The commercial and residential building sector in Australia is in poor health and needs fairer contracting practices to remain viable, a new report has shown.

Published by the Australian Contractors Association, the All Risk No Reward report highlights that the building sector – which includes commercial, residential and public sector building construction but does not include work on heavy or civil infrastructure projects – is in crisis.

According to the report – which draws upon data from ASIC as well as credit reporting bureau Equifax:

• Building firms are current entering external administration at a rate which is twice that of other industries (see chart).
• Average profit margins have fallen from around three percent to less than one percent.
• Liquidity among building firms has fallen from 15 percent to less than five percent.
• More than half of all large builders are now carrying current liabilities which exceed current assets and therefore may technically be considered to be insolvent.

According to the report, these observations are not a simple reflection of the competitive nature of the building market.

Professional service firms operate in competitive markets yet enjoy pre-tax profits which are four times as high as builders whilst suffering only one-fifth of the rate of insolvency, the report says.

Moreover, the report argues that significant challenges arise out of common industry practices.

First, there are fixed price contracts.

As will be well-known to many readers, fixed price contracts require building projects to be delivered according to a specified price.

Under this type of contract, all project risk is transferred away from the client and is borne by the builder. This risk can involve factors such as design, ground conditions, weather, material cost/availability, third party interfaces and other matters.

Whilst the risk transfer that occurs under these arrangements offers benefits for clients, it may compromise project viability from the builder’s viewpoint in cases where a significant portion of the risk involves does indeed manifest itself.

Such builders are then forced to either wear a loss on the project or attempt to place pressure upon the supply chain to reduce costs. Where the latter is chosen, this can have flow on impacts upon both supply chain viability and the quality of construction.

This, ACA says, is especially problematic as many of the risks concerned are difficult to quantify at the time of contracting.

In addition to fixed-price contracts, the report says that the ‘lock in’ nature of many building contracts makes it difficult for either party to exit a contract and leaves dispute resolution processes as the only means by which problems can be resolved.

This, it says, negatively impacts all stakeholders including clients, contractors, subcontractors and suppliers.

Moving forward, the report urges change in three key areas.

First, contractors should be involved in project design through early contractor involvement.

This will enable a more robust assessment of the project’s risk profile to be undertaken during design and will deliver a more accurate estimate of cost. Involving contractors in design can also help to ensure that the final design is such that it enables the most efficient construction methodology possible.

When doing this, clients should avoid setting a formal cost at the start of projects.

Rather, the early contractor involvement should take place on a fee for service basis whilst the contractor works with consultants on design.

Through this process, the contractor will be able to quantify as much risk as possible and develop the more robust estimate of costs referred to above.

Once this has been done, the subsequent contract to deliver the main construction on the project can them be released to the market on more conventional terms with prospective bidders now having more robust information and greater certainty on which to base their bids.

Finally, the report urges clients to consider collaborative and equitable approaches toward the sharing of risk on contracts.

Under one approach, clients, contractors and consultants would work together during planning and design to develop a target cost for the project.

The deliver contract can then implement ‘painshare/gainshare’ arranagements under which differences between the target and actual costs are shared by the parties.

This would see clients pay a lower price and contractors receive a higher margin of profit on any projects which come in under budget but would see the client and the contractor each bear part of the impact of any cost overruns which occur.

Whilst the report acknowledges that government clients do not have the same aggregate influence within the building sector as is the case with engineering and civil construction, it nonetheless encourages governments to lead the way by adopting the above principles in their own procurement practices.

It argues that private sector clients are less well positioned to drive change compared with government clients on account of the fragmented nature of the private market and the fact that private sector players are subject to market forces that make it difficult for private sector practices to change forces in isolation.

(According to the report, private sector clients account for roughly 80 percent of non-housing related building work.)

The latest report comes as Australia’s building sector has been impacted by cost blowouts and delays over recent years on account of COVID, material shortages, freight costs, the Ukraine war/rising energy costs and shortages of skilled workers.

According to Producer Price Index data from the Australian Bureau of Statistics, this led to a 21 percent increase in overall building costs across all types of building (but excluding civil construction) over the two years to March.

The report also comes as the Commonwealth Government has established a National Construction Industry Forum, which consists of representatives from industry, unions and government and will advise the Government on matters such as workplace relations, industry culture, skills and training, safety, gender equity and productivity.

All up, Australia’s construction industry employs more than 1.3 million people (building and civil construction combined) and performs around $250 billion worth of construction work each year.

Australian Constructors Association CEO Jon Davies said that better practices are needed to put the industry on a more sustainable footing.

“The building industry is a textbook example of market failure,” Davies said

“The basic lesson is simple: fixed price contracts work well when the buyer knows exactly what they want, and the seller knows exactly how much it costs to produce. That market is not construction.

“In the building industry, all the uncertainty and risks are the responsibility of the contractor and, when those risks are realised, they are funded out of the contractor’s already razor thin profits.

“This practice of transferring all the risks to contractors under fixed price contracts has led to a deeply unstable industry.

“No contract can account for all the unexpected events that will complicate a building project as it unfolds, but it can incorporate mechanisms to encourage the client and contractor to resolve them fairly and reasonably.”

Davies says that benefits from fairer practices will be significant.

“Changing current practices will create the conditions for improved productivity and a healthier industry,” he said.

“A profitable construction industry is in everyone’s interests and should be a key priority for all governments.”

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