This article was first published by Marsh here.
As the construction industry sets its sights on 2023 and beyond, many economies are expanding construction budgets and key infrastructure spending. This should lead to numerous planned and critical projects finally taking off.
However, the industry is still reeling from the effects of global shocks, including the pandemic and the conflict in Ukraine, which has disrupted people, supply chains, and economies. And now virtually every type of construction project — whether residential, commercial, industrial, or infrastructural — is being impacted by the highest rates of inflation in more than 30 years and a significant staffing crisis.
As a result, while there is optimism about project startups and future growth, in the near- to mid-term, the industry is expected to remain in a state of flux.
Confluence of risks affecting construction industry
Construction companies are operating in a difficult risk landscape. The current price uncertainty is significantly disrupting assumptions previously used to estimate costs of materials, which makes it extremely difficult to both budget for and forecast contingencies for new projects.
Today’s reality is also affecting owners’ confidence in choosing the right general contractors and delivery mechanisms for their projects amidst heightened concerns of contract default due to higher pricing, material delays, and a shortage of skilled workers.
Despite the plethora of challenges, the industry and its stakeholders have proven to be resilient when faced with previous high inflation rates and cost and supply uncertainties. And now the industry has access to better data, information, and toolsets to help them mitigate risk and build upon resilience strategies at a time when it’s becoming increasingly difficult to establish and maintain project budgets and keep to established schedules.
As they continue seeking ways to improve their competitiveness and reap the promise of renewed spending in the sector, construction companies should focus on three actions
- Review contracts and delivery mechanisms
The strategic decisions made at the start of a contract are often the most important ones when confronted with a challenge, whether a contract dispute over roles and responsibilities, cost overruns, a contractor/subcontractor default, or a force majeure. At these moments, it is important to improve communication and strive for more clarity in agreements, keeping in mind the following.
- One size doesn’t fit all. Start with a fresh look at contracts rather than reflexively reusing the wording of previous agreements.
- Pay close attention to your chosen project delivery mechanism, which will be included in your contract.
- Refine your contract wording to reduce the risk of disputes, including those that may arise from cost escalation, labor shortfalls, and supply chain disruptions.
- Develop and implement a project risk management (PRM) system
Construction projects, especially major ones, require the involvement of a range of subcontractors at various phases. And many times, being able to progress the overall project will depend on a particular subcontractor having the needed materials and skilled personnel to carry out the work during the allotted slot, allowing the project to remain on track.
While many companies have enterprise risk management (ERM) systems in place, few have established a project risk management (PRM) system, which can reinforce financial and other stakeholder confidence in a project and help a project stay on track through the identification of risks and mitigation actions. A PRM system can also identify subcontractor performance issues early on and help owners and contractors address challenges in real time, either by working with the subcontractor to remedy the issue or identifying a replacement. Either approach can help reduce the risks of a project upset that triggers a costly delay.
- Take steps to minimize claims
Whether a claim is tied to faulty design, poor workmanship, the impact of a natural catastrophe, delay-in-start-up, or subcontractor default, it can significantly affect a company’s liquidity. Companies should focus on trying to reduce the potential of claims by identifying problems early on and addressing them in a timely manner via a PRM system or other means.
If a claim cannot be avoided, it is important to focus on reducing the costs and processing times so that work can continue. Companies can use effective claims benchmarking to help determine best practice in handling claims and identify cost savings opportunities. It is also important to identify causes of loss and address the issue to reduce the risk of similar challenges in the future.
The current geopolitical, economic, and social risk landscape is putting increased pressure on construction companies, requiring a robust risk management plan that helps them identify evolving and emerging risks and take action to address them. As risks become more intertwined and complex, contractors should seek a more collaborative approach with project owners that allows for risks to be shared and projects to move forward to their successful completion.