11 August 2022

A recent market report by cost consultant Turner and Townsend describes the UK contracting environment as a pressure cooker with contractors facing into cost increases whilst also having high workloads. The report forecasts tender price inflation for building projects of 8.5% for 2022, which is double Turner & Townsend’s Winter 2021/22 forecast! It also warns that if firms seek to mitigate those increases by stockpiling materials that could trigger further inflationary bubbles and / or material shortages – an unwelcome re-run of some of the shortages we saw as the COVID-19 lockdowns unwound. That is all pretty worrying and it looks like inflation and material shortages – which have been themes over the last year – are going to continue to be issues even if inflation does recede in 2023. So, what can be done?

Some clients are taking their projects back to the drawing board, changing the focus or mix of the project or seeking to reduce costs by value engineering.  Some are going further, deferring entire developments or later phases so that they can either focus on projects with more certain returns, or reduce the period of price volatility.  RSLs don’t necessarily have the same latitude given the very significant need for new affordable housing and for the upkeep and improvement of existing stock.  So what if you are taking a project to market in the next twelve months or more?

It sounds trite, but make sure that your procurement strategy and contract terms are fit for purpose before you go to market.  What do we mean by that?  It means working within your procurement obligations to find a route to market where you are not assuming risks that you don’t want or paying for a contractor to assume risks that you are best placed to manage.  If we look at material shortages and cost increases as an example:

If you utilise one of the standard form construction contracts or template call-off terms, then you are likely asking tendering contractors to make a judgement call on price increases and shortages for the duration of the project.  That might be what you want – a fixed price – but in current context, such a judgement call is difficult and there is a risk that contractors will either overcook the risk premium they include or, as we have seen in the last six months, misjudge matters completely.  In the latter case, that can mean the contractor withdrawing their tender (assuming it hasn’t already been excluded as an abnormally low tender), repudiating the contract or seeking to cut corners in their delivery.  Obviously those are all negative outcomes for the parties and the project. 

Would a better outcome be achieved by including a formal price fluctuation clause in the contract documents?  That clause could be limited to increases on specific materials, a portion of any increase, cost increases after a particular date, or for a particular phase of a project.  It could even do all of those things, reducing the pricing cover that contractors include in their bid and giving you the benefit if tender price inflation reduces later this year or next. 

Alternatively, would an adjustment to the payment profile or the advance purchase of materials be a solution so that the contractor can better manage the supply of items that have extended lead times or are increasing in price? If so, are you adequately protected, given the difficulties of securing title to off-site materials in Scotland?

More radically, is there scope for you to increase the use of modern methods of construction, or even adopt a modular construction route?  This is something we are seeing across various sectors, including social housing, and there are a number of really important issues to consider in your contract terms.

Material shortages and cost increases are an example of an industry wide issue, but in our experience there are often other project specific issues that are not appropriately addressed in the contact terms.  We have an experienced team of specialist construction and procurement lawyers available to help you navigate these issues.

Michael Kitson, Senior Associate: mki@bto.co.uk / 0141 221 8012