A Brexit survival guide for UK construction

Jon White.

With the UK construction sector in a state of uneasy calm following the EU referendum result, Jon White discusses plans for surviving Brexit.

As the dust settles on Britain’s seismic decision to quit the EU, an uneasy calm is returning to the construction sector.

Industry sentiment in particular has been on a rollercoaster journey since the June referendum. In July the UK Construction Purchasing Managers’ Index, a closely-watched barometer of sector momentum, fell at its fastest level in seven years. Yet by September it had vaulted firmly back into growth territory. 

The impact of the referendum result on levels of work was equally mixed, with the latest official figures showing that UK construction sector output rose by 0.5% in July but fell by 1.5% in August. Yet the sector’s robust sentiment has led some commentators to conclude that the initial gloom following the referendum result was overblown. “What was all the fuss about?” they ask, while arguing that Britain and the EU will divorce amicably with little economic fallout.

However, such a stance underestimates the scale - and length - of the challenge ahead. Brexit will be a process, not an event. It will take several years and involve countless, as yet unknown, elements that those responsible for capital programmes must identify and adapt to.

The immediate repercussions of the referendum result is market uncertainty which is  being felt in four key areas:

 1. Supply chain

The supply chain is the lifeblood of a construction project and it’s essential that clients respond to the current uncertainty by showing leadership and engaging with and reassuring their contractors.

Even before June, UK construction had been grappling with what RICS describes as the worst skills crisis in almost two decades. The post-referendum uncertainty is inevitably putting greater strain on supply chain capacity.

Contractor balance sheets have not fully recovered since the recession leaving them weak and susceptible to further negative impact. In the current market uncertainty, contractors may be tempted to bid at lower margins to secure work. In addition some clients may make late changes in their investment decisions which will disrupt contractor pipelines resulting in extra supply chain costs. This backdrop could increase the threat of contractor insolvency.

Clients must therefore watch their contractors closely in coming months for any evidence of distress. But there is a delicate balancing act to be achieved – the intelligent client will monitor, support and collaborate with their suppliers in equal measure.

 2. Contract commitments and liabilities

In normal times, contracts offer protection for both clients and suppliers – a bulwark against unpleasant or unexpected change. However an event as game-changing as the UK’s surprise vote for a Brexit may test existing contracts, and their interpretation, to the limit.

Brexit’s as yet unknown consequences are unlikely to have been foreseen in the drafting of some contracts or procurement strategies. Alternatively, parties may seek to argue that unexpected changes in statute introduced as part of the Brexit process could invalidate certain contractual agreements.

Clearly such a prospect represents a major liability for clients, so it is essential they review thoroughly all existing contracts for any such exposure. This should be done as part of a contract 'health check' or scenario-testing of the baseline cost, scope, risk and schedule to give the client a clear picture of what they have paid for, and what their future commitments and liabilities will be.

3. Cost base

The slumping value of sterling is rapidly translating into input cost inflation for UK projects that are already underway. British construction is heavily reliant on European imports – both of materials and labour, and Sterling’s post-referendum weakness was quick to filter through to material costs. In August, the annual rate of inflation for raw materials jumped to 9.3%, up from 6.2% in July.

Overall construction cost inflation could now rise further if contractors seek to cushion the impact of falling new demand and exchange rate volatility by increasing risk and contingency pricing on two stage tenders.

Looking further ahead, any weakening of the UK economy or tougher migration controls will make Britain a less attractive destination for foreign labour.  A reduction in the supply of skilled foreign workers would exacerbate the existing skills shortage and drive up labour costs. 

With inflationary pressures looming for construction’s two primary inputs – materials and labour – it’s essential that clients take proactive steps to review their project scope and identify potential risks to both cost and schedule.

4. Project controls

Robust project controls serve a twin purpose – as both a guarantor of efficiency and as an early warning system. They are never more important than in the current uncertain climate and clients should dial up the levels of scrutiny on all aspects of their projects.

In many cases this will mean using existing control tools more intensively – for example holding fortnightly rather than monthly progress meetings – but clients should also update their opportunity and risk registers to reflect the new reality. 

Where problems are identified, corrective action can be taken.  Where no problems are found, the client will enjoy the reassurance that their project is well managed and delivering business objectives.

Cool heads and considered responses 

Sterling depreciation poses an inflationary threat, but on the plus side it also increases the UK’s ability to attract foreign investment.

For all the speculation about the long-term effects of Brexit, the immediate impact is easier to quantify – continuing uncertainty, rising costs, deferred investment and pressure on the supply chain. One factor that will mitigate Brexit uncertainty is the government’s recent decision to proceed with the “three H” infrastructure projects.  This long term tangible commitment to the industry should allow us to invest and help ride any downturn in the real estate market. 

As the UK embarks on the formal process of Brexit, new challenges will emerge. Individual tactics will need to evolve in response, but an agile strategy that includes robust project controls and a commitment to a collaborative supply chain will enable clients to continually anticipate, adapt and achieve the best project outcomes.

Jon White is UK managing director of Turner & Townsend.