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The construction industry has spent the last four years rolling with the punches. Recession, redundancies, cuts and the evaporation of investment have all become facts of life. Now, after a period of relative grace, the blows are raining down harder than ever. Last month鈥檚 Office for National Statistics (ONS) GDP figures revealed a 3% contraction in construction output between January and March, a fall that some have suggested was responsible for pushing the UK economy as a whole back into recession.

And this is just the start of the real pain for many contractors - especially larger firms - according to Rick Willmott, group chief executive of Willmott Dixon. 鈥淭he recession we have been predicting since 2010 has finally arrived,鈥� he says. 鈥淯p until this year, many contractors鈥� results benefited from good work volumes procured in the last few years. This year and going into the next, falling work volumes combined with acute margin pressures will see the industry face the hardest phase of the downturn. Work procured now will define performance over the next two to three years and contractors that chase work at all costs will expose themselves to serious risk.鈥�

This is already being reflected by a volatile atmosphere that is spreading across the contracting sector. Within the last month alone there has been news of a major restructure at Balfour Beatty鈥檚 construction division, contractor Killby & Gayford has gone into administration and medium-sized firm Thomas Vale has been subsumed by French giant Bouygues.

Things may look bleak at the moment but there is some hope for contractors. Stephen Ratcliffe, director of the UK Contractors Group (UKCG), points out there is 拢90bn of public sector work out there to be won.

There are also glimmers of hope in other sectors - some of which might even favour smaller firms. Here we consider the common challenges facing UK contractors, examine how key sectors are faring and gauge where new opportunities may lie.

Big worries: The state of play for major contractors

Large contractors have often been considered the construction industry鈥檚 ocean liners - better able to glide through rough seas, but with the disadvantage of not being as quick to steer a new course as their smaller counterparts. This lack of nimbleness could prove damaging in a fast-changing market, as many of the large projects that have been sustaining these firms come to an end.

Restructures are likely to become more commonplace, according to construction commentator Brian Green, following the announcement last month that Balfour Beatty, the UK鈥檚 largest contractor, was putting all 12,000 staff across its construction arm on notice as part of a shake-up to 鈥減osition for growth鈥�.

With a much heavier reliance on public sector work than smaller firms, major contractors have been left reeling as we head into the second half of 2012.

Pellatt says that larger firms may even move away from traditional contracting altogether, opting instead to bid for infrastructure and nuclear schemes: 鈥淚 think we will see a lot of hardship among the large contractors. Some of them may even disappear, and I am talking about some really
big players.

鈥淭hey can鈥檛 afford to keep bidding for big jobs and losing due to increased competition and lower bids.鈥�

Reasons to be fearful

• Increasingly fierce competition for large jobs due to low bids
• Government spending cuts hit the larger firms hard due to them having a larger proportion of public sector work than smaller firms. Plus, there is still uncertainty hanging over the nuclear pipeline
• Major projects that have been sustaining the industry from 2008/09 are coming to an end.

Reasons to be cheerful

• Infrastructure schemes including HS2 and billions of pounds of energy, utilities, road and rail projects, all backed by the government
• There are still potential overseas opportunities in growth areas including eastern Europe and Asia
• There may be specific chances to cash in on London 2012 by exporting sports-related construction expertise to countries such as Brazil - host of the 2014 FIFA World Cup and 2016 Olympics - and Qatar - host of the 2022 World Cup.

Sectorwatch: Where the opportunities are

Infrastructure

Ratcliffe describes this as 鈥渢he biggie鈥� and last month鈥檚 Construction Products Association (CPA) forecast figures identify infrastructure as one of the only growth areas in the sector. The 拢250bn National Infrastructure Plan (NIP) gave government backing to 40 major schemes between now and 2016 and CPA figures show that infrastructure output growth is expected to be 6% year on year until 2016, when it will be worth 拢17.3bn.

Rail overtook roads as the biggest growth area in infrastructure in 2011, with output totalling 拢3.3bn and new orders doubling. Roads output, by contrast, contracted by 46% but is still worth 拢3.2bn, or 24% of total infrastructure construction. One billion pounds will be invested in improving the national road network in 2012/13. Water and sewage has a planned 拢21bn framework spend between 2009 and 2015 and was worth 拢2.1bn in 2011. The sector is expected to grow, on average, by 7% year on year through to 2015. Output in electricity network upgrades is set to triple by the end of 2016. This is being driven by year-on-year rises in nuclear and renewable work of 18% in 2012, 20% in 2013 and 30% in 2014.

Health

Capital spending on health premises in the UK was 拢5.1bn in 2010/11. This figure is expected to fall to around 拢4.4bn a year until 2015. Output in the sector fell by 17% in 2011 and orders fell a huge 47%. Much of the uncertainty around primary and secondary healthcare premises and the resulting lack of a clear pipeline, stem from the continuing confusion over NHS reform. But there is still likely to be work on hospital upgrades, refurbishments and extensions, as well as the creation of new, larger GP surgeries, as 23% of the NHS estate remains 鈥渦nfit for purpose鈥�, according to AMA Research.

Education

CPA figures show that output for the education sector fell by just 2% in 2011 and remained at 拢7bn. The future, though, looks less clear. As projects finish, they are unlikely to be replaced at the same rate and output is expected to fall sharply by 20% in 2012, 14% in 2013 and 6% in 2014.

However, tenders are expected in the autumn for the government鈥檚 拢2bn Priority School 好色先生TV Programme, which should go some way to boosting the sector.

Commercial

With big-name clients including Development Securities and Hammerson diversifying away from the commercial sector, the future doesn鈥檛 look bright. Office projects鈥� share of commercial output fell to a historic low of 26% in 2010 and saw only a modest 3% growth on this last year, while orders fell by 5% to 拢3.6bn.

