The race to the bottom

Why are construction companies going bust in the biggest boom period in New Zealand history?

The MBIE’s 6th National Construction Pipeline Report released this year provides for a sustained growth in the construction industry over the next six years-$41
billion worth.

Despite this however, some of New Zealand’s most well-known construction companies continue to experience difficulties.

Previously Hartner Construction and more recently Mainzeal and Ebert Construction were liquidated. In the case of Multiplex, it has departed for greener pastures. Meanwhile, Fletcher Construction has survived, but not without an uppercut or two.

How could this be? One simple answer made by assorted commentators is that they’ve been in a race to the bottom.

The answer in some cases is more bespoke than that, with additional factors such as leaky building issues, poor management and governance, the assumption of unallocated risk, a lack of loyalty in some cases from longstanding subbies, price escalation of materials, a tight workforce and other complications.

In order to attract work in a highly competitive market, some construction companies in New Zealand have been offering their services at lower and lower prices, each trying to out-do the other to be the lowest tenderer in the market – the so- called race to the bottom.

While this may sound like a good thing at first glance, it can have a terrible long term cost.

Cutting your prices down as low as you can go means you have an extremely tight margin  before you start running at a loss. In some major cases the agreed contract price was completely under the true cost from the get-go.

To keep yourself afloat you have to cut corners and reduce costs as much as possible. This leads to poor quality work and rushed jobs, which will cost more in the future. Describing building as a mug’s game is bang on in this context.

In order to attract work in a highly competitive market, some construction companies in New Zealand have been offering their services at lower and lower prices, each trying to out-do the other to be the lowest tenderer in the market – the so called race to the bottom

All of this price cutting means that construction contractors need a constant influx of cash flow to keep themselves afloat. This has resulted in trying to paper over the cracks by taking on multiple projects at once and cycling the cash from one project to prop up another project to get enough cash to hopefully prop up another project, and so on.

It’s simply not sustainable, and when there’s even a small hiccup the whole house of cards falls over.

Directors should be familiar with the reckless trading and trading while insolvent provisions of the Companies Act 1993. Sometimes it
can take a protracted period of time for the whole shooting match to come tumbling down, but the writing will be on the wall for those paying close attention.

On top of that, contractors are taking on more risk to stay competitive.

Some contractors have tendered as low as they can go for projects with incomplete design, signing themselves up for fixed price contracts for work no one can properly define. This results in problems further down the track when there are variations required, the job costs more, or was completed slower than expected.

Instead of doing a job once and doing it right, nobody knows what they’re doing and people are floundering about trying to get last minute extensions or asking for more money.

There was a time when principals were willing to pay a premium for a reputable contractor, knowing that spending a little extra money would result in a quality project done well. But the current market’s mind set is too focused on the bottom line, such tunnel vision focussed solely on cost reduction.

And part of this is due to government contracts. When a government project looks like it’s about to go over budget, there is a scramble to replace the project management team with people who are willing to keep everything within a certain budget, no matter what.

And construction companies are compelled into either taking it on the chin and hoping to recoup their losses later if they want more government work, or risk ruining their relationship with the government and losing out on future contracts.

For significant construction projects, only large construction companies with acceptable balance sheets can take on such jobs – so New Zealand could stagnate if we don’t have anyone left to take on the big jobs.

For significant construction projects, only large construction companies with acceptable balance sheets can take on such jobs — so New Zealand could stagnate if we don’t have anyone left to take on the big jobs.

Construction companies need to understand how much value they add to all projects, push back harder, and fight for what they’re worth.

There is a lot of drivel from assorted commentators about these issues, but that’s the guts of it. While the market usually regulates itself, the current situation can’t be allowed to stand, as it is destructive and predatory and can end in acrimony and tears.

We need to put an end to this race to the bottom philosophy or everyone loses. It would seem that the balance needs to shift back to a more sustainable equilibrium where builders are paid fairly for an honest day’s work.

If you have any construction or litigation queries, please feel free to contact Tina Hwang or Marcus Beveridge at Queen City Law.

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