In 1984 there were four construction firms among the 100 largest UK companies, now there are none. Not only is the industry inefficient, it's deaf to how far it has fallen behind foreign competitors.
As so often in England, the tale is told most honestly through black humour. There is the line, popular since the early 1990s: 'What do you say to an architect with a job?' 'Big mac and fries, please'. Or there is the story about how the upper floors of all new offices must have sealed windows, to stop the builder jumping out; but the architects don't build any windows at all, to remove any temptation to follow the builder.
Both are examples of stoicism in the face of fearful odds, but they are also a reflection of the dire state that the construction industry finds itself in. Ever since the fading of the last boom, an upswing during which the building trade prospered as mightily as any other sector, the contractors have been sunk in a pit of despond. This, for a time at least, they could live with. The turning of the business cycle was something the trade had learned to live with. Boom and bust was to them a sequence as natural as spring following winter. But this time something strange and a little scary happened. Spring came but the temperature in the building trade hardly shifted. Seemingly frozen in some early 1990s permafrost, it suddenly appeared as if the economic cycle had stopped turning for the contractors. Recession has become a permanent way of life.
A few statistics illuminate the story. The output of the construction industry reached a peak in 1990 at £14.5 billion. It was a heady summit; in 1986, at the end of the last recession, the output of the industry was just £7.5 billion. It had close on doubled in just four years. Since 1990, the industry has, however, declined badly. For the past two years, output has been steady at about £12 billion, a drop of some 20%, and with no sign of a recovery as yet. Worse, although the drop in output may be only 20%, buildings are not constructed quickly, and much of that output still reflects orders placed at the height of the last boom. The figures for new orders tell an even gloomier tale, with today's order books down 40% from their 1989 levels.
The industry has been hit in all its markets at the same time. The market for big new office, retail and industrial buildings has dried up, as the recession curbs the expansion of space, and as big customers such as the supermarket chains find they have built more stores than the market can contain. And while in the past, builders could rely on housebuilding to provide a steady flow of new work, the recession in the house market has lead to a dramatic fall in the number of new houses being built. Few experts see the housing market turning up for a generation or more.
The price has been paid mainly in jobs. Since 1990 it is estimated that 500,000 jobs have been lost in the industry, which, by itself, would be enough to account for around a quarter of the current unemployment numbers. The Royal Institute of Chartered Surveyors predicts that another 100,000 jobs are likely to be shaken out of the industry in the next two to three years, even if output does recover slightly, lengthening the dole queues still further.
And yet it is not just the unemployed who are suffering. In the opinion of many experts, the construction industry has been dealt a crippling blow, one from which it may never recover. More than that, it has been exposed. Where once the massive boom covered all manner of disasters and inefficiencies, the recession has laid bare the fact that the British construction industry is ramshackle and uncompetitive. Like many other industries before it, the constructors have proved to be unable to compete with European, American and Japanese rivals. And, in the view of some, the industry is now in irreversible decline.
When the FTSE-100 index was launched in 1984, there were four construction companies among the 100 largest British companies. Now there are none. Indeed, since the largest construction company is Wimpey with a market capitalisation of £475 million there are none even close. The value of all the major companies in the sector has fallen precipitously; Tarmac's share price is now less than a third of its 1987 high, Wimpey has risen from 125p to 132p over the course of a decade, and John Laing has only risen from 240p to 252p over the same 10 years. This contrasts strongly to the situation in the rest of the world. In France, for example, where the big construction companies are among the country's leading companies, Bouygues is capitalised at £1.4 billion. In Germany, Hochtief is valued at £1.8 billion, and Holsmann at £1 billion. The Swedish company Skanska is valued at £2.8 billion, while the two Japanese giants, Kajima and Kumagai Gumi are capitalised at £6.1 billion and £1.7 billion respectively. The US has decent-sized firms too, such as Flour with a market value of £3.4 billion. Compared with their British peers, these are big, important companies, with the financial strength that the industry increasingly requires.
That is one measure of failure. Another is the attitude of the industry's major customers. Sir John Egan, the chairman of BAA, owner of most of Britain's major airports, is one of the largest buyers of building work in the country. In his view the industry is not only inefficient, it is also deaf to how far it has fallen behind its competitors in other countries. 'The trouble with many of the British contractors is that they are not competitive,' says Egan. 'At BAA we set up a world benchmarking team, to look at how the prices we were being offered in this country compared with the rest of the world. Often we would find we were pointing out dramatic differences in efficiency. For example, on pavement manufacture, the American companies could do it five or six times faster than companies in this country. Across the board, we found that most things were 55% cheaper in the US.' Egan maintains that he has tried to make his company a good customer, harassing his contractors to offer lower prices, and creating his own team of people to point out to the contractors ways they can improve their efficiency. But he is understandably frustrated that the company has to work so hard to keep a lid on prices. Most customers expect the supplier to scour the world finding out the cheapest way of doing things, and then sell it to the client, not the other away around. So far the construction industry does not appear to have troubled itself.
