The big MEP rebound
Vivek Vijayakumar on Frost & Sullivan's latest research report
Senior research analyst Vivek Vijayakumar talks about Frost & Sullivan’s latest research report on the MEP sector in the GCC.
How has the economic crisis impacted on the MEP sector?
MEP services are an integral part of building activities, and the most demanded services within the construction sector, as it is required to keep building functions fully operational. So any impact on economic growth will directly impact the growth of the construction sector – which, in turn, will impact the growth of MEP services.
The growth rate of MEP services in the GCC over the last three years was around 19%, a period when there was a boom in the construction sector and oil prices were soaring. However, the growth rate showed a slight dip in 2008, and tumbled to almost 5.5% between 2008 and 2009 due to the sluggish economic and financial outlook, thereby reflecting the reduction in construction activity.
We expect the market to grow at a compound annual growth rate of 11% during the next five years, showing a gradual incline in growth during the end of 2010 or at the beginning of 2011 till 2013 owing to higher investments in real estate and infrastructure projects, mainly because of the GCC’s significant market characteristics and resilience.
You state the sector was valued at US$13.53 billion in 2008. What are the criteria for this figure?
The criteria are based on the comments and estimates from major market participants on the overall market size across GCC countries; their perceptions and expectations on the current and future market have also been taken into consideration. Finally we summed up their revenues using a bottom-up approach to estimate the market. We also considered the overall population of small, medium and large companies in each of the six GCC countries and the percent share they account for based on the revenue bracket they fall into through considerable sample-size coverage.
You talk about a ‘fragmented and highly competitive market’?
The market is fragmented and highly competitive mainly because of the presence of many small and medium scale companies at the local level, which have capabilities to do either one or two of the three types of services by competing directly with other contractors or by sub-contracting with top companies, thereby providing more opportunities for the growth of local players.
We have noticed that many civil contractor companies/real estate developers are trying to enter the MEP services market with their in-house technical capabilities in order to maintain their profit levels. Many international companies are entering/expanding into the market either through tie-ups (with existing and established civil or MEP contractors) or solely into potential markets such as the UAE, Saudi Arabia and Qatar. Apart from this there is not much consolidation happening in the GCC market in terms of MEP services.
MEP service providers are trying to get into the FM services business as a value-added resource (aftersales services) mainly to streamline their profit levels and to maintain their sustainability levels in order to offer a comprehensive, one-stop service solution and to balance the risk involved in both businesses.
Have the entry barriers into the MEP sector changed significantly as a result?
Due to the reduction in construction activity, increase in construction material and labour costs, players are likely to assume higher risks and finally end up with lesser profits, thereby resulting in limited or lesser entry into this market currently, which may likely change in the future once MEP costs go down. These are some of the barriers that are likely to impinge the entry of global, regional and local players.
The sector ‘is likely to take off in 2011’?
Yes, the reason is an increase in investment from both the public and private sectors in real estate and infrastructure, which is expected to boost the market further during the end of 2010 or at the beginning of 2011. The factors that could impinge on this take-off are:
• Delay in the commencement of construction projects due to lack of availability of funds;
• Lack of investor confidence;
• Decrease in oil prices;
• Volatility in exchange rates; and
• Higher inflation costs and construction commodity prices etc.
Has the downturn brought to light any structural problems or deficiencies within the MEP sector?
The following structural problems or deficiencies are prevalent within the MEP sector:
• Higher attrition rates is a major problem during the downturn, as emerging economies are drawing labourers away from the region, posing a threat to manpower;
• Reluctance of existing players to take on large-scale projects that require a high level of technical expertise and innovation and involve a high risk due to the increase in construction commodity/material prices and labour costs;
• Delay in payment to the contractors due to insufficient fund reserves, which result in stoppage/postponement of projects;
• Volatility in exchange rates and material prices, which tends to result in the rescheduling of projects/tenders;
• Higher inflation costs are affecting project development directly by a delay in commencement or sometimes even the stalling of projects. In light of this, contractors are instituting a two-stage tender process, which will allow them to keep a project moving without stalling, thereby removing risks as well as enabling efficient management of pricing and price inflation.
You state that Saudi Arabia, Qatar and Abu Dhabi are expected ‘to shore up the market for MEP services’?
Yes, the Saudi Arabia, Qatar and Abu Dhabi economies are relatively insulated from the financial downturn due to their surplus cash reserves and the latest stimulus packages announced by their governments, providing more opportunity for MEP services going forward. According to Proleads, there are around 2 837 real estate projects estimated to be worth in excess of US$2.4 trillion under construction, with the bulk of the development being carried out in Saudi Arabia and the UAE.
Moreover, the Saudi Arabia and Qatar economies were considered to be profitable for MEP services in the range of 9.5% to 10% due to their uninterrupted construction activities, backed by government spending, especially in the infrastructure sector, whereas the UAE is considered to be even more profitable than its neighboring counterparts, in the range of 10% to 11%, and it will remain the same due to its steady focus on huge iconic and sophisticated projects.
Has there been much of a ‘brain drain’ due to the downturn?
Yes, the downturn in GCC nations has created job insecurity, thus causing higher attrition rates.
