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Supply and demand for supply chains
This month, partner Jonathan Hart from award-winning infrastructure law fi rm, Pinsent Masons LLP asks whether contractors are showing enough love to their supply chain and highlights some potentially unpalatable changes that might be felt for pricing of work
Historically, construction businesses are often the last economic sector to go into a recession but also the last to emerge, when the dust settles. In part this is a refl ection of the way in which contracts are let, especially where the public sector or regulated utilities are concerned. As a consequence of protracted procurement processes, projects which have been planned in happier times can be awarded in different economic conditions, whilst even when recovery has begun and there is talk of a new pipeline of work, it may be many months before that talk converts into genuine tendering opportunities, let alone having the potential for generating income.
It is perhaps too early to tell whether things are going to be different this time around. Certainly the speed of economic recovery seems to be different from country to country; interventions by governments also have had varying success in terms of stimulating positive economic reaction. However, perhaps the time has arrived to start taking measure as to how changing conditions are going to affect the assembly of supply chains and pricing new work, as and when that work comes to the market.
A shift in power
Despite talk of partnering and sharing in success, the relationship between main contractors and subcontractors often operates as a fairly rudimentary balance of power. Sometimes circumstances favour the main contractor and sometimes the subcontractor. The contractual allocation of risk and payment arrangements between members of the supply chain will usually be determined by this. Coming out of this downturn, it may well be that there has been a shift in power back to the subcontractors.
Why is that the case? A signifi cant factor is that the construction industry is in a different shape to how it was six years ago. Accountancy fi rm KPMG has identifi ed that in the UK alone,
since the end of 2007, over 4,000 businesses in the construction industry have been placed in receivership, administration under the Enterprise Act or subject to other form of insolvency administration such as corporate voluntary arrangement. In addition over 18,000 businesses have been wound up. Many companies which were part of pre-recession supply chains no longer exist. Those companies that are still active may fi nd themselves poorly equipped to face the change in the tendering landscape, whether as a consequence of redundancies to staff or under-investment in plant and machinery during the last few years.
New opportunities but fewer subcontractors may create serious capability problems. Increased demand – whether in respect of green-fi eld opportunities or picking up on backlogs of planned maintenance work – is almost certainly going to create capacity gaps and constraints on supply chains.
Considering pricing
Supply chain constraints are going to be most clearly felt where pricing is concerned. This may require re-thinking of tender strategies and how to engage with subcontractors prior to putting bids in. For those contract forms which are based around call-off mechanisms, frameworks or similar, this may be a particularly hard ask. Equally, where contracts are linked to pain/gain mechanics, such as the NEC option C or D forms, then pressure may be put on achieving targets. On those types of contracts there may be further issues to address as to how costs are treated as referable to the target cost. Defi ned terms around “disallowed costs” may mean that there is relatively limited scope to switch from one subcontractor to another in the event that there is inability to reach agreement with supply chain members as to price. There is no simple solution to this kind of problem – with the exception, perhaps of considering whether previous “master-servant” approaches to negotiations (if they have been used in
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