Adapt or die

CW gleans fascinating insights for local contractors

Contractors are striving to cut costs and ensure safety and efficiency are not sacrificed as a result.
Contractors are striving to cut costs and ensure safety and efficiency are not sacrificed as a result.

CW gleans fascinating insights for local contractors from the latest KPMG survey of the global construction industry.

Following the doom and gloom that pervaded the construction industry over the last couple of years, things seem to be looking up again, with major contractors cautiously optimistic about prospects going forward.

Al-Futtaim Engineering MD Dawood Bin Ozair says: “I am still very hopeful for 2011 and going forward, especially as we are seeing a little bit of buoyancy in Dubai and the Northern Emirates.”

Ozair adds that Abu Dhabi is a big market, while Qatar is growing as well. Saudi Arabia is almost a greenfield market in terms of its potential.

Voltas Limited executive VP and COO Shaukat Ali Mir says that while some projects had been cancelled, “we are positive they will all come off in the first half of 2011.” The company is also engaging with a local partner in Saudi Arabia in order to crack that market.

While it has not done a lot of actual work in Saudi to date, Mir says a lot of effort has gone into making sure the essentials are correct: “In terms of business development, in terms of getting business recognition, in terms of getting prequalified, all that has happened. What is happening now is we are resourcing the joint venture now, and we are bidding on a number of projects, and we are hopeful that the next few months will bring in some work as well.”

What is interesting about such comments from major contractors is that they dovetail neatly with the findings of KPMG International’s Adapting to an uncertain environment Global Construction Survey 2010. The survey offers fascinating insights for local contractors.

As with many industries, the depth and length of the worldwide economic downturn meant another trying year in 2010 for the engineering and construction sector, noted Geno Armstrong, KPMG international section leader: engineering and construction.

Declining backlogs and falling profits meant it was hard to predict what would happen in the next six months, let alone a year ahead.

In order to provide an accurate picture of the global industry and what its prominent players thought of as the main issues and stumbling blocks, KPMG conducted face-to-face interviews with 140 senior leaders in 2010.

Many of these were CEOs from major engineering and construction companies in 25 countries, with turnovers ranging from $250million to more than $5billion, and operational ambits extending from domestic to regional and global.

Interestingly, Europe, the Middle East and Asia represented 46% of respondents. It is these regions that are anticipated to lead the global recovery in construction.

Despite the slow economic recovery in many regions, the global engineering and construction industry retains a surprisingly positive outlook, states the survey. Four out of ten (38%) of respondents said their backlog had increased in the past year.

Margins continue to erode, however, with few seeing any improvement soon and a third seeing further declines. However, the impact has been cushioned to some extent by reduced overheads due to cost-cutting measures.

Only a small proportion of global businesses have avoided price cuts, and even here there is a strong fear that cost-cutting will have to be implemented to boost margins.

Interestingly, 39% of the larger organisations stated they were slashing prices to near break-even levels – moreso than their smaller rivals.

The logic behind this approach is that shortfalls can be made up further down the line through by additional orders, increased internal efficiency and lower sub-contractor pricing.

“The responses to our survey suggest that many contractors are considering moving out of their comfort zone into new sectors or regions,” says Armstrong.

“On a global basis, there is a shift away from heavy infrastructure projects such as railways, roads and bridges towards power, energy, mining and water, particularly amongst the larger companies.”

The Middle East is probably an exception to this rule, where infrastructure – from rail to water and power – is in a boom period as it catches up with the residential and retail focus of the recent boom period.

“Facing stiff competition in their home markets, a number of businesses are developing an appetite for expanding overseas. There is strong interest in the Middle East, Asia, Australia, Africa and India,” says Armstrong.

Such growth is likely to be organic, rather than through mergers and acquisitions, while public-private partnerships (PPPs) are becoming increasingly popular as finance vehicles for costly infrastructure projects.

Importantly, expansion is not just about new markets and geographies, says Armstrong. It is also about increasing the service offering, and often reinvigorating the business (that is, if the downturn was not enough of a shock to the system).

Contractors are looking to move into such diverse fields as programme management and even facilities management.