These are some of the reasons for drawing labourers away from the region as the emerging economics are providing opportunities in terms of job securities and higher salaries. The impact is greater on the informal sector due to reduced profit margins as a result of players being unable to sustain their competitiveness amidst higher inflation, construction material and labour costs, weaker financial background and lack of regional presence, track record and technical expertise. Only the top MEP service providers are currently providing training for their employees, either in-house or on-site. Some are sending them to institutions to become qualified, and then reabsorbing these employees.
What is the future outlook for smaller MEP companies?
The smaller MEP companies with strong technical capabilities and a local presence are trying to establish themselves through a tie-up (either JV or acquisition) with top companies (either MEP service providers or with developers with an in-house MEP division) having a presence in all six GCC countries, or at least with companies having a presence in the top three potential countries, so as to expand themselves regionally.
These smaller MEP companies will normally end up doing a limited number of projects either through sub-contracting or self-performed. There is a chance that these companies will sometimes end up not doing any projects in a year; some might close down after a year. These companies generally have a profit margin in the range of 5% to 7%, depending on the economic conditions of the country and the type of projects they get involved in.
You state that ‘contractors are continuously upgrading their services’. This implies a new focus on quality, customer service and value addition?
Yes, in order to cope with the growing development of next generation/green buildings, huge iconic or sophisticated projects, island projects and multi-tenant/mixed-use developments, MEP contractors are upgrading their services continuously by investing in in-house pre-fabrication, design and service capabilities. The increasing focus on next-generation developments is mainly due to the need to be cost-competitive due to energy-efficiency and environmental sustainability factors, and also to enhance the market dynamics.
What is the forecast in terms of material and labour costs?
Due to the rise in construction commodity prices and labour costs, we expect the direct material cost to go higher in future. Also, the cost of direct labour will increase in the future due to rising staff accommodation costs. Finally, net profit margins are likely to decline further, placing added pressure on contractors going forward. All material prices related to construction are an important end consideration in terms of profit margins.
Technologies such as BIM are becoming more important?
BIM software currently does not play a major role in the sustainability of MEP services in the construction sector in the GCC, as the construction industry still has a long way to reach such a high level of technical proficiency. It is dismaying to note that everything concerning MEP design has been done manually in 2D to date, especially in a region like the UAE, where there are massive and incredible projects taking place. BIM software will allow MEP engineers to slash overall project costs, speed up the design process and improve build quality by reducing mistakes. The usage of BIM is not under the scope of the study.
• The most demanded services within the construction sector are MEP;
• The market was valued at US$13.53 billion in 2008. This is estimated to reach US$22.44 billion in 2013, at a compound annual growth rate of 10.6%;
• The fragmented and highly competitive market is likely to take off in 2011;
• Saudi Arabia, Qatar, and Abu Dhabi are expected to shore up the market for MEP services till 2013;
• Many civil contractor companies/real estate developers are trying to enter the MEP services market; and
• MEP service providers are trying to get into the FM services business as a value-added resource.
MEP gets a leg up with the expansion of the construction industry,
A surge in population, economic expansion and subsequently higher investments in real estate and infrastructure projects have generated considerable oil revenues and consequentl, cash reserves, aiding the exponential growth of the GCC construction sector. This development of the construction industry bodes well for the MEP services market, since it is considered an integral service within the construction industry.
New analysis from Frost & Sullivan, entitled ‘Strategic Analysis of the Mechanical, Electrical and Plumbing Services Market in the Middle East’, finds that the market earned revenues of US$13.53 billion in 2008, and estimates this to reach US$22.44 billion in 2013, at a compound annual growth rate of 10.6%.
The fragmented and highly competitive market is likely to take off in 2011, once the effects of the recent economic slowdown and reduced construction activities wear off and the economy rebounds.
Nevertheless, Saudi Arabia, Qatar, and Abu Dhabi are expected to shore up the market for MEP services till 2013, as their economies are relatively insulated from the financial downturn, thanks to their surplus cash reserves and the latest stimulus package announced by the government.
“Moreover, improved awareness about energy and environmental sustainability, as well as public health and safety concerns, are expected to go a long way in boosting the market for MEP services in the next five years,” says Frost & Sullivan research analyst Vivek Vijayakumar. “Already the most in-demand service of the construction industry, MEP’s popularity will soar further with the strengthening of the GCC’s commercial, residential, hospitality, infrastructure, and educational sectors.”
Meanwhile, the GCC has mandated all types of buildings to install technologies and services that will make them environment-friendly. Owing to such constant demand, contractors are continuously upgrading their services by investing in in-house pre-fabrication, design, and service capabilities to diminish the strong bargaining power of the end users.
Such measures will involve dealing with the escalating cost of construction, construction commodity prices, and labour cost. The prices are not likely to decrease due to the steady global demand and rising accommodation costs of labour, which could severely constrict contractors’ profit margins.
The market could also be adversely affected by the labour drain, as emerging economies are drawing labourers away from the region. In such a scenario, it has become vital for a company to recruit and send employees to training institutions to hone their skills, initiate training in-house or provide on-the-job training.
However, contractors can skirt the issue of manpower through technological developments, which will limit on-site prefabrication and thereby lower time and manpower needs on-site and boost productivity hours. Additionally, the involvement of design engineers in the early stages of construction and correct selection of materials will ensure proper building integration and sustainability by reducing its operating costs.
“To gain a competitive edge, it is critical for MEP contractors to offer scalable and comprehensive contracting service solutions as a one-stop shop, and back it up with effective qualified manpower for project design, installation and service support,” notes Vijayakumar.