With major London commercial schemes such as the Pinnacle being put on hold due to lack of finance, and with many clients opting to convert commercial space into residential units instead, it will be a while before there is any light on the horizon.

Retail is faring a little better, according to the CPA forecast, growing 5% in 2011 to reach a sector value of 拢5.4bn, which equates to 22% of overall commercial output. Fuelled by supermarkets鈥� aggressive expansion plans, this sector is a good place to be for contractors of all sizes thanks to the wide range of projects, from superstores to convenience chains.

However, retail clients are notorious for preferring to work with an established supply chain, so if a contractor does not already have a relationship with them, breaking into this sector may prove tricky.

What clients want

We asked three top clients what contractors can do to stand out in such a competitive market:

The retail client: Tony Jacob, head of construction, engineering and environment at John Lewis Partnership

鈥淲e always ask that our contractors try to think like retailers, especially now that the sector is facing its biggest-ever challenge in the current tough economic climate. Our supply chain needs to offer us ever more reliable services at a reduced cost. It must be able to design space that is more flexible than ever and adapt to change along the delivery journey in a controlled way.

鈥淓veryone in the retail industry, including John Lewis, must prune their capital and revenue budgets. Saving money on utilities and maintenance costs is increasingly vital to our ongoing profitability. So our suppliers need to be both efficient and honest enough to be able to tell us where we鈥檙e getting it wrong.鈥�

The private sector client: Julian Barwick, head of development at Development Securities

鈥淎s a developer, we are moving away from commercial work into residential and retail so we鈥檙e looking for a shift in skills. This could open the door for new firms but, equally, we are seeing our existing supply chain adapt too, as the market has ebbed and flowed. So many of them have now developed skills in retail and residential. We鈥檙e looking for a good track record, innovation and willingness to challenge.

鈥淭he best suppliers, without overdoing it or taking it to an excess, are those that find themselves treading on the toes of the other members of the design team. There is nothing I like better than seeing structural engineers persuading the architects to move in a certain direction, for example.鈥�

The major public sector client: Dennis Hone, chief executive of the Olympic Delivery Authority (ODA)

鈥淭he ODA has strived from the outset to get contractors to buy into challenging targets and their response has been nothing short of fantastic.

鈥淭he proof? We have built the stage for the London 2012 Games on time, within budget and having achieved new benchmarks across a range of areas.

鈥淭hese include tough sustainability targets, industry-leading health and safety records, and emphasis on local workforce and apprenticeship employment. That鈥檚 what we asked from our supply chain and that鈥檚 exactly what they delivered for us.

鈥淭he record of the British construction industry is as good now as it has been in an extremely long time. I believe that the London 2012 project has really helped to promote the UK鈥檚 expertise to a global audience.鈥�

Views from the Top

Three construction bosses predict what the future might hold for UK contractors

We knew it was coming鈥�

Simon Rawlinson, head of strategic research at EC Harris considers how contractors are placed to rise up from the double-dip

鈥淭he UK鈥檚 re-entry into recession may have come as a surprise to many commentators. But construction has known that its double-dip has been coming for some time - providing contractors with an incentive to lock in to frameworks or to diversify into sectors that have been forecast to remain more buoyant.

鈥淢arkets are exceptionally challenging, but main contractors have the strategic opportunity to develop propositions that add greater value to their clients - through earlier involvement in integrated teams, for example, or by using 好色先生TV Information Modelling to de-risk delivery. Contractors that evolve their business model will be in a potentially strong position when the recession ends.

鈥淲ork-winning tactics in the short term are absolutely critical. Four years into the construction downturn and despite increased output in 2010 and 2011, many contractors have run down their cash surpluses. They are also potentially exposed to losses on projects secured through highly aggressive pricing. Avoiding future liabilities is critical. With workload still scarce, and clients still being able to call the shots in terms of their choice of procurement route, bidding for projects is highly competitive. Given the extent of risk transfer required by many clients, contractors are becoming risk averse themselves, both with regards to their own contractual terms and the agreement of subcontractor costs.

Recent developments in the market have, if anything, increased levels of uncertainty. Reorganisations in big-spending government departments such as the Ministry of Defence and the introduction of complex new frameworks, including the Priority Schools 好色先生TV Programme, have led to delays in the procurement of major public sector projects.

At the same time, the commercial sector has been hit by the stalling of many office schemes due to funding constraints and, more recently, a reduction in retail roll-
out programmes.

The upshot of these developments is that the market is unlikely to start to recover until towards the end of 2012 in London and 2013 in the regions. Given current conditions, main contractor failures, such as the recent insolvency of Killby & Gayford, can鈥檛 be ruled out. However, the latest data from insolvency specialist Begbies Traynor suggests that although around 1,200 construction firms are rated as 鈥渃ritical鈥�, the overall condition of the sector has not deteriorated further this year - a small comfort for the rest of the sector.

There are a few bright spots for contractors, but most involve frameworks and long-term relationships. From a workload point of view, the obvious sector to be in is infrastructure. However, barriers to entry are high in some instances and many infrastructure clients are facing their own performance and cost reduction challenges.

Local authorities are also an area of innovation and opportunity, with Manchester鈥檚 拢1.2bn City Deal being one of the more positive announcements in the last budget.

With greater local autonomy and cooperation between public and private bodies, Regional Improvement and Efficiency Partnerships (RIEPs) have the potential to be a significant route to the market, and Next Generation frameworks for SMEs and major contractors are now in place.

Mega projects - in the commercial, energy and transport sectors - are still out there, but provide opportunities for only the largest contractors with the capability to deliver. And these will no doubt become even more competitive as all firms seek to secure vital long-term work.

NEXT WEEK, READ ABOUT THE STATE OF PLAY FOR CONSULTANTS