Tender Prices To Increase At A Slower Rate in 2019

Construction Tender prices continued to increase through 2018[1]. With increases noted of 13% - 16% from early 2017 to late 2018 the tender price increase has potentially raised the estimated outturn cost of projects in planning. Projects on site are not immune too with significant cost increases having recently come to light on the National Children’s Hospital project due to Tender Inflation[2].
 
Once again, the quantum of increase in tender prices experienced emphasises the importance of providing for future tender inflation in feasibility studies and development cost planning – calculation of an appropriate allowance needs to be a key part of financial risk planning for a project. This allowance should be based on four things:

1. The estimate of project costs (including contingencies) at current market prices;
2. The pre-construction and construction period for the project;
3. The procurement and expenditure profile over the design and construction life of the project;
4. Anticipated market conditions.

 
Amounts provided for tender inflation should be identified separately in a budget and should be incorporated into the individual cost components and adjusted as necessary at various project review stages. This article looks at the current trends in material and labor costs and, based on an assessment of the level of competition, demand and supply in the market, lays out a prediction for future tender inflation illustrating a clear estimation methodology.

Supply Chain Profitability
Financially, the contracting market remains vulnerable and insolvencies are rising[3]. The top 10 contracting organisations typically achieve an average pre-tax profit margin of 2% (Sisk – 2016 1.7%, 2017 3.1%[4]). This is a meagre profit margin relative to other industries and the huge risks taken. The precarious state of contractors’ finances drives risk aversion and restricts the supply chain’s ability to reduce or hold pricing. Contractors are being more selective in what projects they are bidding for with higher margin work targeted. This selectivity, possible on account of the capacity constraints in the industry, is driving margin recovery through higher tender prices.

Tender Forecast – Tender Prices To Increase at Lower Rate than 2018.
The combination of rising labour and material costs, in addition to capacity constraints in the industry, are feeding into increased tender as firms selectively increase margins in the face of increasing construction demand. The increase in tender prices emphasises the importance of providing for future construction inflation in feasibility studies and development cost planning. On this basis estimates regarding tender inflation over the period to 2020 have been forecast using the following assumptions:

1. Forecast GDP growth in Ireland of +4.5% in 2019.
2. The general rate of CPI inflation forecast at 1.2% in 2019 (0.6% 2018) and 1.4% in 2020. Thereafter it is assumed that CPI inflation is in line with the 2.0% target set by the ECB;
3. Inflation in building and construction materials rises by 4% in 2019 and then by 3% in 2020 and 2021, unwinding some of the material price reduction experienced at the end of 2018;
4. Average labour costs rise by 5% in 2019 and then by 4% in 2020 and 2021;
5. It is assumed that the weighted building and construction cost inflation rate is made up of 60% materials and 40% labour costs;
6. Competitive tendering of projects.

 
The forecast of cost and tender price indices has been calculated using the following formulas:
 
Cost Index Forecast = 60% x Equipment and Materials Inflation + 40% x Labour Cost Inflation
 
Tender Index Forecast = Cost Index Forecast x Expected Change in Tender Margin
 
After peaking in 2018 at a rate of 7.8% our forecast is for tender inflation to moderate in 2019 & 2020 to c. 5.6% & 4.2% respectively based on the noted assumptions.

Reviewing the sensitivity of tender price to changes in labour and gross margin recovery our calculations indicate that increases above 5.3% in tender prices would require a mark-up on costs increase of above 5% (from current estimated levels) and a minimum wage increase of 4% in 2019.
 
On this basis Keogh Consulting believes that given the significant increases experienced in 2018 it is possible that price increases will moderate in 2019 & 2020.

Conclusion
Amounts provided for tender inflation should be identified separately in a budget and should be incorporated into the individual cost components at various project review stages and updated as necessary. This article has looked at the current trends in material and labour costs and, based on an assessment of the level of competition in the market, lays out a prediction for future tender inflation illustrating a clear estimation methodology. After peaking in 2018 at a rate of 7.8% our forecast is for tender inflation to moderate from 2019 on to c. 5.6% based on the key assumptions noted. Our full report can be downloaded here.

The Keogh Consulting iOS App (download here http://bit.ly/KeoghCosts) can assist you in the benchmarking of the costs of your project and estimation of an initial inflation allowance based on your programme.

[1]Source: SCSI
[2]Source: Irish Times https://www.irishtimes.com/news/health/rising-cost-of-national-children-s-hospital-a-scandal-in-the-making-1.3739648
[3]Source: https://www.independent.ie/business/personal-finance/property-mortgages/insolvencies-for-builders-up-50pc-despite-housing-crisis-37685780.html
[4]Source: www.johnsiskandson.ie