The impact of an economic recession

Abstract

Purpose – The aim of this report is to evaluate the impact of an economic recession on the current tendering practices of UK contractors.

Design/methodology/approach – An extensive literature review of the topic was undertaken to form the research hypothesis and a number of research questions. This was further developed through two interviews with industry specialists which formed the basis for cognitive mapping which when mapped can then assist in forming a questionnaire. A pilot study was conducted and upon receiving positive feedback the questionnaire survey was completed.

Key findings – The results show that clients and contractors are reverting back to type and that the advances made by the Latham and Egan reports has stalled as price has become more important than quality once again. Public sector contracts have been observed to offer considerable opportunities for contractors as the client has a triple A rating and the projects are typically long term which can help contractors to survive the recession.

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Implication for practice – The construction industry cannot obstruct change but needs to embrace it and adopt and improve existing practices which can benefit all the stakeholders. Comparable to the Latham and Egan reports, a new report needs to be completed which can aid the construction industry so that the effects of this recession are felt for the shortest time possible.

Originality/value – The literature review and cognitive mapping provide a detailed insight into the topic but due to time constraints the quantitative analysis does not contain an adequate amount of responses to be relied upon.

1. Introduction

The construction industry is constantly evolving as a result of; a levelling of the trade cycle, methods of placing contracts, increased emphasis on quality, experience and innovations, increased competition among firms and a change in clients buying behaviour (Yisa, Ndekugri & Ambrose, 1996).

In addition to the changing attitudes of clients in construction which was promoted by the Latham and Egan reports the economic climate has brought additional difficulties to the industry. Clients have become more advanced and are continually seeking improvements within the industry to meet there needs. They have also realised that during difficult times, they can use their dominance to acquire a better deal (Woods & Ellis, 2005, pp.321).

This report presents a study aimed at evaluating the impact of an economic recession on current tendering practices of UK contractors. The hypothesis of this research is;

“That the construction industry has adapted and improved in the last number of decades but will have to continue to do so in the face of new challenges”.

The research questions include;

1. What are the main factors considered by contractors when deciding to tender and how does an economic recession alter these? e.g. Below cost tendering.
2. How can lean construction, partnering and supply chain integration be used in construction to add value?
3. How has a change in procurement methods been used to improve tendering practices in construction?

It was decided to combine qualitative and quantitative research methods in order to receive a greater understanding of the topic. The approach employed is that qualitative research facilitates quantitative research by providing a hypothesis or assists measurement by suggesting questions (Oyedele, 2009).

The hypothesis was established through reading relevant journals and this was developed further through carrying out two interviews which when mapped assisted in forming a questionnaire. This questionnaire was completed by a number of industry personnel in order to facilitate further analysis through factor analysis which followed on to regression analysis.

The report provides a detailed analysis of relevant literature aswell as two detailed interviews with industry specialists. Due to time constraint however the quantitative analysis was limited to fewer questionnaires than would have been liked so the results are helpful but not to the standard that would be required for this report to be become significant to industry.

A future quantitative analysis is recommended in order to make use of the work to date and complete the research.

2. Literature Review

2.1 Tendering Practices

The construction industry has evolved greatly in the last number of decades and this has been mostly due to changes in the economy and how the construction industry and others viewed it. There was an obvious need for change following previous recessions and a common agreement that the industry was failing to meet all the stakeholder’s needs.

2.1.1 Construction Industry Reports

The different reports which have been published in an attempt to improve the construction industry and consequently tendering practices are discussed by Cooke & William’s and shown below in Figure 2.1. (Cooke & Willams, 2009, pp.5).

Naoum (2003, pp.72) highlights the Egan report which was published in 1998 and how it compares the construction industry to that of the 1960’s manufacturing industry. This theme of the construction industry lagging behind its industry counterpart is evident in not only tendering practices but many other aspects (Emmitt & Jorgensen, 2008).

