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How rising prices are affecting construction companies

Rates of inflation are increasing rapidly in many developed economies. And construction companies are feeling the effects — not only are essential materials and skilled labor significantly more expensive, but supply chain pressures and shortages are making it harder to secure needed construction materials.

Lumber, steel, and many other materials critical for construction projects have experienced skyrocketing increases in pricing. While the root of the problem was supply chain disruptions due to the COVID-19 pandemic, new challenges — including geopolitical risks — continue to put pressures on pricing. And an increase in government-led infrastructure activity is further increasing demand for construction materials.

At the same time, the available construction workforce is shrinking as an ageing cohort of skilled workers either retire or face local restrictions related to travel and workers move into other professions given competitive salaries elsewhere.

Skyrocketing costs impinge on slim margins

From a 66% increase in the price of fabricated steel, to major spikes in the price of softwood lumber, to a jump of more than 500% in the price of oriental strand board (OSB) — a wood product that is critical to the integrity of a building structure — the dramatic price hikes are having a significant effect on contractors and developers. Often, they have no option but to absorb the increased costs, eating into already slim margins and affecting their liquidity.

And lack of clarity about future costs is complicating the bidding process and affecting contractors’ competitiveness. In the UK, for example, bid prices are expected to increase by up to 8.5% this year — up from 2021’s 6% increase.

Rising fuel prices are putting even more pressure on contractors’ budgets. Not only has it become significantly more expensive to get materials to a construction site, but many pieces of essential heavy equipment — such as bulldozers, cranes, and backhoes — run on fuel.

Labor shortages and increasing wage costs have been affecting the construction industry for a number of years. Given the broader economic pressures that exist, this challenge is unlikely to be resolved in the near future. Since wages can account for over 50% of the overall construction costs, the impact of labor pricing can have an acute influence on the profitability of a project.

What does this mean for the construction industry?

Since most contractors operate on slim margins, increased costs are impacting the bidding process. The steep recent price increases make it extremely difficult to estimate future costs, which may be several times the original estimates by the time work commences and more still by the time the job is completed. And delays in getting materials on site due to supply chain challenges often mean that the timeline for a project’s completion is often unclear.

In most countries, the risk of inflation is borne by contractors. In these situations, incorrectly pricing costs into a bid can have catastrophic effects on their budgets, particularly for contractors that operate via fixed price contracts. This has led to an increasing number of construction companies getting into financial difficulties and even going out of business.

Some contractors and developers are facing increased challenges to secure funding for projects amidst questions about the bankability of projects. In a high inflationary environment, funders will generally be more cautious when offering funding to projects that are high in value, complex, or have long build times.

As inflation continues to affect economies and industries, contractors and developers should consider actions that can reduce the impact on their operations. Some actions include:

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