ways in which technological innovation and digital automation can facilitate improved productivity, efficiency and profitability within the construction industry are well-known. Technology like the integration of artificial intelligence and BIM to modern methods of construction, modular prefabrication, 3D printing of construction components and the use of drones and wearable technology to monitor site activity are not new, but the uptake has been slow. This is partly due to the cost, and also perhaps due to a general reluctance for change. The pandemic has provided the impetus for many to adopt remote working and digital alternatives to traditional practices. Now is the time for businesses to fully embrace those ways of working in order to maximise their potential.
Reproduced from Practical Law with the permission of the publishers. For further information visit www.practicallaw.com.