Lathams (1994) main focus was that there needs to be a ‘win-win’ mentality between the client and the contractor whereas Egan (1998) focused on how quality and efficiency could be improved within the industry. This led to a more client focused approach which Oyedele & Tham (2005, pp.53) feel aided in creating a more integrated process within construction.

2.1.2 Changing Client in Construction

Awareness and competition between contractors has allowed the client to become more advanced and to seek improvements within the industry to meet there needs (Yisa, Ndekugri & Ambrose 1996, pp.51). The client has realised that during difficult times, they can use their dominance to acquire a better deal (Woods & Ellis, 2005, pp.321).

The largest client for the construction industry at present is undoubtedly the public sector and this is discussed by RICS in their third quarter report for 2009 when they use the headline, “Public sector workloads continue to support construction activity”, (RICS, 2009).

This fact was also noted by Naoum in 2003 when she noted that despite a decline in public spending the public sector was still the largest client, (Naoum, 2003). The changing face of the client can be traced back to the early 80’s where there was a rapid privatization of government bodies such as the NHS, prison services, water services, schools, etc, (Yisa, Ndekugri & Ambrose, 1996, pp.54).

These clients sought further changes in tendering practices as their emphasis was on speed, value based services and cost-time-quality performance and a move towards partnering (Langford & Fellows, 1993).

2.1.3 Current Tendering Practices

(Edum-Fotwe & McCaffer, 1999) discuss how tendering has transformed from the 1960’s whereby private and public jobs were awarded solely on competitive tendering to a situation whereby a variety of issues are evaluated. There has been an industry wide shift from “lowest price wins” mentality to a “multi criteria selection”.

Naoum (2003, pp.72) goes into further detail by outlining the disadvantages of using price-based competitive tendering. The traditional forms of contract have been adapted (JCT 98 standard form – JCT 2005) to accommodate change in the industry but the Latham report regarded the NEC contract as having the best potential for achieving a positive outcome for all the stakeholders, (Cooke & Willams, 2009, pp.7).

The change in procurement methods are shown in the late 90’s in Figure 2.3 (Yisa, Ndekugri & Ambrose, 1996, pp.55). This change can be contributed to the need for a more integrated and less fragmented approach as the main contractor is managing both the design and construction activities and can promote contractor led innovation.

Risk, which is increasingly important in a recession is being shifted away from the client and towards the contractor under Design & Build and Private Finance Initiatives.

2.1.4 Decision to Tender

A contractor’s decision to tender can greatly affect their balance sheet at the end of a year. Projects are becoming more expensive and time consuming to tender for and the factors which need to be considered are highlighted in Figure 2.4 (Cooke & Willams, 2009, pp83-86).

Hughes (2004) found that the average contractor will spend 3% of turnover on winning work. He also suggets that traditional competitive tendering is much more expensive than design and build as there is considerably more competition and a lower success rate.

Walwork (1999) argues that there is equal importance between “right project” and “right price” in order to make a profit. Kometa et al, (1996, pp.273) evaluate the need for the clients financial stability to be discussed in greater detail. They draw attention to the risk of late payments or client insolvency.

This point is highlighted by Shepherd (2009) when he states in a correspondence that;

“Undertaking such large tenders, where procurement costs are north of £5m, takes a lot of thought and consideration. The client will have to show, for example, that they are organised and appear to be an efficient procurement authority. In a recession we will become a more discerning bidder as cash is tighter and projects more sought after.”

Happy to discuss more as is fit.

Cheers,

Andrew.

2.1.5 Below Cost Tendering

Whitten (2009) writing for Construction News explained how The Civil Engineering Contractors Association has warned of an emerging trend of firms pricing below cost.

They believe that for some organizations it is a matter of short term survival but that if it continues there will be an increase in disputes and a decline in investment in training and technology. Client and contractor relations have significantly improved in the last ten years but;

“will be stretched to breaking point if we see clients take advantage of the recession and of declining workloads to push for bargain base­ment prices.”

