Margins of 5% – Utopia or a realistic expectation?

26/3/18
Utopia

With contractors generally reporting that their so-called legacy projects have been worked through and a return to positive margins and even profitability is being heralded, a new debate is raging … whether, with prudent selectivity and concentration on core business activities only, 5% margins are achievable.

With industry standard margins being at between 2 & 3%, however modest the aspiration may seem on first view, a 5% margin would be more than double what the best performing contractors declare in the normal trading conditions.  Remember too, this is margin, not profit, which means that after business overheads profit levels will be perhaps 1% – a meagre return for the contracting risk.

In a typical construction contract, whether traditional or design & construct, perhaps 85% of the Contract Sum value will be comprised of sub-contractor and supplier costs.  This does not leave much then for the cost of preliminaries, contractor’s risk and contingency allowances and the margin.  Preliminaries vary significantly with project durations, height and distribution requirements, but would typically be in excess of 10% of the prime cost of the Contract Sum.

To deliver the project and earn or collect the margin it has built into the Contract Sum, the Contractor has to procure the sub-contractor packages within it budget allowances, bring them to site and enable them to construct their works within their respective time allowances in conjunction with other sub-contractors which may precede, follow or work in parallel with them, such that the project overall is completed by the Date for Completion – that’s all there is to it!

Many contractors are seeking to improve their results by exiting from sectors and procurement routes that have been unprofitable for them previously, to find a niche, a value of contract or a specialism at which they can excel – all very laudable, but that is what every other contractor is seeking to do too.  Although I have seen many statements by contractors about withdrawing from competitive tendering, in practice I do not believe that there are many true instances where competition of some description does not feature in the selection process and over-supply is an issue in a competitive environment.

Margin erosion, the deterioration of the end result, can occur for any number of reasons, such as: preliminaries overspend; scope gaps; supplier claims; damage and contra charges; supplier failures; management of defects; delays & time over-runs; programming; project changes.  The Contractor can control some of these areas, influence others and may have neither control nor influence over certain of them despite being ultimately responsible under the contract.

It is a myth that contractors make money out of variations and changes; the best projects, for everyone involved are those which are properly considered and designed meaning that they can be delivered within the contracted budget and time allowances.

Despite what has been done and said about trying to make the construction industry less adversarial, about definition of roles and sharing of risks appropriately, little seems to have changed in the last twenty years.

The question of whether a 5% margin is achievable, or reasonable, lies with the Contractor and the relationship that it has with its respective market; what value it brings and what is the proper worth of its contribution.  Let’s look at this another way: do contractors get the margins they deserve, or deserve the margins they get?