Inflation has been grabbing the headlines for the past several months.
Pundits, economists and politicians have been debating whether our current inflationary environment is a temporary pandemic induced supply chain shock or a longer lasting phenomenon that will need to be tackled with more aggressive action by central banks.
Regardless of the root cause, it is clear the inflationary environment has been more stubborn and persistent than many expected when it first arrived.
An environment like this presents many challenges and opportunities if contractors understand the risks and mitigate them appropriately.
In today’s Surety Corner we will discuss some of these concepts and what contractors should be doing to help weather the storm and come out on top.
David Bortolussi works as a part-time CFO and consultant for several construction companies through his Halifax based company DMB Consulting Inc.
“Inflation has become a major challenge for the construction clients I work with over the past two years since the pandemic began,” he said. “Construction costs have gone up even higher than the general rate of inflation and, in many cases, contractors are having to purchase early on in a project before major price increases occur (or because of longer lead times required), which presents an additional challenge in managing project and company cash flow. Recent interest rate increases by the Bank of Canada have trickled down to all lenders and has affected financing costs for new vehicles and equipment, whether purchased or leased. All indications are that the increases will continue for at least another year.”
Material price escalations
If you are active in the contracting world you are very familiar with the new reality that subs and suppliers will only hold their prices for a short period of time.
Things like wood, plastic, steel and other inputs have been fluctuating wildly, meaning subtrades and suppliers are unwilling to take long-term fixed price risk on these items.
However, for general contractors they could be left waiting weeks or months for a formal award.
This leaves the general contractor at significant risk on a bid where they are asked to submit a fixed price but the inputs into that bid are only guaranteed for seven to 10 days.
GCs should be taking one of two routes here.
Either accept the risks of these escalations and price accordingly with additional margin or be upfront with owners around the areas that are subject to inflation and where prices could run away.
This could include conditioning your bid. The key here is the owner has the information to be able to make decisions. If they know the price could escalate this might result in a quicker award so materials and supplies can be ordered quickly, locking in prices.
Contractors need to be wary of high value, critical path specified equipment required for any project. Today, items that once took two to three weeks lead time are now potentially six months to arrive and even at that there are no guarantees.
The name of the game here is communication. Owners need to know the facts early so they can plan accordingly. Contractors should be upfront about lead time risks and present alternate options for a piece of equipment which might allow a building to be occupied and turned over while the specified piece is waiting to arrive.
The Canadian marketplace is now seeing the confluence of several issues that have been building over decades. Our workforce continues to age with boomers retiring. Our industry is only now just putting the level of effort required to get young people into the trades at a rate to keep up with industry requirements.
Add to this the fact all levels of government are looking to spend on infrastructure to stimulate the economy, keep up with aging infrastructure and meet the demands of a growing population.
This now means that the fight for talent is fierce.
When discussing labour, Bortolussi said, “The labour shortage is affecting the construction industry and we see it in how much clients are having to pay every level of worker – from entry level labourer to carpenters, supers, estimators and project managers. Where a few years ago, you could pay $16/hr for an entry level labourer in Nova Scotia, now even at $20/hr it’s hard to find and keep people. Skilled trades have similar shortages – many are ‘baby boomers’ and are retiring or nearing retirement and no longer interested in working 50-plus hours per week compared to when they were in their younger years. There are not enough new trades to fill the gap. As a result, some projects are delayed, other projects are not bid on, and the ones bid on are priced higher to reflect labour, equipment and material inflation.”
There are important things to consider here.
As a business owner it is easy to get caught up in the race with rumors about salaries required to attract key talent.
While there is certainly wage inflation many businesses don’t have concrete facts about where the market actually is. Owners need to be armed with information about salary bands for their desired positions so that they are paying fairly but aren’t throwing money out the door.
In addition, any good business needs bench strength. Contractors should be investing in programs to hire graduates and train them from the ground up. You will sometimes lose these people but having a program that is consistently bringing in and training talent is a competitive advantage.
“Contractors are mitigating the challenges in several ways, by billing for materials purchased early on in a project, by ensuring that longer term projects have more significant price escalation clauses built into contracts, and by trying to find other ways of attracting and retaining employees other than constant pay increases. If employees feel part of a team and enjoy the people they work with day to day, not only are they more productive on the job, but they are much less likely to jump ship for a slightly higher rate,” said Bortolussi.
Many contractors who use surety capacity, or lending capacity for that matter, understand everything comes with limits.
While there can be flexibility with these limits, the current environment is pushing everything up.
A $1 million addition from just a few years back could now be $1.5 million. A $10 million school now might cost $15 million to build.
Ultimately, the sticks and bricks of the jobs are mostly the same but these new costs put pressure on cash flow, operating facilities and surety bond limits.
As with our other points, communication is key. Helping lenders and bond companies to understand the realities of the marketplace will put them in a position to accommodate larger projects.
Informing them how you are mitigating risk in an inflationary environment will also help. Any good broker should be helping you both understand today’s risks and how to communicate your plans effectively so you are ensuring you get what you need.
Andrew Cartwright is the vice-president of surety for FCA Insurance. Cartwright recently joined FCA after a decade long tenure as RVP for a large national surety company. Matt Manol is the manager of surety for FCA Insurance. Manol recently joined FCA after spending his last six years underwriting contract and commercial surety products for a large national surety company. Send comments and column ideas to firstname.lastname@example.org.
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