Construction Outlook 2023: Smart Management Will Help Counter Profit Squeeze

By Sean Clements

Contractors that invest in the future, and keep a firm hand on the various risks that keep pressure on the construction industry, will be in the best position to weather the continuing business and economic uncertainties in 2023.

Supply of materials and skilled workers are still under pressure, and more expensive, too, with inflation. Fears of a looming recession are a major damper, especially when combined with interest rate hikes that are driving up the cost of borrowing. Add spiking insurance rates to the mix, and it’s causing many projects to be put on hold or canceled altogether – especially in markets that deal with the greatest risks of environmental catastrophes.

It all makes predictions dicey, but no question, cost and work schedule management is increasingly challenging. The upshot is likely to be shrinking profit margins, requiring agility and creativity to manage the risks and protect profits. Here’s what to expect.

The squeeze on profits
The post-pandemic building boom is already starting to diminish, especially in residential construction as higher interest rates to control inflation make mortgages less affordable. But total construction starts have risen 17% this year, according to Dodge Data and Analytics, and will probably be flat in 2023. That’s a fairly positive outlook, all things considered.

But those uncertainties paint a good news/bad news picture: Material costs are 70% below their peak of May 2021, but still 17% higher than in 2021 overall. Delivery lead times continue to cause shortages and wreak havoc on schedules. Contractors with sufficient wherewithal have taken to pre-ordering materials, a practice that will likely continue for the duration despite the downside: it ties up capital and adds more risk and insurance costs.

Meanwhile, the shortage of skilled labor has become acute, given the shortfall of 650,000 workers needed to fill current demand. The aging of the workforce – one in five construction workers is 55 or older – means the issue won’t go away in 2023, and will actually worsen over the next decade.

Several trends will deepen into 2023 that will have an impact on risks and how they can be managed. A commitment of resources – financial and others – will help make headway, and a positive long-term return on investment.

For labor issues, it’s past time to rethink the culture
Especially for non-union and smaller shops, owners should look beyond wages to the benefits that add value to individual workers and can be a big competitive differentiator.

Enriched benefits, including paid leave, can be a big bonus. Vacations and sick days have tremendous appeal. Setting policies on other types of leaves, such as family and parental leaves, can be particularly attractive to younger workers. Other benefits, such as employer-sponsored retirement plans, have value, too.

Also coming into sharp focus is the industry’s reputation for safety. By ensuring the highest workplace safety standards are in place and strictly followed, as well as promoting safety track records internally and externally, contractors will burnish their reputations with employees and clients.

Another accelerating trend that’s worth looking into is adoption of employee stock ownership plans. Almost 20% of the largest U.S. contractors have adopted ESOPs as a strategy to strengthen capital structures, while also attracting and retaining workers.

Technology cures many ills, but risks need managing
Technology investment is a critical means of addressing many of the issues the industry faces, from the labor shortage and lagging productivity to rising costs and safety. The transformation that technology is prompting in construction has made the failure to adopt and adapt become the biggest risk it faces.

More than a third of construction firms say they haven’t embraced technology because of limited financial resources. But whether it’s automation, wearables or robotics and drones, it’s reaching the point that the industry can’t afford not to take the plunge. The returns can’t be ignored.

Take 3D printing, which has gained tremendous ground in the last several years, with the global market expected to reach nearly $600 billion by 2030. Savings in material costs alone can reach 40%, never mind the advantages it poses in reduced labor costs and logistic processes.

The downside to the industry’s growing dependence on technology, however, is the accompanying exposure to malicious third-party actors, especially those seeking financial gain. Construction is particularly susceptible to breaches tied to web applications; smaller organizations are the most vulnerable. More than 75% of construction-related respondents to a Forrester survey experienced an incident in the previous 12 months, with an industry-wide average annual cost of about $6 trillion.

That risk is particularly worrisome as insuring against it is increasingly difficult. Cyber insurance is harder and more costly to get than ever before. It puts the onus on managers to create and follow a stringent technology plan with safety protocols. At a minimum, employees must be trained regularly on safe practices to guard against phishing attacks, and a multi-factor authentication mechanism must be in place.

Other risks that loom large
Other uncertainties on the horizon must also be managed, but that’s not so easy when act-of-God risks are only intensifying. In general, construction insurance is stabilizing after several years of higher rates and tighter capacity, but the pressure on the industry has not yet abated.

Liability insurance against catastrophic property losses has hit the coastal areas especially hard. In markets like South Florida, premiums on condo development have grown fourfold in the last two years and are stymying projects. Developers told the Wall Street Journal that insurance costs are over 8% of total project costs for some high-rise projects.

Also, a concern is the devastation of 2022’s Hurricane Ian, which caused at least $41 billion in estimated damages and is likely to drive higher-yet premiums in 2023.

It’s also pressuring builder risk insurance, especially in areas most vulnerable to catastrophic conditions. Rates are expected to escalate by 40% in 2023. Also increasing is fleet coverage – by 15-20%. And the shaky economy will put subcontractors at greater risk of default, calling for extra precautions in vetting and choosing partners, as well as a hard look at ways to best cover the risk.

In 2023, the construction industry will face a continuation of challenging circumstances. To come out ahead will take preparation and actions to strengthen profitability, getting smart on ways to counter the labor issue and building resiliency with strong risk management and insurance strategies.

 

Sean Clements is senior vice president for Commercial Lines at Hub International.