It is simple economics. If a product becomes too expensive demand for it declines. The companies involved in the industry then lose their economies of scale, and costs keep on rising. That pushes demand down further, and so the cycle goes on. The industry becomes locked into a cycle of decline. Something like this appears to have happened in the construction industry. But to find out why involves learning more about the structure of the industry, and the companies involved in it. Contracting has always been an insular, parochial industry, more protected than most from international competition. For decades it was scarcely even a national industry, let alone an international one; even today, there are strong regional building firms which flourish within their own area, but would treat other parts of Britain as a foreign country. Because the essential job of a contractor is to bring together a disparate pool of skills - architects, civil engineers, builders, suppliers and so on - it relies heavily on expert local knowledge, and good contacts, and therefore remains an intensely local industry.
This has been both a blessing and a curse. Protection from international competition has meant that British contractors have been able to charge relatively high prices, and have had to deal with only a few competitors. But it is a curse, because, without strong competition, building contractors have not been spurred to improve their efficiency in the way that other industries have done. Now that international competition is increasingly arriving, contractors are poorly equipped to cope.
There are peculiarities about the industry as well, oddities which make it easier to decline and harder to recover. Whereas in most industries there are barriers to entry - high costs that make it hard for new competitors to come in - in the building trade there tend to be barriers to exit. On most contracting contracts, the developer pays a big sum up front; not the whole cost of the building but a large proportion of it. Because of that, any company experiencing cashflow problems is most likely to respond by pitching for some more contracts. Any attempt, conversely, to scale down or rationalise the business is likely to lead dangerously close to bankruptcy. Once you are in, it's very difficult to get out. On top of that, there are plenty of companies that have been tempted to see construction as a loss leader. The big building products companies such as Redland, for example, have often seen their own activities in building work as a source of steady demand for their products, even if it did not generate any significant profits by itself. And, as a result, the industry tends to be too crowded, with too many companies chasing each piece of work.
Then there is the role of people. A contracting company is a kind of specialised consultancy, an organisation that brings together many different skills for a particular task. An infrastructure of expertise is needed to stay in the business, and the main players in the industry are therefore reluctant to slim their organisations for fear that they will never be able to build them up again. As a result through boom and bust, they tend to carry heavy costs. Costs that have to be recovered in extravagant prices.
Some of these problems would be, if not solved, at least eased by internationalisation. For example, the need to carry high overheads through boom and bust could be mitigated by operating in countries with different economic cycles. The British companies have internationalised their operations, in the past. Unfortunately it was usually in the wrong places. 'Most of the large contractors are big in the former colonies,' says Mike Foster, construction analyst at stockbrokers Grieg Middleton. 'They have been big in places like Ghana, and after the oil price rise they were quite successful in the Middle East. Alas, these are not the markets that are really growing. They have not been big in places like Germany or France, and the market is certainly not growing in the UK.' Other companies did the same thing, but realised some time in the 1960s and 1970s that, with the exception of Australia and Malaysia, the former colonies were not the markets to be in. Most tried to reposition themselves in the US and Continental Europe. The construction industry, however, never woke up to the need to be in strong, growing markets. Or not, at least, until it was too late to make an impact. It is only in the past few years that the big contractors have started talking about the need to build their presence in Europe.
The contractors have also always had a very confrontational relationship with their customers. One of the key tactics for making money out of the building trade has always been to pitch for a piece of work, often hoping to do no more than break even on the work itself. 'After you have finished, you then sue the client, and make a profit through the courts,' said one industry insider. 'It has worked well enough in the past, but it does mean there are very bad relations with the customers. It does not create an atmosphere where they can work together in partnership, which is probably the way it should be.' Traditionally, none of the British construction companies felt they needed to be very big. 'The whole secret of the building industry was that you used other people's money,' says one analyst. 'Everything was hired in, and you used skilful cash management. All the profits were paid out every year in dividends. There was never any reason to retain earnings or raise capital to build a strong balance sheet.' Unlike French and German companies, where customers have usually been more reluctant to pay up front, and where companies as a result built strong balance sheets to carry them through contracts, the British companies always remained small. It was fine while it lasted, but this reluctance to create strong organisations is now extracting a price. One reason is that clients have realised they are paying too much up front and have started changing the terms of contracts. Another is that large contracts are now increasingly going to companies with strong balance sheets where there is no risk of bankruptcy. Often that means a foreign rather than a British company.
