After several tough years, New Zealand’s construction sector was hoping for a more stable operating environment. Instead, the conflict in Iran has driven costs higher and stalled demand just as it was picking up again.
Time to read: 7 mins
Diesel prices alone rose more than 40% in a single month and many suppliers have raised prices of materials. Should businesses be passing these price increases on to clients, or keeping prices lower to win more work in an increasingly competitive market?
The challenge is managing short-term pressure without undermining your business’s long‑term viability.
In a more competitive market, price often becomes the decisive factor in winning work. A Wellington builder recently lost three months’ worth of work after diesel and supply costs forced him to reprice a major contract.
On the other hand, while it can be tempting to aggressively compete for work by cutting prices, that’s a particularly risky strategy. Being busy is not the same as being profitable. You need to know what your current margins are, so you can make an informed decision on how much you can afford to absorb and how much to pass on.
Start by looking at how much actual costs have increased, using the guidance issued by suppliers on price increases, and how much it’s costing to fill your fuel tanks. Increasing your prices is easier to explain when you can point directly to these underlying costs. While there’s no ideal margin, your earnings should easily cover direct costs and wages, with enough working capital left over for overheads. If your margins are reasonable, you can then consider whether to absorb some of the price increases to attract business and maintain good client relationships.
You should aim to be consistently taking good work with a solid margin, which also makes it easier to plan and retain your workforce.
The terms of your contracts will dictate how easy it is to pass on costs, so now is a good time to review these. Clients and their banks often prefer fixed‑price contracts, but when prices are going up so fast, that leaves a lot of risk with the contractor. Where possible, contracts should include provision for cost movements to be passed on. At its most basic, you might add tags or variations to a quote advising that the actual price for materials will be charged. When that is not feasible, build a realistic contingency into your estimates.
Some firms are choosing to hold additional stock to reduce the risk of shortages. While this ties up working capital, it can reduce exposure to price increases later. Consider how much you can reasonably afford to bring in early, and make it clear in your contracts what will happen if certain products should be unavailable.
Strong relationships matter in construction. However, you also need to ensure your business has enough cash flow to avoid becoming insolvent. Ensuring your clients adhere to agreed payment terms should remain the default, with flexibility only where there is a clear and workable payment plan from them. One bad debt can wipe out the margin on several good jobs, so strict and consistent enforcement of payment collection is key.
If you are seeking credit for your own business, you’ll also need a robust plan and financial forecast – this will be the first thing your lender asks for. Construction firms should be stress‑testing scenarios, such as fuel or material costs increasing by 10%, 30% or 50%, to provide clarity on realistic pricing, how much stock to pre-purchase and how much to reduce operating costs.
Identify ways to optimise your costs by going through them with an advisor. They can also help improve short-term cash flow and reduce your risk. For example, Inland Revenue is increasingly taking court action against directors of businesses caught using PAYE and GST monies for paying expenses, and is tougher on late tax payments. Tax pooling can help spread, or delay, payments, while also allowing business to retain more working capital when it’s needed.
Some of these measures may be hard to apply in practice, especially when you have customers you’ve worked with for many years and want to retain. That is why it is always better to make these key decisions consciously, based on a thorough knowledge of your actual position now and your expected position in the future. Supply chains, energy costs and geopolitics mean that pricing is now a core business risk and needs to be managed more actively.
For more guidance, contact your local Baker Tilly Staples Rodway "Property and Construction" advisor.
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