March 6, 2023
There is no shortage of concern about the current state of the Australian construction industry. Economic pressures continue to take their toll as insolvencies in the sector continue to rise while construction-related business failures are set to outstrip previous years. Hyper-escalation of material costs, inflation, supply chain delays, and labour shortages have coincided to create a bleak environment for a number of industry participants.
In this three-part series, we will consider:
- the current challenges facing the Australian construction industry;
- the operation and suitability of project delivery models in the current market; and
- what the future of project delivery in Australia might look like – is the future fully cost reimbursable?
What is the Problem?
The impacts from a number of stressors on the Australian construction industry have crystallised for many construction business who have found themselves in extremely dire circumstances, while others are left to tread very carefully to avoid the same fate.
Recent high-profile collapses of some of the construction industry’s bigger local players, including Probuild, Condev, Clough Group, and Longriver Group, highlight the seriousness of the circumstances at hand. The latest figures from the Australian Securities and Investments Commission (published on 28 February 2023) show that actions involving liquidations, receiverships, and administrations in the sector had reached 1,236 across eight months of the current financial year. To put this into perspective, the previous financial year closed out with 1,284 actions. With four months of the financial year left to go, we could expect the hits keep on coming.
What are the Causes?
There are a number of reasons which may be attributed to the vast number of casualties we have seen, including:
- increased costs to deliver Australian projects; and
- accumulation of risk under fixed-price construction contracts.
Increased Costs
The costs to deliver projects in Australia have increased significantly which has added more strain on contractors who are often operating on thin, or single digit, margins.
The construction industry is still grappling with the fallout from the COVID-19 pandemic which saw construction material input costs rise between 20% to 100% for materials such as timber, steel, and concrete due to an extreme global demand for materials, combined with supply chain disruptions. Although cost increases for material prices have slowed, they remain elevated above pre-pandemic levels and are predicted to rise again in 2023. Adding fuel to this proverbial fire, oil prices skyrocketed as a result of the war in Ukraine, contributing to further increases to some timber products and transportation costs.
Rising interest rates and inflation have added additional pressure to overhead costs as loan commitments for projects become more expensive. If a project costs more to run, the additional costs can impact the profitability of a project.
Further compounding the costs problem is a critical shortage in skilled labour. Demand for labour has increased in an overheated construction market, largely fuelled by the federal government’s record investment in infrastructure projects. As a result, the supply of labour has been constrained and costs have increased. Australia must compete for a limited global supply of skilled workers which has further added to wage pressures.
Together, the issues identified above have combined to create a “perfect storm”, leaving many contractors vulnerable to failure. This is often the case where contractors have assumed the risks for increased costs under unforgiving project delivery terms.
Contracting Models
The impacts of higher costs can be devastating for contractors who have assumed the responsibility for cost escalation under fixed-price contracts – often which may have been entered into years prior to the current market conditions.
As a result, a growing number of contractors have been unable to recover escalation costs which has pushed many into, or to brink of, failure. This can become a much larger problem for contractors who have entered into multiple projects and are now unable to service the accumulated costs.
This is not to say that fixed-price contracts are the cause of the problem. However, in the absence of best for project contractual mechanisms that equitably address the allocation of risk for extraordinary price escalation, this contracting model may not be suitable in volatile and unpredictable market conditions, or where projects risks are not reasonably quantifiable.
Considerations for Your Next Project
Critically, parties should ensure they take appropriate steps to address the clear and present risks in the prevailing market conditions. This may include, for example:
- Negotiating the inclusion into a construction contract of a rise and fall mechanism for extraordinary material price escalation;
- Ensuring payment terms facilitate positive cash flow for the duration of the project; or
- Adopting appropriate contracting models which minimise cost risks or provide a reasonable allocation of risk between the parties.
Stay tuned for the next article in this series where we will discuss the operation of project delivery models in the current construction market.
Lamont Project & Construction Lawyers
We have the industry knowledge and experience to assist both principals and contractors in all major construction projects. If you would like to discuss any of the matters raised in the above article or the forthcoming series as it relates to your specific circumstances, please contact Lamont Project & Construction Lawyers.
The content of this article is for information purposes only; it does not discuss every important topic or matter of law, and it is not to be relied upon as legal advice. Specialist advice should be sought regarding your specific circumstances.
Contact: Peter Lamont or Kristopher London
Email: [email protected] or [email protected]
Phone: (07) 3248 8500
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