It is against this backdrop that the recent history of the major British construction companies should be set. It is, mostly, a sorry tale, and none sorrier than Costain, a company that is in many ways typical of the building trade's family-dominated firms. Once one of the strongest names in the industry it is now only a shadow of its former self. Valued at £1 billion as recently as 1990, it is now worth less than £100 million (considerably less than the £161 million of equity it has issued in the past four years). Much of that dramatic fall can be attributed to some ill-judged diversifications; it moved into housebuilding, into mining, and into property development, each time having to retreat again at a huge cost. Like many of its peers, it was strong in markets such as Zimbabwe and the Middle East, but had neglected faster growing markets. At one time it was a strong enough to put forward projects such as building a second deck all the way around the M25 and sinking a road tunnel underneath the Thames, but in the past eight years its share price has fallen from a high of £32 (adjusting back for rights issues) to just 72p. Many shareholders pinned the blame for that collapse on the chairman, Peter Costain, the heir to the family stake, who had spent more than 30 years at the company, 15 of them as chairman or chief executive. In September last year, they took their revenge, forcing Costain to demote himself to non-executive deputy chairman, and cutting his £170,000 salary. Inbred family management, for too long a feature of the sector, was finally being eased out.
Of a similar magnitude to the disasters at Costain has been the trail of woe at Trafalgar House, Britain's largest contractor, which is now controlled by Hong Kong Land. Through its John Browne subsidiary, it is one of the major players in the market, but it has been as deeply embroiled in the disasters of the industry as its rivals; in December it announced half-year losses of £321 million, and construction has been one of the main culprits. Chief executive Nigel Rich has complained of wafer-thin margins on building work, and spoken of how stronger balance sheets are now needed to compete with Continental rivals. Unfortunately, after the financial ravages of the past few years, his company's balance sheet is no longer strong.
Costain has been trying to negotiate a takeover as a way out of its plight - so far unsuccessfully. Other companies have been involved recently in a series of corporate moves designed to strengthen their position. The construction company Amec was recently on the receiving end of a £360 million hostile bid from the Swedish company Kvaerner. Amec escaped because fund managers did not like the strong-arm tactics employed by its advisers SGB Warburg; few have any great faith in Amec's ability to prosper on its own. In late November Tarmac and Wimpey announced an asset swap, whereby Tarmac handed over its housebuilding business in return for Wimpey's contracting and minerals divisions. The deal will make Wimpey the largest private housebuilder in the world while making Tarmac one of the largest contractors in Britain. 'This is the two visionaries of the industry getting together,' said Wimpey's chief executive, Joe Dyer, at the time the deal was announced. While Tarmac's chief executive Neville Simms expressed the view that, 'You need asset-backing and scale to play at international contracting.' Plenty of other deals are in the pipeline. Companies such as YJ Lovell, Mowlem, Costain, Birse and Balfour Beatty have either sold or announced plans to sell their housebuilding divisions; meanwhile others, like Alfred McAlpine, are examining their involvement in contracting. 'You smell that the change is about to happen,' said Simms recently. 'There are too many medium-sized players in the market. They should do something to come together, for there is nowhere to hide.' Consolidation is now very much in vogue in the industry. One impetus is the arrival of the private finance initiative, which forces contractors to become risk-sharing partners in new infrastructure projects. One consequence is that companies now need to be much larger in order to compete for contracts, and to manage the consequent risk. Another is the simple desire to take capacity out of the market to bring supply into line with demand.
It is not likely to be successful. The very big contracts aside, construction is not an industry where much capital is needed. 'People are being laid off,' says one analyst. 'But they are not leaving the industry because they have nowhere else to go. They are just setting up on their own, and therefore competition is not really being reduced.' Consolidation is usually said, by it propagandists at least, to be a way of arresting decline. In reality it is more often a way of managing it. By merging their interests, and by swapping assets, the major British contractors will buy themselves time. But it is doubtful whether any of them will emerge significantly stronger from the process. None of them appear to be addressing the issues raised by Sir John Egan and other major clients. There will of course always be a construction industry in Britain; buildings, after all, have to be built on site, and there will always be a demand for new factories, malls and houses. But take a look at the boards on the next building site you pass; the Anglo-Saxon names once so prominent are now more likely to be Gallic, German or Japanese.
Top 20 contractors by turnover
Year end Contracting Total
Trafalgar House Sept 95 3,300 3,721
Amec Dec 94 1,770 1,962
Balfour Beatty* Dec 94 1,468 1,546
Bovis Dec 94 1,262 1,521
Tarmac Dec 94 1,040 2,510
Mowlem Dec 94 1,110 1,355
Laing Dec 94 948 1,171
Costain Dec 94 702 1,005
Wimpey Dec 94 684 1,722
Taylor Woodrow Dec 94 643 1,146
Alfred McAlpine** Dec 94 597 926
Kier June 94 478 500
Tilbury Douglas Dec 94 338 406
Birse Apr 95 256 298
Norwest Holst* Dec 94 286 286
Miller Dec 94 283 360
Wiltshier Dec 94 265 265
Raine Industries June 95 238 510
Higgs and Hill Dec 94 232 288
Newarthill Oct 94 230 264
*full split of activities not provided in reports and accounts, therefore
turnover assigned to contracting; **14 months.