“The increased importance of sustainability is also generating new strategic options via environmental businesses such as solar power, nuclear and water,” says Armstrong.

What all this translates into is a general feeling among global engineering and construction companies that the worst is over. However, Armstrong warns that such a sentiment could be premature or misplaced.

“Although there are hopes for an improved order book, much of this hope rests on the confidence of commercial project owners, and the various government spending reviews taking place, with a number of projects on hold until these have been clarified.” This is particularly true of the UAE market, and Dubai in particular.

The survey states further that “the highly competitive commercial environment is putting strong downward pressure on bid prices and margins, and is also forcing construction companies to consider newer niche markets where the opportunities are greater.

Rather than simply fight it out over more standard building work, a number are choosing to focus on oil, gas, nuclear energy, power generation, water and infrastructure.”

Voltas is a prime example of such differentiation, as Mir explains: “We were mainly focusing on the built environment until 2009. In 2010 we came up with the strategy of a new vertical, which is industrial and oil and gas, where we will have a major focus on infrastructure, including district cooling, rail and metros and industrial plants.”

Mir says there are major opportunities in this regard in the vast industrial estates being planned in Saudi Arabia, for example.

“The willingness of contractors to move into new markets, and possibly to evolve their overall value proposition, could be the telling difference between thriving and merely surviving. With margins likely to rise in terms of traditional businesses, such a repositioning could be vital.

However, in a sluggish economic climate, there is only so much work to go around, and the coming year will most likely see some consolidation,” says Armstrong.

Another important feature highlighted by the survey is an increased focus on risk management. “We are very careful in taking on a project,” says Ozair.

“We evaluate the strength of the customer in terms of its ability to pay, which means we carry out a lot of due diligence in this regard.”

Key risk-management initiatives adopted by some of the respondents include educating and training employees, which goes hand in hand with an increased focus on health and safety. Other strategies are increasing analysis at the bidding and planning phases and standardising processes.

Other common approaches include a more formal risk framework, more frequent reviews, ERM integration and hiring risk practitioners. There is also a growing awareness of the need for risk committees, external reviews of major projects and peer risk reviews.

“When asked about the causes of underperformance against financial forecast, the most common response was poor planning, bidding and estimation, followed by inadequate project team performance and design changes,” says Armstrong.

Checklist for contractors
Despite the optimism demonstrated by many of the respondents to KPMG’s 2010 Global Construction Survey, the future is far from certain. While the research highlighted some real progress, it also identified a number of key concerns. To evolve further and achieve profitable growth, engineering and construction companies should address the following:

Continue to invest in risk management
By placing an emphasis on the upfront elements of a project – bidding, planning, estimating and design – and monitoring team performance, contractors can control quality, avoid errors and preserve margins.

Develop a permanently leaner business
In a world where prices are consistently under pressure, greater efficiency is the key to achieving profitability in the face of shrinking margins. By carefully managing all elements of the supply chain, and increasing productivity, it is possible to create a lower-cost operation.

Expand horizons
By looking beyond traditional markets and geographies, contractors can find valuable new niches. Higher margins may await those prepared to vertically integrate into financing, program management and facilities management, or alternatively to specialize in bio-electricity production, solar power technology, nuclear or water.

Build the right skills
To move into new markets, and achieve successful vertical integration, engineering and construction companies should nurture talent in key positions, invest in necessary training, and strive to retain the best people during adverse conditions.

Demonstrate good corporate ethics
Compliance, sustainability and safety can be key differentiators and are increasingly valued in the marketplace. Businesses that can show they are leaders in the fight against corruption, and that they are good corporate citizens, can emerge victorious in both the public and private sectors.

Get ready for change
Although the current revenue recognition accounting standards used by the industry have served it well for decades, the accounting standard setters’ proposed changes could significantly alter accounting and operational procedures.

And while many in the industry provided constructive feedback on the proposed changes during the comment period, it remains to be seen how the rule makers will address those comments in the final pronouncement.

Contractors should be thinking about how these possible changes would impact the accumulation, tracking and reporting of project data used in the revenue recognition process.

- 38% Have increased their backlog in 2010
- 31% Expect to hire more labour in 2011
- 6% Feel clients can get financing for speculative projects

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