May 2021 Issue
FW discusses the outlook for construction with Erin Roberts, Fernando Gonzalez Cuervo and Axel Schäfer at EY.
FW: Could you provide an overview of the key challenges the construction industry has faced over the past 12 months or so? How difficult has it been for the industry to find opportunities for growth?
Roberts: Much of the industry entered 2020 with healthy business conditions and historically high backlogs after almost 10 years of consistent growth. The initial impact of the pandemic was reduced productivity during the social distancing-related slowdowns and shutdowns that occurred for a short period of time as contractors adapted to the new environment. However, the pandemic’s most significant impact was new awards being significantly delayed across the sector due to the economic uncertainty. This has created a hole in the backlog which has carried into 2021. For this reason, we expect 2021 will be challenging and my concern is that backlogs will continue to burn off and eventually companies will hit that hole in their backlog, creating liquidity concerns until new work can start. This is exacerbated by the lack of shovel-ready infrastructure plans across the globe that have yet to be implemented by governments.
Gonzalez: In terms of the industry’s difficulty in finding opportunities for future growth, several things come to mind. For the renovation-focused part of the construction industry, we typically see most players in this space being middle market in size, and their availability and access to working capital and funds are often not as robust, which makes them less resilient than some of the larger players. Regarding government infrastructure plans being stuck and exacerbating the lack of additional projects for companies in that space, we are seeing that in Europe and Latin America too, and we need to come together as an industry to help push our governments forward in this area. Lastly, I would add that larger construction companies often use expatriates to fulfil projects, but the pandemic-related travel restrictions are making the ability to efficiently move people from one country to another problematic.
Schäfer: A lot also depends on what region and segment firms operate in. What we have seen in Germany, for example, is growth on the demand side, with some companies experiencing strong 2020 results and revenues, but there are other countries where lockdowns affected construction sites much more heavily, so in those countries you had dropping markets. If you look at general market structure within Germany and other mature markets over the last 10 years, two-thirds of the overall volume of projects is driven by renovation, while one-third is new build. Renovation typically has smaller projects with shorter lead times, and demand has remained high in that area and provided an overall push. On a more granular, sector by sector level, we will continue to see office, retail, hospitality and oil & gas construction suffer, while areas such as healthcare, logistics and data centres will continue to prosper in 2021.
“Overall, the whole ecosystem in construction is changing, some parts being driven faster by the pandemic, but many other parts changing rapidly despite the pandemic.”
FW: Prior to the emergence of coronavirus (COVID-19), what were the main issues affecting the industry? To what extent have these been exacerbated by the pandemic?
Roberts: Pre-COVID-19, we had surveyed US engineering and construction company executives and the number one topic on the minds of chief financial officers (CFOs) and chief executive officers (CEOs) was the war for talent and having enough available skilled workers to efficiently and productively build their high levels of backlogged work. The second was investment in technology and making good choices that would improve productivity. Those two things were affected differently by the pandemic. We have seen some skilled worker shortages and an overall increase in unemployment rates in the US, where we have only achieved a 77 percent return to work compared to pre-COVID-19 employment levels. But the worker shortage was not as severe as some anticipated because of the pauses we had in construction and the social distancing restrictions that limited the number of people allowed on a job site. But on the technology side, the pandemic has really accelerated that adoption. Remote sensing technologies, remote work capabilities, robotic process automation (RPA) and other digital tools have been pressed into action to maintain and enhance productivity.
Schäfer: Sustainability and the future carbon reduction targets that many in the industry have formulated were also some of the main pre-pandemic issues. In many global regions, for example, a significant emission of carbon dioxide comes from creating building products, so it is not just about making buildings more energy efficient, but also the ecological footprint of producing building materials. We have not seen a reduction of interest in this area due to the pandemic; in fact, the pre-pandemic rise of investor influence on the industry is likely increasing interest. Construction decisions have historically been driven by architects and installers, but institutional, commercial and private investors are much more informed now and are having a greater influence on decisions, including environmental ones. Other issues that continue to gain traction through the pandemic include more multi-channel distribution chains, a steep rise in construction technology start-ups, and large tech industry players entering the arena with products like building automation systems. Overall, the whole ecosystem in construction is changing, some parts being driven faster by the pandemic, but many other parts changing rapidly despite the pandemic.
Gonzalez: Low margins and how to increase those margins is another big, pre-pandemic issue that construction companies continue to deal with, even more so now because of the pandemic. Traditional cost reduction analyses and initiatives continue to be an important area of focus. However, non-traditional areas are also being closely considered now, such as rethinking how to bid on projects more accurately, determining the right projects and locations on which to bid, how to optimally structure project teams once the work is won and determining the most appropriate technologies to enhance efficiencies within the back office, within the supply chain and on the jobsite. The pandemic has significantly boosted interest in these areas because, for some, it is the ideal timing to strategically reinvest record-level revenues to help ensure future success, while for others, it is a simple matter of survival.
