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ANALYSIS: Govt will have to pay up for high-rise and other construction

Monday 23rd September 2019

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If New Zealand's construction industry is to thrive, the bottom line is that clients, particularly government ones, are going to have to pay more for buildings.

Steve Killeen, chief executive of Downer's New Zealand operations, spelled out the numbers at an industry conference earlier this month.

Any "decent" construction company wants to achieve a 3 percent profit margin after tax, Killeen told the conference, implying that a 7 percent gross margin is required to maintain the status quo to avoid further industry collapses and losses.

If the government wants the industry to invest, particularly in technology and training, gross margins need to rise by about another 3 percentage points to 10 percent, Killeen said.

He emphasised that the industry shouldn't be signing contracts it doesn't understand, or which impose unreasonable conditions. Nor should it be exposing itself to risks it can't quantify or manage. Ground condition risk, for example.

The consequences of failure abound at a time when construction in New Zealand has been booming for years and with a visible pipeline ahead suggesting that's not going to end in a hurry.

Treasury has just published a document, the National Construction Pipeline Report for 2019, which forecasts total construction, including the gamut of housing, commercial and infrastructure projects, will peak at $43 billion in 2021 but tapering off only a little to $42 billion by 2024.

The major indicators of industry distress are the collapses of Ebert, Orange-H and Arrow International, the sale of Hawkins to Australia-based Downer and the near $1 billion in losses Fletcher Building's high-rise construction arm, Building+Interiors, has reported.

When Fletcher announced its withdrawal from the high-rise construction market in February 2018, the government was clearly alarmed at the loss of such an important domestic player and that led to the signing of the Construction Sector Accord in April this year.

It was no accident that Fletcher's construction head, Peter Reidy – recruited in the wake of those losses – chaired the committee that developed that accord and Fletcher Building chief executive Ross Taylor has since declared the B&I unit open for business again, albeit cautiously.

Treasury's Infrastructure Transactions Unit will be folded into the planned new Infrastructure Commission, Te Waihanga, once it has been established. The unit's interim head, Karen Mitchell, told the conference that understanding of risk in construction is very poor across both the public sector and within the industry.

A lot of that came down to the growth of contracts that forced all the risks onto contractors.

The 197 pages of special conditions attached to Fletcher's contract to build the Christchurch Justice and Emergency Services Precinct - that project alone accounted for more than 40 percent of the B+I losses - was "bizarre," Mitchell said.

Often such additions to contracts have been a "transfer by stealth" of risk by consultants with the actual government-sector client unaware that was happening, she said.

But, as well as ensuring this ceases, public sector procurers of construction projects also need to be aware of situations in which the construction contractor is ignoring risks because that can point to a lack of commercial acumen.

Such commercial acumen has been missing from both sides of the table in the recent past, she said.

A report by independent engineering consultancy Advisian, commissioned by ITU and released last month, has a number of findings pointing to a "culture of mistrust" between the public service and the construction industry.

It blames this culture on the proliferation of special conditions added to standard construction contracts and that has led to misunderstanding, confusion "and ultimately, litigation."

As the report points out, "construction is not the core business of most public sector agencies," and it is unlikely this will change, so changes to procurement practices need to be made that will still improve project governance while tapping advice from industry experts.

In particular, "there are perceptions that the public sector does not understand the difference between lowest price and value for money."

The industry also believes that public sector procurers often aren’t fair and transparent in managing tenders, providing evidence of instances in which some public sector agencies haven't adhered to the evaluation process described in tender documents.

Advisian is recommending that government departments and agencies move away from simply selecting the lowest-priced tender.

"Responsible staff must be capable of evaluating construction tenders on a value-for-money basis, considering the whole of life costs and the impact of risk transfer."

One of its recommendations is that public sector procurers should actively assess "the level of risk transferred to individual contractors."  Tender analysis should also include an "assessment of the ability of the contractor to manage the risk and the costs and time associated with this."

A major reason that companies such as Fletcher tripped up was the adoption of the "early contractor involvement" model under which contractors signed up even before designs and specifications were finalised.

Advisian recommends that this ECI model "be examined."

It seems obvious that the model should be scrapped altogether; signing up to commitments before risks are even knowable goes to the heart of the problem.


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