Online Exclusive: Strategies for dealing with rising construction costs
High materials costs, shortages of labor and commodities, supply chain issues and ongoing COVID outbreaks are enormous hurdles for the construction industry to overcome. Risks to contractors and subcontractors are apparent: lower—and sometimes no—profit. Risks to owners are not as immediate but, if not proactively addressed, may come in the form of defaults, delays or disputes. Collaboration between members of a project team, along with risk-sharing and involvement of contractors in constructability considerations, are what will bring new or resumed capital projects to successful completion.
Increased costs due to supply chain issues are accompanied by greater competition for building materials as many delayed projects are being resumed all at once. A January 2021 article in Material Handling & Logistics reported many companies were putting capital projects on hold due to the pandemic at that time, and it referred to an Accenture study that put the percentage of project delays for owner-operators of factories, mines, and refineries at 61 percent. Early 2022 finds a significant portion of those projects resuming and placing orders for materials. The spike in demand translates to even greater cost increases and longer lead times.
Since March 2021, The Associated General Contractors of America (AGC) has posted several editions of their Construction Inflation Alert, tracking fluctuations in materials costs and the lengthening of lead times for production and deliveries. The report issued in February 2022 was the fifth update of the alert and the fact that five such alerts have been issued in less than a year is considered by the AGC to be, in itself, indicative of the uneven recovery the construction industry is experiencing. The report cites a year-over-year change in producer price index (PPI) for steel mill products that went from a 5.2 percent change in December 2020 to 127.2 percent in December 2021. This accords with what construction teams in the hydrocarbon market are experiencing when supplying metals such as rebar and structural steel.
In addition to raw material availability, supply constraints with steel products include shop and fabrication delays, which should be a focus of consideration during preconstruction and early construction, with efforts made to achieve early commitment for material procurement. This means it is more critical than ever for owners to involve their contractors early. Early decision-making can accelerate relationship-building with vendors, subcontractors and suppliers, and it is the trusting relationships between contractors and suppliers that can mitigate some supply chain issues.
For example, a supplier may accept a contractor’s letter of intent and place a hold on prices or shop availability, although hold times are currently shorter than they have been in the past. Other solutions that were available prior to the pandemic, such as fees to expedite orders, can be off-the-table if materials are not available to work with, or if a shop is experiencing a labor shortage. Early planning among the team will need to consider this and other changes in the way business is conducted.
Early contractor involvement (ECI) enables more accurate constructability reviews and the presentation of alternatives that help ease supply constraints, because industrial contractors are skilled in balancing competing considerations across the entire building timeline. For example, they can run scenarios comparing materials costs to installation costs. Considering the situation with steel, it has been typical to place orders for the least amount of tonnage—and to lower tonnage, a shipment typically contains more individual fabricated pieces. In the current environment, one solution may to be to order fewer pieces, allowing the shop to fit in fabrication of the order sooner. However, this must be balanced against the cost of larger construction equipment to support heavier steel pieces, expected labor capabilities, and transportation costs. The team should also be strategic with delivery times and materials storage, where possible, although delivery and storage adjustments must also be balanced against other concerns, such as insurance. Designing or redesigning mechanical systems to use standardized shapes and sizes is another option that may shorten lead times and lower costs.
Phased bidding and work releases allow procurement and work to start before the final document set is complete. One of the first questions that should be addressed in preconstruction is how far in advance a critical material--especially steel-- can be purchased to ensure timely delivery and what will be needed by the designer to ensure what’s ordered will remain relevant to the completed overall project design.
With historical databases being less reliable than usual due to price volatility, regular communication with reliable third-party sources and vendors can help fill in the knowledge gaps. In addition to GCs, subcontractors have direct links to specialty suppliers for early indications of price escalation or shipping delays on the horizon. Cost volatility isn’t limited to materials; labor availability and the need to manage schedule impacts to limit overtime costs go hand-in-hand with rising construction costs.
These facts emphasize, again, the importance of assembling the team early. It is also important to achieve transparency for owners into how price escalation and product and labor availability may affect the project.
By working proactively together as a team, the effects of inflation on a given project's forecast costs can be more accurately determined, and as the project progresses, the effects of alternates can be weighed, values reviewed and adjusted, and the forecast refined. Data collection and analysis should rely on published indices agreed upon by both the owner and project managers.
Prequalification of subcontractors and vendors can reduce project variables by confirming a company’s safety and quality records—and it is more important than ever to assess a company’s financial strength. Subcontractor prequalification also allows efficiencies associated with division of labor. By looking at what capacity a given subcontractor has, and what labor they bring to the pool, output can be maximized. In addition to capacity, a subcontractor can be assessed for their ability to manage a specific risk category; the most able subcontracting company can then be made responsible for managing that risk, improving the odds of a good outcome. Contractors who remain friendly competitors with others in the market differentiate themselves in the current environment, improving results by partnering to combine strengths.
While procurement of metals, concrete, plastic, lumber and other major materials may be the first thing that comes to mind when thinking through supply line issues, it is important to manage all of the other manufactured elements, as well, such as insulation, paint and supporting construction materials (scaffold, specialty tooling, consumables, etc.). When it comes to contracts with shipping companies, non-traditional approaches are also being seen. Shared transports, alternate modes of transportation and more just-in-time deliveries are being maximized.
Finding out early in the project where challenges exist, and focusing on finding solutions, is key.
A final way in which early-stage planning can mitigate downstream delays and price escalation is through contract documents. Contracts should be written with a high degree of transparency, with language adjusted to share risks in the event of price escalations. Including such clauses in a bid can reduce uncertainties and actually lower bid amounts, since it reduces the incentive for contractors to include other contingencies to cushion themselves from price increases—a result that is beneficial to the owner.
Thorough risk assessment and evaluation of alternatives are keys to success as capital projects continue to experience delays and the potential for cost overruns. Early planning and contractor involvement fosters transparency and timely supply chain feedback for team-wide communication and proactive decisions for effective cost management and forecasting.
Shawn Anderton, Operations Manager, Graycor