FW: How significant is the level of bankruptcy and restructuring activity seen across the industry?
Gonzalez: Many of the companies I have seen go bankrupt or restructure have mainly been a result of prior issues or situations not driven by the pandemic. I do, however, see some construction organisations selling their non-strategic assets to gain cash that can be invested in other parts of the business, often through concession agreement opportunities, since those, once the construction is completed and are under operation, have a good market for the infrastructure funds that are willing to invest.
Roberts: We have not seen a high level of bankruptcy to date, with a few exceptions like oil & gas construction. Many oil & gas contractors have been hit hard from multiple angles, all at the same time. COVID-19’s impact on fossil fuel consumption has resulted in a sharp drop in prices and resulting capital expenditure reductions by oil & gas companies. There has also been an impact on productivity due to quarantine and social distancing measures, as well as delay in new contracts being signed. This has been a compounding effect which has been disastrous for many in oil & gas construction. Additionally, when you then factor in the new sustainability goals of a growing number of players in the industry, the oil & gas sector that has historically been one of the largest end markets for construction, in terms of spend, is going to have a very challenging road ahead. One of the most significant risk factors for bankruptcy in 2021 is bidding discipline. Construction companies often have an automatic response to market downturns – a kind of muscle memory that causes them to drop their price and take higher risk work for lower margins to keep their talented people busy. We are also seeing contractors taking on adjacencies from their core business, such as a commercial building contractor taking on a road job. When you sacrifice margins, take higher risks or venture outside of your core competency just to keep your talent busy, there is almost always a poor result. And that is where we see financial risk, bankruptcy and restructuring occurring.
“Construction companies are ready, willing and able. They just need governments to move the infrastructure ball forward and pass it to them.”
FW: How do you see the construction industry contributing to global economic recovery efforts? How would you gauge its capacity to adapt and innovate in the months ahead?
Roberts: Historically, our industry is an engine for growth and has played a major role during times of economic recovery and we expect to see that continuing. Infrastructure spending, for example, has a multiplier effect whereby each dollar spent on infrastructure translates into greater gains for gross domestic product (GDP). In the US, according to S&P Global, an additional 1 percent of real GDP spent on infrastructure could boost the economy by a factor of about 1.2. The challenge of that is obviously getting political agreement on funding, the tax impacts and other considerations. Regarding the industry’s capacity to adapt and innovate, many are doing that already – especially when it comes to the engineers who are busy creating the future by designing green buildings and leveraging technology such as internet of things (IoT) sensors and digital twins. But we would like to see more construction companies accelerating that technology adoption to strengthen their resilience and prospects for growth.
Schäfer: In the past year, the construction industry has already contributed to growth and stability, given the backlogged work that has largely continued to move forward during this pandemic. Part of the EU’s recovery fund being discussed is expected to be used to promote new innovations and projects in sustainability but is also expected to provide direct subsidies to individual building owner renovation projects, such as better insulation or more efficient heating and cooling equipment, and that too drives construction industry employment and revenues. Overall, the pressure to innovate in this industry is growing, in both product and process innovation. Product innovation, such as IoT or energy neutral buildings, is quite high. But for process innovation, such as building information management (BIM) or redesigning the value chain, the old muscle memory of the industry is quite high.
Gonzalez: What is curious about the industry, at least when you visit a construction site, is that there is quite a lot of micro-innovation going on to solve challenges associated with that site, but those innovations, at the least the transferable ones, often do not find their way to other projects. Knowledge just remains in the minds of the teams who participated in the project. Companies that are finding ways to lift and shift those process innovations to other sites and scale them in a way that makes the entire enterprise more efficient are gaining longer-term benefits. In terms of contributing to global economic recovery, construction companies are ready, willing and able. They just need governments to move the infrastructure ball forward and pass it to them, and they will then use that larger field of play to score points for the entire economy. But the EU and other governments that are pushing green infrastructure plans also need to balance the amount of funds allocated to innovation initiatives with investments in shovel-ready projects. Innovation initiatives often do not create employment right away because they usually begin with a research and development (R&D) period that sometimes takes years, so we also need investments that can also inject employment on an immediate basis to boost the economy.
FW: What role do digitalisation and industrialisation have to play in transforming the construction industry? How can technology help companies to gain insights, streamline processes, improve productivity and create a sustainable future?
Gonzalez: Digitalisation and industrialisation is going to be very important to the industry, but there are real estate developers in Spain, for example, that are trying to push industrialisation in the construction process as they want scale. They want more than just two or three players to help make it work, so the industry needs more companies that are willing to not just think about it, but to act. This is always easier said than done; it is difficult to break away from the pack and be among the first. Moving to the civil works infrastructure industry, they usually manage a very large volume of papers and data points at their sites, and the right approach to digitalisation and a commitment from management would enable them to be much more efficient in this area.
