Amec shed more than 2500 jobs from its capital projects division last year. Most of the jobs are believed to have gone in the oil and gas sector but there have been a large number of cuts in the contracting businesses (see news). Taylor Woodrow鈥檚 contracting arm shed 250 jobs in 1999, and there are rumours that it will make further cuts this year. There is also talk of overheads reviews and job losses at Carillion, Amey and Balfour Beatty.
It all adds up to the biggest rationalisation in the industry since the early 1990s. But whereas the hefty culls of the last recession were an overt reaction to dismal orders, today鈥檚 cuts are less easily explained. After all, times are good. The RICS reports that construction activity is at its highest level since late 1997. And for the first time in years, growth levels look sustainable 鈥� most forecasters are predicting output growth of 2-3% for the next two years.
So, why the cuts? Leading City analysts believe the answer is in Laing鈥檚 announcement last year that, as part of its strategy to improve margins, it planned to cut overheads. 鈥淎t the time of Laing鈥檚 shake-up, it set itself an overheads target of 3.5%, and that has set a precedent,鈥� says Mike Betts, analyst with investment bank JP Morgan. 鈥淔or the past 20 years at least, the industry has been stuck with the attitude that a 5% overhead on turnover is an acceptable level. Laing has now put its head above the parapet and said it鈥檚 going for 3.5%, which was previously unheard of.鈥�
Mark Hake of Merrill Lynch agrees: 鈥淲e are in the days of benchmarking and it is fair to say the benchmark has been redrawn.鈥�
A spokesperson for Taylor Woodrow admitted that the Laing figure had had a major impact on the company. 鈥淚f our shareholders said to us, 鈥業鈥檝e noticed Laing鈥檚 set an overheads target of 3.5%鈥�, we鈥檇 clearly be shooting ourselves in the foot if we ignored it.鈥�
The chief executive of another top 20 contractor agreed that Laing鈥檚 move has played an important part in the current round of downsizing. 鈥淏ut it is hard to see how we can get below 4% or 5%,鈥� he said.
Laing set itself an overheads target of 3.5%, and that has set a precedent
Mike Betts, JP Morgan
But why have overheads become such a hot topic? Despite the industry鈥檚 healthy output, the long-awaited improvement in contracting margins has failed to materialise. In the late 1980s and early 1990s, margins averaged 2.5-3%. The downturn knocked margins down as low as 0.5% in the early and mid-1990s. But last year, the top 50 contractors averaged margins of only 1.3%. 鈥淭hose kinds of levels of return are simply unacceptable for shareholders,鈥� says one City analyst.
Contractors, whose stock market ratings have generally underperformed compared with the rest of the stock exchange, know this all too well. Most of the top 20 have now set targets of 2-3% margins for the next few years. Mowlem, for example, wants 3% margins by 2004. Like most other big players, it wants to do this through more negotiated work. It is also planning to cut overheads by 15%. And for a contractor moving away from competitive tendering, the obvious starting point for a cull is estimating, procurement and finance staff.
Of course, in the medium term, prefabrication threatens the survival of the trades, and job losses can be expected there, too. But at the moment, the professionals are first in line.
Peter Jenkins of Ernst & Young explains why the axe is falling on managers, rather than site workers. 鈥淭he difficult days of the early 1990s saw sites downsized dramatically. That left the head offices and regional offices relatively unscathed, and this is where you still see excess layers of management that can be stripped out.鈥�
What is an overhead, anyway?
And just to confuse contractors struggling with tough new cost-cutting targets, the definition of an overhead can vary significantly between companies, depending on their accounting techniques. One may count a QS working on several different projects as a site or direct cost, whereas another firm would consider the QS an overhead because they are less directly involved in production than a QS on a single 拢50m job.
It鈥檚 a bit like pruning the roses. If you prune too hard, you don鈥檛 get any bloom back
John Armitt, Chief Executive, Costain
However, the City has little patience with such discrepancies. As JP Morgan鈥檚 Betts says: 鈥淎nyone who tries to fudge the issue of what an overhead is, is simply trying to come up with excuses as to why they shouldn鈥檛 cut costs. Frankly, I鈥檓 not interested in excuses.鈥�
The fact is the largest part of any definition of overheads is staff costs. 鈥淥verheads mean everything from estimating, to marketing, to my job,鈥� says Costain chief executive John Armitt.
So, it is the professionals who are under threat. But several observers believe that firms may hurt themselves in their eagerness to cut out waste. 鈥淭he question arises, how far to the bone are people going to cut before one of them does irreparable damage?鈥� asks Jenkins.
One analyst points out that the 鈥渂etter contractors鈥� are cutting jobs as part of larger restructuring programmes. 鈥淭hey want to work for fewer clients and spend more time winning repeat work with them,鈥� he says. 鈥淏ut those that are just planning 鈥榗lassical downsizing鈥� will end up being small bad contractors rather than large bad contractors.鈥�
Bankers also point out that cutting turnover and staff could lead to serious cash flow problems. Laing鈥檚 restructuring will cost 拢14m in redundancy payments alone. And there are concerns as to whether there will be enough local managers to deal with problems on site.
Armitt agrees that cutting too far can cause more problems than it solves. He merged Costain鈥檚 building and civils arms last year and later made the merged division鈥檚 managing director, Stuart Atkinson, redundant because their roles overlapped. He says: 鈥淚f you haven鈥檛 got sufficient resources to work on a tender, you could start winning jobs at too low a price. Similarly, if you have too few people in your accounts department, you won鈥檛 be able to pay your subbies properly.
鈥淚t鈥檚 a bit like pruning the roses. If you prune too hard, you don鈥檛 get any bloom back.鈥�
