GROSS PROFIT MARGINS INCREASE IN 2019

BDO’s 2019 Construction Survey Report has revealed some of the challenges facing the construction sector and, over the next few issues, Under Construction will look at the emerging themes more closely. This issue, we focus on the gross profit margin increase for head and subcontractors

After surveying 216 construction businesses, accounting and advisory firm BDO suggests the key theme from the survey is that the sector is becoming increasingly divided “between the good operators with strong financial and operational attributes, and those with significant fragility”. Gross profit margin can be used as an indicator of which side of the divide a business occupies.

“Gross margins have slightly improved [from 2018] but are still inadequate to maintain a healthy sector,” said BDO construction specialist Nick Innes-Jones. “Due to intense competition and a focus on providing services at the lowest cost, many subcontractors’ margins remain too small for long-term viability.

“Head contractors greatly need these subcontractors to undertake available projects – the survival of both depends on it. The industry therefore needs to focus its attention on the survival of
capable subcontractors.”

Head contractor results improving

The survey asked: ‘When competing for new projects, at what margin are you missing out on winning contracts?’

For head contractors, the median increased to 7% in 2019, up from 5-6% last year. The number of respondents who missed out on projects on margins over 8% almost doubled, increasing from 28% to 42% year-on-year.

The number of respondents missing out on projects with margin of less than 3% decreased by half, from 8% in 2018 to 4% in 2019.

While this improvement seems to be a step in the right direction, and indicates more businesses may be prioritising long-term sustainability, BDO says there are still too many companies pricing low to secure work when they shouldn’t.

While their motivation may be altruistic – possibly to ensure there is a steady flow of work – BDO says that in most cases, this approach leads to operating on low-margin projects and incurring cost overruns.

According to the report, industry participants need to be more selective with the projects they choose to work on and not take on work for the sake of staying busy.

The report also suggested that businesses missing out on winning work at 4% or lower is most likely unrelated to their contract price, and due to other reasons.

Including responses from head contractors who didn’t miss out on projects, gross margins from the past financial year revealed an average of 7% to 9%, which aligns with the trends identified.

Changing client perceptions

The BDO report notes that client behavioural change could be influencing the move towards higher margins, as a result of high-profile insolvencies in the construction industry over the past 12 months.

This may have led customers to place less emphasis on price and more on working with reputable and long-standing companies. Such behaviour plays a part in the widening gap “between long-established and reputable companies and those who seek to compete mainly on price”.

Subcontractor results alarming

To highlight the difference between trades, subcontractors were also asked: ‘When competing for new projects, at what margin are you missing out on winning contracts?’

Close to a quarter of subcontractors said they were missing out on projects between 10-19%. Although the number of respondents missing out by this margin bracket decreased by 25% from last year, BDO said there are still too many subcontractors competing for projects at an unsustainable level.

BDO said it was particularly alarming to see that more than a third of the subcontractors surveyed (35%) are missing out on margins under 10%. The report stated that because subcontractors have a lower turnover and higher overhead proportion compared to head contractors, it’s important they “operate with higher margins to recover these expenses and be profitable”.

Including responses from subcontractors who didn’t miss out on projects, gross margins from the past financial year revealed an average of 16% to 20%, which aligns with the trends identified.

The report stated that the shortage of staff, high compliance requirements and difficulty in controlling costs due to price increases are all likely to have had an impact on subcontractor margins.

Pressure on price

BDO says that, put simply, there is too much emphasis in New Zealand on price. High price competition between head contractors in order to improve their own margins and profitability places similar pressure onto subcontractors. This contributes to the price competition culture amongst subcontractors.

To read more on the survey’s findings on gross margins and other areas of discussion, visit BDO.NZ