Roberts: With industrialisation and modularisation, you gain speed to market, lower costs, greater efficiency, increased safety and more sustainability, but it is difficult to do. However, it is a future part of construction that is going to be one of the most impactful. We view industrialisation and digitalisation together – one facilitates the other. You cannot have highly effective and efficient industrialised construction methods without digital tools such as BIM, data analytics, robotics, 3D printing, and other such technologies. If you look at housing, for example, the desperate need for affordable homes around the world has never been greater and has been exacerbated by the pandemic. The companies that can figure out how to more quickly mass produce and prefabricate homes in a quality-controlled environment will not only have a financial win but will help solve one of the direst issues in the world.
Schäfer: If you look at Asia and the speed with which industrialisation takes place there, I am not so certain that critical mass is as important as some may think. Much of the difficulty starts with building design, and again, the old muscle memory of our industry often prevents new innovative design that fosters industrialised production practices when erecting a structure. This then makes it challenging for a construction company to apply industrial methods when it is not built into the front-end design process. In addition to sustainability, industrialisation and digitalisation are several of the most important trends that will shape the future of the industry. It will allow companies to make great progress in process innovation, which is where one of the biggest optimisation levers of the industry is hidden. We already have great product innovation, but if we can now uncover process innovation on a larger scale, that is where important progress will be.
“Stay disciplined in the bidding process, especially in periods of crisis and during this potential dip that we might see in 2021.”
FW: What trends do you expect to shape the construction industry throughout 2021, and beyond? How would you characterise the prospects for recovery?
Roberts: 2021 could be a challenging year, given the burn off of backlogs and delays in booked work, but we are hopeful that governments can spur economic recovery through various infrastructure programmes around the world to stimulate that demand side, get people back to work, and take advantage of the multiplier effect to not only create growth in the industry, but to also increase country-level GDP growth.
Schäfer: The trends for 2021 are many of the same topics we have discussed, but 2021 will likely come with a high level of economic uncertainty. The balancing act for companies is the ability to keep some of their powder dry, but at the same time, make decisions on important areas in which to invest.
Gonzalez: Government infrastructure plans and their ability to put significant measures in place will be key. Part of it also depends on how the pandemic evolves, so companies need to continue building resilience into their business model as they position themselves for future growth opportunities. The industry is cautious due to the current circumstances, but at the same time very optimistic considering the opportunities that might come.
FW: What advice would you give to construction companies on managing the future challenges they face?
Schäfer: Do not be complacent – the industry is changing rapidly and generally doing well right now, so prepare for the future and start investing in the trends we have been discussing. A client of mine recently shared an analogy that you need to build a roof in summertime, not in wintertime. For many players in the industry, it is summertime from a financial perspective, but they are forgetting to build the roof that will protect them when winter comes, and that will be a tough wake-up call.
Roberts: Stay disciplined in the bidding process, especially in periods of crisis and during this potential dip that we might see in 2021. Do not sacrifice profit just to gain revenue. Also consider your supply chain resilience. Companies with a strong dependence on low-cost providers of materials within the supply chain, for example, were most impacted by the crisis. Owners and investors that procure construction projects also should not be driven by the lowest cost, and instead take a more balanced look at quality, resilient supply chain, and other important characteristics that you want in your builders.
Gonzalez: Do not focus just on cost reductions, but recognise the path forward is digitalisation, industrialisation and attracting talent, and begin to chart a course toward that destination, or you will risk getting lost and left behind. One way or another, the industry will be disrupted.
Erin Roberts is EY’s global leader of the engineering & construction (E&C) sector, coordinating the sector’s go-to-market efforts across the firm’s assurance, consulting, tax, strategy and transactions service lines. Having served some of the largest E&C clients in the world, he has 25 years of insights into the operations, critical success factors and innovations throughout the industry. He can be contacted on +1 (713) 750 1373 or by email: erin.roberts@ey.com.
Fernando Gonzalez Cuervo is EY’s EMEIA Engineering & Construction (E&C) Leader, coordinating the sector’s go-to-market efforts across the firm. Having served some of the largest E&C clients in the world, he has 17 years of insights into the operations, critical success factors and innovations throughout the industry. Mr Cuervo is used to collaborating with economic press and business school events in the industry. He can be contacted on +34 635 62 66 05 or by email: fernando.gonzalezcuervo@es.ey.com.
Axel Schäfer is a partner with EY-Parthenon in Germany and head of construction at EY for Germany, Austria and Switzerland. He focuses on strategy development and implementation for players along the industry and construction value chain: manufacturers, distributors, service providers and investors. His expertise covers, for example, corporate strategy, brand and sales strategy, digitalisation, internationalisation and portfolio strategy. He can be contacted on +49 (211) 9352 11300 or by email: axel.schaefer@parthenon.ey.com.
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