Why do so many construction companies get into difficulties?

It seems that every couple of weeks, a construction company goes into administration or announces financial difficulties. In 2024, one in six of all company insolvencies was related to the construction sector.

Since the collapse of Carillion in 2018, which caused 43,000 job losses and turmoil among existing contracts, the focus has been on ensuring construction companies are better positioned to cope with industry challenges. So why do we still see so many companies in trouble?

These companies still operate on wafer-thin margins, giving them little room for error. Although they are generally governed more stringently these days, a perfect storm of circumstances has arisen to threaten them more than ever.

High inflation, driven by the Ukraine war and events in the Middle East, has caused extreme price volatility in materials, especially steel reinforcement. While prices have cooled from the 2022 highs, they remain historically high.

Interest rates also remain frustratingly high, making finance expensive. The construction sector, especially housebuilders, is acutely exposed as their consumers are impacted by higher interest rates. Although rates have begun to decrease, it will take time for this to filter down the supply chains. High interest rates also deter investors from funding infrastructure projects, harming the pipeline for construction companies and their suppliers.

Labour costs have also increased. Nearly a quarter of a million new construction workers will be needed by 2027 to meet demand. Shortfalls have already led to labour cost inflation, which is set to worsen in April as the rise in National Insurance kicks in. Firms with salaried staff must pay these costs regardless of whether they win work, while those relying on contract workers must match inflationary salaries to attract staff.

The nature of construction projects and the way they are bid does not help matters. Many companies currently in difficulty agreed contracts and prices several years ago, often on fixed-price agreements. Rising costs have made these agreements commercially unviable. Companies must divert resources from more lucrative contracts to keep projects afloat, leading to future problems and margin erosion.

Materials often have to be paid for well in advance of reimbursement by clients, making accurate financial planning essential. This is challenging against a backdrop of rising costs and geopolitical instability, with cashflow being a constant headache for CFOs across the sector.

The effects of larger contractors who filed for insolvency 18 months ago are only now being felt in their supply chains. Companies such as ISG, which went into administration in 2024, have yet to impact many cases, so the future looks tough for those affected. Subcontractors won’t get paid on time or to the agreed levels, escalating problems. This can filter back up the food chain, impacting larger companies' ability to complete contracts on time and within budget. When things go wrong, the sums involved are often huge and, sadly, terminal in many cases.

This pressure on cashflow has often resulted in contractors ‘buying work’ or agreeing to fixed-price costs without securing the same terms with their suppliers. While tempting, the thin-margin nature of construction projects leaves little room for the unexpected. To combat this risk, we have seen more joint ventures or companies pooling risk and resources, such as the Redrow/Barratt merger. However, the spike in insolvencies results in reduced capacity, less competition, and further pressure on costs.

All is not doom and gloom, however. There is political will to build more and invest in infrastructure. The government has given the sector confidence with its desire to achieve ambitious targets in the next five years. However, with over half of companies in the FTSE Household Goods and Home Construction Sector issuing profit warnings in 2024, we need to hope they will still be around to deliver on those targets.

We have already seen this focus on cashflow and cost-cutting increase demand for experienced interim finance professionals, and we expect this trend to continue throughout 2025.