1 Gun Wharf Quays

2 Construction Economics Aims of Lecture:  To develop an understanding of the Macro economics that affect Corporations. Objectives: On completion of the lecture students should:  Understand the consequences of Macro Economics for the Construction Industry.  Appreciate the position of the Construction Industry in the National Economy.

3 Syllabus Outline The topics covered in this unit will include: 1 Economics of the construction industry. 2 Factors of production. 3 Sources of business and project finance. 4 Management accounting. 5 Budgetary planning and costing systems. 6 Project planning. 7 Cash flow. 8 Breakeven analysis. 9 Methods of economic appraisal. 10 Decision analysis.

4 NATIONAL ISSUES  The value of goods and services produced for final use in consumption, capital expenditure and exports is called GROSS DOMESTIC PRODUCT (GDP).  Ideally the Government should aim for an economic growth (in GDP) rate of 2-3% whilst maintaining low inflation (for the benefit of competitive exports) and low PUBLIC SECTOR BORROWING REQUIREMENT (PSBR).

5 PSBR The Government controls the economy in a number of ways, including:- 1. Bank Base Rate adjustment. At high base rates companies become reluctant to invest in new capital expenditure and individuals have less surplus cash to spend (Graph 1).

6 Graph 1

7 PSBR 2. Government Expenditure. The Government is itself a major capital investor and can influence demand particularly in the construction industry sectors (Graph 2). 3. In the UK construction accounts for about 10% of GDP. Since the 1970's the Government share of construction output has fallen from almost 50% to almost 20% by 2002 (Graph 3).

8 Graph 2

9 Graph 3

10 Repair & Maintenance  These figures do not include infrastructure spend which has shown a steady increase but is mostly repair and maintenance rather than new work. The R & M market has grown steadily for the last 20 years across all sectors, with current government expenditure being about 45% of this total (Graph 4).

11 Graph 4

12 Bank Base Rate  Graph 4 also shows total construction output and by comparison with Graph 1 shows the influence of bank base rates.

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14 Company Issues Tender Price less - Plant, labour and materials less - Finance charges less - Overhead costs = Profit

15 Tender Price Affected by Demand  Government is a major client of the construction industry and has been accused of using the industry as a regulator to control the economy.  Deferment or cancellation of construction projects to reduce PSBR are an obvious example.  Construction projects produce three extra jobs for every one construction job. Employment creates confidence breeds spending.  Much of the UK infrastructure and transportation industries has been privatised. Additionally the increasing use of (DBFO) schemes reduces the impact of construction spending on PSBR.

16 Government Influence on Demand  Statistics show that the public sector share of construction work has reduced from almost 50% in 1970 to less than 25% in 2002 (most highways still public), including Repair and Maintenance.  The Government is able to intervene in construction through finance such as grants to entice industry to an area of high unemployment.  Changes in taxation rules may encourage more investment in R & M. Regulations such as Town and Country Planning may be relaxed to encourage localised investment, or investment of a preferred type.

17 Overseas Demand  The UK economy does not operate in isolation but has to compete on a world stage. Events in other countries over which the UK Government has no control can have major consequences for investment and hence the construction industry in the UK.  The major influence of the UK Government is therefore to create the right environment for inward investment by interest rate control and confidence building.

18 Tender Price vs Competitors  The number and size of competitors has a major influence on a contractor ’ s tender price. At times of a construction boom profit margins initially tend to increase. However, the increased profitability attracts more competitors into the market and encourages existing competitors to expand. This then leads to an oversupply, tender prices are forced downward and companies go into bankruptcy (Graph 5).

19 Graph 5

20 Costs - Plant  Up to 25% of the cost of a major civil engineering contract may be allocated to plant costs.  Construction as a whole, including Repair and Maintenance and housing, as little as 5% of the average project cost may be spent on plant and equipment.  Due to the varying requirements for plant contractors generally do not invest heavily in plant. A separate plant hire sector has grown to the extent that now hire companies own over 50% of plant in the UK.  Depending on hire plant has many advantages for a main contractor in terms of cash flow and balanced books, but it must be recognised that in times of demand plant hire charges will increase (Graph 6).

21 Graph 6

22 Costs - Labour Labour costs can be divided into direct and indirect charges.  Direct costs such as wages are subject to national agreements but these are often superseded in times of labour demand.  There is a shortage of tradesmen in particular leading to wage inflation. The wider use of sub-contract labour is likely to emphasise movements in labour costs (Graph 6).  Indirect costs such as NI etc is subject to Government policy that is in turn influenced by comparisons within the EEC

23 Costs - Materials  Material costs are also influenced by supply and demand. Materials that are imported, such as bitumen, are also dependent on world price movements. Manufacturing costs of some materials e.g. steel vary from country to country and the threats or opportunities from imported materials must be recognised.  Local materials such as aggregates rise independently in price due to planning restrictions and environmental costs (Graph 6).

24 Graph 6

25 Costs - Finance  Depending on their method of operation contractors may need short term finance, long term finance or, a combination of both. The interest charged being set according to the national bank rate set by the Bank of England plus a further percentage to cover the lending banks perceived risk.  Short term finance is to cover operating costs. A ready mix concrete supplier may have to buy in raw materials, stockpile and then wait typically 28 days after delivery of the concrete for payment.  Long term finance is that provided for purchase of office and workshop space or for plant with a considerable lifespan

26 Operating Costs  Costs such as insurances, maintenance of premises administration etc have to be recovered from income. Taxation and social policies influence many of these costs.  Environmental charges (such as Landfill and aggregate tax) and restrictions must also be considered.

27 Conclusions National Level 1. Direct government influence on the construction industry has reduced in the last 10 to 15 years. 2. Government policies have a major indirect influence in terms of interest rates and regional interventions. 3. International events have a growing influence on the UK construction economy.

28 Conclusions Company Level 4. The tender price quoted by a company has to take many factors into account. Plant labour and material costs will be influenced by market demand. Administration and finance costs are influenced by Government policy. (Graph 7). 5. The ability of a company to survive and grow depends on how well it manages these variables (Graph 5).

29 Graph 7

30 The Construction Economy - Ready Mixed Concrete  The production of ready mixed concrete closely follows the pattern of the national construction output (Graph 8).

31 Week 1 tutorial - Macro Economics 1. Discuss how economic growth, defined as increasing GDP, can have both positive and negative effects on the construction industry. 2. Discuss why construction tender prices do not necessarily reflect prices for construction resources such as plant, labour and materials.