Both Whitten (2009) and Scully (2009) argue the point that below cost tendering is unsustainable and will increase the risk of contractors facing insolvency. Reductions in material and plant costs have been exceeded by the drop in tender prices. Insolvencies are predicted to occur firstly among contractors who tender correctly but fail to win the contract and then among those who win the contract with unsustainably low bids (Whitten, 2009).

2.2 Impact of an Economic Recession on the Construction Industry

A recession impacts on every sector but none more so than the construction industry as it is relies on large capital expenditure for its lifeblood. This results in a reduction in the number of projects along with an increase in the cost of borrowing to repay loans and pay wages (Ren & Lin, 1996).

RICS reported recently on their website (1st October 2009) that tender prices for new construction work will not rise until 2011 and that pre-recession levels wont be seen in the next five years. It was noted that if public spending was cut it would have a detrimental effect on the construction industry.

2.2.1 Economic Recession in Construction

A recession can be caused by many factors but the underlying reason is high inflation. The construction industry is labour intensive and owing to union’s demands for higher wages through government agreements, wages do not increase due to demand but social factors and move in one direction. This is the main cause of inflation in construction costs. Ren & Lin (1996) illustrate this relationship in Figure 3.1.1 for the last recession of the late 80’s and early 90’s.

The UK Government’s policy has been to provide a fiscal stimulus by increasing spending on large public projects so as to inject money into the economy which will filter down through all sectors (McFall, 2008). Green (2009) forecasted that the recession will match up to the recession of the late 80’s and early 90’s but that it will recover quicker. Once again public spending is the underlining reason for the upturn but it is questioned whether the continuous spending can be sustained.

The logical relation between high inflation which causes a rise in borrowing costs and a reduction in construction investment and thus a fall in the construction cycle is shown below in Figure 3.1.2 (Ren & Lin 1996).

2.2.2 Lean Construction & Supply Chain Integration

Lean construction is an adaptation of lean industry which is used aggressively by large car manufacturers to great affect (Emmitt & Jorgensen 2008). It is particularly relevant in a recession as it can be used at every stage and its main focus is to eliminate waste from the production life cycle so that value is added to each process, leading to lower costs, shorter construction periods and greater profits (Cartlidge, 2002).

It is shown below in Figure 3.2 how lean construction can be applied to different sectors of the construction industry (Cooke & Willams, 2009, pp.105). Lean construction benefits tendering as it promotes innovation and off-site production which reduces over all costs and provides increased quality to the client.

Practices such as downsizing, out-sourcing, de-layering and re-engineering have been widely used within both construction company’s and specific projects (Thorpe et. al., 1998). The use of sub contractors has increased as there is less overheads involved (Langford & Male, 1992). The benefits of partnering can be applied to co-contracting (main contractor-sub contractor) and supply chain integration (contractor-supplier), (Edum-Fotwe & McCaffer, 1999). This allows greater flexibility as both partners are working for a common goal and greater economies of scale can be achieved when tendering as contractors will have their own list of preferred suppliers or sub contractors which allows them to price new projects quickly and efficiently.

As suppliers account for such a high percentage of building costs their involvement at an early stage should be welcomed as they can contribute new ideas, products or processes (Cartlidge, 2002). Green & May (2005) propose that three models can be applied to the adoption of lean in construction: a lean model of waste elimination, partnering and structuring the context.

2.2.3 Partnering in Tendering

Partnering has been widely adopted in tendering in the last number of years as it offers the opportunity for improving the project outcome aswell as benefiting the whole supply chain (Dozzi et al., 1996; Larson and Drexler, 1997). It utilizes each participant’s expertise and resources so that the required business objectives can be met or exceeded (Bennett & Jayes, 1998).

Cooke & Williams (2009, pp.45) highlight the crucial elements of partnering which are reproduced in Figure 3.3 and they note that without all these elements, it is not partnering but merely an alliance. Partnering follows on from the previous sections as continuous improvement is achieved through lean construction, innovation and learning, problem resolution is promoted through use of the NEC3 contract and finally mutual objectives relates to a contractors decision to tender which is extremely important so that the appropiate parties are working together.

