The financial woes of the construction industry in Australia are getting a fair amount of media attention at the moment, especially in Melbourne where there have been several large volume building companies fall over and be placed into administration. There seems to me to be a high level of surprise. Surprise that big firms are going bust. Surprise at the perceived and/or real deceptions by the owners/directors/industry. Surprise that this situation could even occur. But the real story began several years ago and without meaning to say, “I told you so”, I had been predicting this very situation, so what has occurred is definitely no surprise to me at all.
The construction industry has for many, many years been the leading industry in Australia for formal insolvency actions. Pre pandemic the nationwide number of insolvency cases for construction companies averaged around 1,700 per annum. This amounted to between 20-25% of all insolvency cases in Australia annually. However, this is only the tip of the iceberg. There are over 425,000 construction businesses in Australia of which over 95% small businesses (under $5m turnover). In Victoria at the end of June 2022 there were 127,370 construction and building firms according to Master Builders Victoria. Of these 62.7% were sole traders not companies. This is an important fact for two reasons.
- The construction industry insolvency statistics are only on the 37.3% of construction businesses in a company structure. Almost the all the remainder are sole trader businesses. Extrapolating the insolvency statistics over the number of constructions companies just over 1% enter formal insolvency each year, and this number is actually decreasing. The number of construction companies is actually increasing by around 25,000 per annum, while the number of insolvencies is fairly stable at 1,700.
- There is little information available about sole trader construction businesses and business failure. Anecdotally though, a high percentage of these businesses cease operating. The Australian Bureau of Statistics show of the total 629,000 sole practitioner businesses in Australia existing in all industries in June 2018, only 54% were still around in June 2022 – an annual decline of 18.5%. Extrapolating these statistics to the construction industry around 49,000 sole trader construction business cease operating every year.
So, if you want to be surprised then you should be surprised and alarmed at the under-reporting in the media, and lack of public awareness of the failure of small construction businesses and especially sole trader construction businesses.
Knowing these statistics, and having lived in Melbourne through the pandemic lockdowns, my team called over 100 small construction businesses at the start of 2021. We did to forewarn of the headwinds that we foresaw and to suggest that construction businesses start preparing for them while they could make changes to ensure their businesses survived the looming storm. Bar none we were told how great the industry was. The government had incentives such as Homemaker to encourage and sustain the building industry. Customers had savings as they had been restricted with holidays, travel, of eating out for a couple of years. The orders books were full to overflowing.
However, this is what is known as a profitless boom. Some of the looming headwinds were: –
1. Structural industry issues
In Victoria residential homes are built with fixed price contracts. There are no escalation provisions. Volume builders also operate with thin margins c.f. milkbars v supermarkets. Therefore, is only takes a small delay, some cost increase and the margin disappears or turns negative. It is estimated that new home build costs have increased around 25% a year for each of the last two years.
2. Regulatory issues
The construction industry is heavily regulated in areas such as safety and environment. Non-compliance can lead to fines, site shutdowns and legal actions which are costly. Also complying with regulations is costly, and the more regulations being imposed the greater the costs being incurred.
Construction is a capital-intensive industry with large amounts of capital required for tools and equipment, vehicles and in the case of volume builders, capital for display homes.
4. Working capital
Businesses that are growing and businesses where delays occur require greater working capital. Lending from financial institutions was/is tightening and in the case of sole traders’ personal finances are becoming strained and savings are dissipating. Equifax report that sole traders are 80% more likely, and director of construction businesses 30% more likely to have missed mortgage repayments than the average consumer.
5. Labour shortage
Pre pandemic there was a skills shortage in the construction industry. Post pandemic immigration has been subdue and especially with skilled workers while at the same time demand and industry requirements for skilled labour has further increased. This is leading to project delays and increase staffing costs. There is also a net loss of construction workers with workers retiring in greater numbers than new entrants joining. It is also affecting suppliers as well.
6. Supply chain issues
The has been a dramatic shortage of material used in construction e.g., framing timber. There are also dramatic delays in actually receiving the material which leads to a spiralling increase in costs.
7. Economic conditions
Like all industries and all countries, economic conditions have worsened post pandemic. Inflation is high, growth is low, wages growth is stagnant. Operating costs have increased, capital requirements and funding costs have increased, and now there is beginning to be a downturn in the construction activity.
8. Environment challenges
While unable to be predicted the construction industry was impacted by floods, droughts, and fires.
So, what could have been done two years ago, and what could be done now?
- The construction industry is an ebb and flow, boom and bust industry. The scout motto is ‘Be Prepared’. There is a failure, especially with newer players in the industry, to plan well and prepare for the change in the cycle (boom or bust).
- At the start of 2021 the businesses we spoke to were too busy. Agreed, but they were too busy working in their business – on the tools – that they had no time to work on their business. This working on their business may have been of securing staff, training staff, securing funding, securing supply chain, planning for the looming change in business conditions, investing time in project management, IT, new methods and practices, and financial management.
- There seems to be culture in Australia to ignore problems – both pending problems and real problems. By the time there is a real problem however the options available to minimise the impact have greatly reduced. In Hemingway’s book ‘The Sun Also Rises’ the character Mike is bankrupt and Bill asks him how he went bankrupt. Mike said, “Gradually and then suddenly”. He is absolutely correct – most business don’t go into insolvency overnight but rather the situation develops gradually over time and then there comes a point where an event happens to bring matters to a head. This event might be a problem with a major project, or an action by a creditor. Often that creditor is the Australian Taxation Office – the fifth bank – calling in their ‘loan’.
- Invest in employees – it is far cheaper to train ad develop your existing staff, than it is to find and train new staff. Also make sure you have the right people – people that are engaged and valued.
- Innovate and adapt to new technology. There are plenty of examples of ‘boiled frog’ businesses that failed to innovate and that led to their demise. Contech reports indicate that 46% of construction industry businesses spend less than 1% of their turnover on IT.
Hindsight is a wise teacher and there are still industry wide actions that could be undertaken to reduce the prevalence and likelihood of failed construction businesses.
- There could be structural changes in the construction and building industry. Queensland have specific solvency reporting requirements before builders can get insurance. NSW government facilitated a market-led rating regime (iCIRT by Equifax) where construction businesses can opt to go through an independent and rigorous review process to obtain a star-rating outcome that substantiates and rates reliability and resilience. Using iCERT in the failure of ProBuild showed years prior to its eventual demise the rating declined from 2.5 bronze stars in 2019 to 1 bronze star in 2021 when it collapsed.
- Insurance process is ‘loose’ with delays in obtaining mandatory insurance leading to a period of exposure for customers. The coverage is also not ‘fit-for-purpose’ with the changes in the industry leaving customers potentially under insured and without the ability to change that.
- Deposits and payments could be managed much the same way as done in the legal professions through trust accounts and restrictions and hurdles to access those funds.
- Training on running a business could become a core competency in every trade qualification.
- Industry bodies and government could put a lot more effort and attention helping sole trader construction businesses – after all 29 times more sole trader construction business cease each year than company construction businesses.
I actually feel frustrated that building and construction firms are failing at the alarmingly high rates, but more so that lessons are not being learned, and action to change things is either not happening, being resisted or happening too slowly. I feel sorry for the unassuming customer victims, for the staff that lose their jobs, the suppliers that don’t get paid. I feel frustrated at the finger pointing and lack of self-accountability of the players in the construction industry. I feel helpless when help is arrogantly refused – like watching the proverbial slow car crash. I feel frustrated that the cycle will repeat itself and more people with suffer needlessly.