The US annual inflation rate increased from 8.6 percent in May to 9.1 percent in June 2022, exceeding market expectations of 8.8 percent and reaching its highest level in 40 years! Inflation – a general increase in prices and a corresponding drop in the purchasing value of money – gradually reduces the purchasing power and gravely impacts sectors of the economy in multiple ways.
The construction industry is also impacted by inflation, both directly and indirectly. Construction costs are volatile, and the prices of materials and other costs continuously fluctuate, creating volatility in economic growth. The construction industry may experience problems with cash flow management, declining sales volume, extended production timelines, and other factors due to inflation. How do we weather this storm?
This blog briefly describes the impact of Inflation on construction industry contractors and recommends ways to deal with the challenges brought on by inflation.
Challenges Faced Due to Inflation
The construction Industry faces significant challenges due to inflation as it drives up the cost of building supplies, machinery rental charges, skilled labor, and other construction resources. It may disrupt the supply chain and project completion resulting in lower profit margins. Some of the most common problems are:
- Increase in Construction Material Prices: The cost of various construction materials continues to rise over time due to inflation, impacting ongoing projects and bids. The construction materials cost around 35% to 60% of the overall construction cost. The profit margins for existing projects shrink, as the bid prices increase. The additional cost grows if construction material delivery issues or delays occur; this results in projects having different starting and ending costs.
- Increase in Cost of Other Construction Inputs: The cost of additional construction inputs such as fuel, machinery, transportation, and technology rises due to inflation. For instance, the Producer Price Index, April 2022, shows an increase of 75.2% in crude petroleum prices from a year ago. Therefore, rising energy prices translate into higher expenses for renting machinery and transporting supplies and equipment. Construction equipment producers frequently raise prices due to rising raw material costs and manufacturing delays brought on by inflation, lowering the project’s overall profitability.
- Increase in Labor Costs: The shortage of skilled personnel in the construction industry makes the problem worse since skilled workers seek more pay due to inflation. An increase in worker compensation during the project could decrease the contractor’s profit as many construction projects are bid-based with a specified price.
How to Mitigate the Impact of Inflation
To address the inflation-led problems in the construction industry, it is necessary for construction industry contractors to develop a technique for formulating the budget at the outset of the project by considering the inflation aspect in the final budget estimation. Below are some of the actions professionals should consider before project initiation:
- Proper Cost Analysis Before Bidding: Contractors must be realistic about the additional costs and make the required modifications/necessary adjustments when submitting bids for construction projects. They may also consider modifying their bid strategy by including contingencies in the pricing models to account for future price uncertainty and rising expenses.
- Discuss Risk Sharing with Stakeholders: The risk of inflation under the contract terms should be shared by the contractor and the project owner, either through alliance-style agreements or alternative contract conditions for both new and current contracts.
- Bring Non-Monetary Value to the Table: Contractors should communicate value beyond price rather than concentrating on the lowest offer and lean on business knowledge, expertise, excellence, or even speed. Although the prices may be crucial, customers also prioritize these non-monetary aspects significantly.
- Purchase Materials Ahead of Time: The best practice would be to review the supply chain again and evaluate its resistance to price increases and delays. When budgeting and scheduling, the contractors should weigh the advantages of stockpiling essential supplies against the higher storage and security expenses.
- Consistent Cash Flow: Consistent cash flow is one of the best ways to mitigate these inflation-related problems in construction operations. As most construction projects demand a down payment from the contractor in advance, this may pressure the contractor to manage operations like payroll or expenses, particularly when the cost of an ongoing project increases due to inflation.
The excessively high and quickly rising construction material costs and supply chain disruptions impact the financial stability of contractors. The situation is worsened due to a lack of skilled labor for the construction projects. There is no single solution to address this challenge; coordinated action by all stakeholders can alleviate the burden. iQuasar LLC, a Civil Engineering support services and staffing organization, has a team of experienced professionals with expertise in hiring workers for the construction industry who are knowledgeable, efficient, and within budget.
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