The benefits to construction companies is that they can share the risk of tendering with another company who may otherwise be tendering against them and have expertise in a certain area which would otherwise have to be paid for. As highlighted previously, future spending in construction is heavily reliant on the public sector which following the Latham and Egan reports is trying to adopt a team-building approach which promotes partnering.

Due to the economic recession in UK construction, companies have been using partnering to expand into global markets which have not been as widely affected. In a bid to reduce risk most companies form local partnerships so as to utilize local knowledge as well as reducing the costs associated with labour transfers (Edum-Fotwe & McCaffer, 1999).

While a more open relationship now exists between the different participants of a construction project Wood & Ellis (2005, pp.324) estimate that it will still be some time before a fully genuine relationship exists as there is an engrained culture of mistrust and deception. Successful partnerships offer the opportunity for repeat work but the client must be assured that tenders remain competitive within the relationship of trust.

2.2.4 Strategic Tendering & Project Mix

Strategic tendering and project mix become even more crucial to a companies success during times of a recession. As the private sector feels the impact of a recession firstly and for a slightly longer period it is in a company’s long term interest to carry out a more aggressive bidding policy towards the public sector (Ren & Lin, 1996). Another advantage of the public sector is its transparency and openness during the tender stage. While the public sector may be susceptible to mal-practice, construction companies know that they will be impartially assessed and receive feedback under new regulations (Statutotory Instrument, 2006).

Strategic planning can be very beneficial as it seeks to align a company in a certain direction. In todays climate contractors need to evalute the client when deciding to tender as many contractors have commenced work on a project only to instructed to withdraw as the funding has been restricted (Edum-Fotwe & McCaffer, 1999). A number of contractors have also begun to take on jobs at cost or even a loss in an effort to win work with the chance of repeat work. Also this keeps the company name in circulation and also to hold onto valued staff that might otherwise have to be made redundant.

Shepherd, the bid manager for Building Schools for the Future (BSF) is of the opinion that;

“Large procurement projects, such as BSF, lose some of the benefits of group procurement by being so expensive to procure. This creates a barrier to entry, which in some ways may affect the value in the procurement. The flip side is that for a contractor, you know you will be involved in a procurement process where you have a realistic chance of winning and that your scale delivers value”.

2.2.5 Innovation & Learning in Construction

One of the most revolutionary changes in tendering has been the use of e-tendering which has been used most notably on the multibillion pound development for the Olympic Games in London 2012. Innovation in tendering can offer many advantages as it provide substantial resource savings to a major part of the supply chain, with the key benefits being enhanced communication, time savings and reduced costs (Stephenson & Tindsley, 2008). IT has aided smaller companies in allowing them to compete with their larger counterparts in certain areas. Thorpe et. all (1998) argue that construction has yet to receive the full benefit of IT advancements compared to other industries.

Due to the competitive culture in the construction industry, up until recently there has been a lack of “organisational learning” which promotes the sharing of knowledge and experiences between companies (Barlow & Jashapara, 1998). There has been very little research into organisational learning but Poyner and Powells (1995) report emphasised its importance in providing competitive advantage which is especially relevant in an economic recession.

3. Research Methodology

The research objective is to evaluate the impact of an economic recession on the current tendering practices of UK contractors. In order to receive a greater understanding of the topic we are combining qualitative and quantitative research methods. The approach employed is that qualitative research facilitates quantitative research by providing a hypothesis or assists measurement by suggesting questions (Oyedele, 2009).

The research hypothesis was established through reading relevant journals and this was developed further through carrying out two interviews with industry specialists which when mapped can then assist in forming a questionnaire. A pilot study was conducted and upon receiving positive feedback the questionnaire survey was completed.

Figure 3.1 Research Methodology.

The literature review was sourced in the Queens, university library from textbooks, databases, journals, magazines and the internet. This source was particularly valuable as it allowed the author gain instant access to a vast array of websites, on-line articles, publications, current news etc.

3.1 Unstructured Interview

Following on from the previous chapter, two unstructured interviews were completed by industry specialists. The main aim is to develop a greater understanding of the subject in addition to the literature review and to stumble upon any differences between the two. This type of interview has no set format beyond the opening question but the interviewer may have some key questions which they can use to keep the interviewee on the topic. The interviewer is receptive to the interviewee’s responses and the interview follows a conversational style.

Both interviewees are employed by the largest privately owned construction company in the UK with offices also in India, Australia and the United Arab Emirates. The company has an integrated capability thus allowing a holistic view of construction.

The first interviewee is a project manager who has experience of tendering with Lagan and Farran construction and is currently working alongside NIW on a large PFI project valued at approximately £130 million.

The second interviewee is a bid manager for on the building schools for the future framework (BSF). He is leading a team on a project worth over £1 billion with a budget of £5.6 million.

3.2 Qualitative Research – Cognitive Mapping

Yin (1989) observes that in qualitative research the broadest question should be stated so that data can be drawn from a number of sources such as: archival records, direct observation, documents, interviews, participant observation and physical artefacts. Qualitative research is any kind of research that produces findings not arrived at by means of statistical procedures or other means of quantification (Strauss and Corbin, 1990). The interviews form the basis for the cognitive mapping and allow a greater understanding of the subject.

3.3 Quantitative Research – Questionnaire Survey

Creswell (2003) explained quantitative research methods are used to test or verify theories or explanations identify variables to study, relate variables in questions or hypotheses use statistical standards of validity and reliability, and employ statistical procedures for analysis. The next step was to formulate a preliminary questionnaire based on the main topics raised in the literature review and interviews and this was used to conduct a pilot study.

Slight modifications were made following the pilot study and a final questionnaire was produced which contains thirty eight factors that can be considered as significant in impacting on the tendering practices of UK contractors. In the questionnaire, the rating of the factors was done on a five point scale ranging from 1 to 5, where 1 represents “strongly disagree”, and 5 represents “strongly agree”. Respondents who had no opinion concerning the factors could select the answer of “indifferent”.

The third section of the questionnaire will be used in our regression analysis and it involves establishing a relationship between the different factors of our analysis. The final section allows respondents to write additional comments on any outstanding issues which had not been brought up in the questionnaire but which they felt were important.

A total of forty one respondents replied to the questionnaire and despite this being lower than was wished, due to time constraints the statistical analysis had to be completed nonetheless. Shown below in Table 3.1 are the total number of respondents and a breakdown of their characteristics.

4. Qualitative Results and Analysis – Cognitive Mapping

Cognitive mapping allows the analysis of large amounts of qualitative information and can be used to structure messy or complex data for problem solving. It is especially useful as a note taking method during interviews and assisting the process by increasing the understanding of the subject (Ackermann et al., 1992).

Decision explorer is a tool which allows relationships to be pictured relating to a subject. Data entry is provided using “concepts”, which capture the core aspects of a notion. The concepts are then linked to show the relationship and factors of importance between ideas (Brightman, 2002).

Figure 3.1 shows the three methods which can be used to question where a concept is leading towards. For the purpose of this analysis the method Action – Outcome was utilized as it was felt that it is best suited to exploring the subject and discovering the goals/outcomes. Once completed, debate and reflection can then follow on the most important factors which have been established.

4.4 Analysis & Discussion

Using the maps in the previous section the main factors can be discussed and their influence on other concepts.

4.4.1 Central Concepts Analysis

Central analysis reveals the concepts that have been linked the most times with other concepts and means that the concepts listed below have the greatest influence on the analysis. A central analysis was conducted and the following top five concepts were revealed:

1. Change in Contractor & Client Attitudes

2. 20 from 39 Concepts.

3. Contractors Using below Cost Tendering

4. 19 from 35 Concepts.

5. To Remain Lean and Competitive During the Recession

6. 15 from 31 Concepts.

7. Economic Recession

8. 14 from 32 Concepts.

9. Increased Likelihood of Repeat Work

10. 14 from 29 Concepts

All these top five concepts are directly related as the economic recession and change in attitudes has resulted in contractors using below cost tendering and lean construction to remain competitive during the recession with the increased likelihood of repeat work.

The main issue/driver mentioned in the interviews was the economic recession which as stated in my literature review impacts severely on the construction industry as there is a reduction in the number of projects along with the cost of borrowing to repay loans and pay wages increasing (Ren & Lin, 1996). This logical relation was explained in my literature review and is illustrated in Figure 4.1.

The change in attitudes from both the contractor and client was also discussed with Latham (1994) trying to adopt a “win-win” mentality and Egan (1998) focusing on improving quality and efficiency and creating a “movement for change”. This change from the 1960’s mentality whereby private and public jobs were awarded solely on competitive tendering to a situation whereby a variety of issues are evaluated (Edum-Fotwe & McCaffer, 1999) has put additional pressure on contractors forcing them to retain quality and project time but reduce their tenders to below cost if necessary.

Clients are having a greater participation and have requested a less fragmented approach which has resulted in a change of contracts to a more frequent use of design and build (Yisa, Ndekugri and Ambrose, 1996).

Interviewee No.2 feels that clients are manipulating the current climate in order to get the same quality of work done cheaper whereas Interviewee No.1 is of the opinion that it is the contractors who are quick to adopt below cost tendering in an effort to hold onto staff as other projects are completed.

The concept of remaining lean and competitive during the recession is extremely important and is discussed in great detail in my literature review. Cartlidge (2002) describes how lean construction eliminates waste so that value is added to each process, leading to lower costs, shorter construction periods and greater profits.

The concept of leanness incorporates reduced bid frequency as overheads need to be reduced. Walwork (1999) and Interviewee No.1 both stress the need for contractors to select the “right project” which will then give a greater chance of success. Innovation can reduce costs through “organizational learning” (Barlow and Jashapara, 1998) but both interviewees felt that as overheads need to be reduced innovation should come from your supply chain which have budgets for research and development. As discussed in my literature review suppliers involvement should be welcomed at an early stage so that they can contribute new ideas, products, or processes (Cartlidge, 2002).

Increased likelihood of repeat work was felt by Interviewee No.1 to come through partnering which allows a greater outcome for the whole supply chain (Dozzi et al., 1996; Larson and Drexler, 1997). A better outcome is achieved as the required business objectives can be met or exceeded (Bennett & Jayes, 1998). Interviewee No.2 felt that early involvement with the client allowed links to be established thus leading onto repeat work.

4.4.2 Domain Concepts Analysis

The domain analysis counts the highest number of links in and out of a concept and establishes connections with other issues within its immediate domain. It analyses local complexity but fails to examine the wider context of the subject. A domain analysis was conducted and the following top five concepts were revealed:

• 8 Links around

• 1 Change in contractor & client attitudes

  2 Contractors using below cost tendering

• 6 Links around

3 Increased public spending

4 Partnering and increased communication

5 To remain lean and competitive during the recession

The previous central results determined the concepts with the greatest influence on the entire map and therefore it follows that these should have the highest number of links.

Changes in attitudes, below cost tendering and lean construction were central to my literature review and interviews and this is why they have been highlighted here. The drivers for change are changing attitudes and below cost tendering with lean construction providing a number of strategies to improve through off-site manufacturing, innovative design and assembly, pre-fabrication, supply chain integration and pre-assembly (Cooke and Williams, 2009).

The government’s policy of increased public spending was noted by both interviewees and McFall (2008) in my literature review as offering a company strategy to survive the economic recession. RICS (1st October 2009) reported that tender prices for new construction work will not rise until 2011 and that if the public spending was cut it would have a detrimental effect on the construction industry.

This is further supported in my literature review which states that strategic tendering and project mix is even more crucial during a recession. Ren and Lin (1996) judge that it is in a company’s long term in