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The Construction Productivity Paradox

Simon Murray
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The productivity of the UK construction sector has been rising up the political agenda.  Reports by the World Economic Forum (WEF) 1, McKinsey 2, the Infrastructure Client Group and the Institution of Civil Engineers 3 have all highlighted that over the last twenty years productivity in construction has barely changed whilst productivity in manufacturing has improved by around 80%.  If the UK construction sector could achieve the levels of productivity seen in manufacturing, there would be a lot more money to invest in hospitals, schools, roads and railways.

 

The construction sector isn’t short of advice on how to improve productivity.  The WEF proposes six key areas for change, McKinsey suggests seven areas for action and, in its Construction Sector Deal, the Government lists yet more actions to support improvement.  The recommendations include familiar themes like greater use of offsite construction, digital technologies and developing advanced manufacturing methods for construction.  These innovations have been available for some time and are not widely used in construction.  Perhaps we should ask why the industry is reluctant to invest in improving its productivity.  And we could begin by understanding what we mean by construction productivity.

 

“Simply put, productivity is the ability to get more economic output from any given level of inputs.  Or, even more straightforwardly, the ability to make more stuff with the same number of workers.”

 

Duncan Weldon, Two Hundred Years of Muddling Through – Little Brown 2021

 

Productivity is the value added by a business divided by the amount of labour employed in producing its products and services and is typically expressed as £/person employed or £/hour worked.  The value added is the wages paid to the workers plus the business’s gross operating profit 4.  The Office for National Statistics (ONS) calculates the productivity of the UK construction sector by aggregating the value added and the labour employed for all of the companies in the sector.

 

The ONS defines the construction sector as all activities within sections 41 to 43 (excluding 41.1) of the UK Standard Industrial Classification of Economic Activities 2007.  This includes the construction of buildings and civil engineering works and some trades such as plastering and scaffolding.  It does not include consultancy services, computer systems or many manufactured items like precast concrete or transport equipment.  Whilst most of these items are recorded as inputs to the construction sector, they are not directly included in the value added by the sector.

 

Construction productivity is a measure of the value added per unit of labour for thousands of building and civil engineering contractors and specialist sub-contractors from the very largest national contractors right down to the smallest local building firms.  It is an interesting economic statistic, but it is of little help in understanding how construction companies add value and in measuring the effects of specific initiatives to improve productivity.  That requires us to investigate the productivity of individual businesses and, in particular, the large general contractors that have such influence over project delivery in the UK.

 

For an individual business, productivity is defined as:

 

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A company’s gross profit is its revenues minus its cost of sales and is shown in the consolidated income statement that most large contractors publish in the financial statements in their accounts.  A metric that investors often use when comparing the performance of different companies is the gross profit margin or gross profit expressed as a percentage of turnover.  It reflects the company’s business model and is seen as a measure of how well it controls its cost of sales or how efficiently it uses labour and materials in its production process.    

 

Data from the accounts of quoted UK contractors suggests that their gross profit margins are typically in the range 5-10%.  In comparison, many leading manufacturers have gross profit margins in the range 10-40%.  Before the Covid pandemic, Boeing Inc’s financial reports showed a gross margin of 19.6% and Apple Inc a margin of 38.3%.  This difference reflects the different business models in contracting and manufacturing.

 

Most contractors obtain their projects through competitive tendering and then sub-contract up to 80% of their value.  This means that the prices they charge for their projects and their costs of sales are largely determined by competition in the market, leaving few opportunities to improve their performance by investing in better people, new technologies or better processes.  This approach also limits contractors’ opportunities to collaborate with their suppliers in reducing the costs of their inputs.  If a supplier has been through arduous tendering and negotiations to win a sub-contract, they are unlikely to share information or collaborate in reducing their prices.

 

It is possible for contractors to improve their productivity without reverting to the 1970s business model when they owned their plant, employed most of the labour on site and controlled the production process.  It requires careful thought and some simple analysis based on the definition of productivity set out above.  It is tempting for firms to just go ahead and implement some of the recommendations in the many reports on construction productivity.  But, without careful thought and analysis, they risk wasting their efforts and possibly, reducing their productivity even further.      

 

An obvious strategy for improving productivity would be for a contractor to produce better projects without increasing costs and then persuade their customers to pay higher prices for them.  Analysis shows that if a company could increase its prices by 5% without increasing its staff numbers or the costs of its sub-contracts, its productivity would improve by more than 30%.  The challenge for the company would be to develop demonstrably better projects than its competitors and then persuade its customers to pay higher prices.  This would require radical changes in current approaches to procuring projects that are unlikely in the medium term.

 

An alternative strategy would be to reduce the cost of sales by improving efficiency in the company’s supply chain.  The contractor could collaborate with its suppliers and invest in its supply chain to reduce costs, sharing the benefits with the suppliers.  If it was able to reduce the costs of its sub-contracts by 10% and share this 50:50 with its suppliers, its cost of sales would reduce by 5% and analysis shows that productivity would increase by nearly 30%.  Unfortunately, the improvement could be short lived, as other contractors would adopt the new approach, and competitive tendering would pass the cost reductions on to customers in lower prices.

 

The most promising strategy for improving productivity could be to reduce the time it takes to deliver projects.  If a contractor was able to deliver its projects in half the time without increasing its staff and with continuity of work, it could effectively double its revenues.  Allowing for the fact that the cost of its sub-contracts would also double, it would still deliver the same gross profits, and analysis suggests that its productivity would more than double.  A 50% reduction in time would require a radically different approach to planning and managing the project from detailed engineering through the manufacture of components to assembly on site.  But the benefits would more than justify the investment.

 

It is in all our interests for construction to improve its productivity, but the industry is not going to achieve this by randomly implementing the initiatives set out in the many reports on the subject.  We should begin by creating market conditions that encourage improvements in productivity, which means helping customers define value in their projects and creating procurement practices that reward the delivery of value.  The construction industry could then start the painful process of adjusting its business models and integrating supply chains to reward every participant for the contribution they make to the value delivered to the customer.

 

In time, these arrangements would lead the construction industry to focus on productivity as a priority and measure productivity consistently across projects.  It would also encourage contractors and suppliers to work together, investing in new technologies and practices that would continuously improve productivity.  As the economist Sir John Kay put it in an article in the Financial Times:

 

“modern humans – uniquely – are productive because they engage in cooperative activity.”

 

John Kay, FT Weekend 28/29 July 2018

 

 

 

 

References

 

1.     Shaping the Future of Construction – Future Scenarios and Implications for the Industry.  World Economic Forum, March 2018.

2.     Reinventing Construction: A Route to Higher Productivity.  McKinsey Global Institute, February 2017.

3.     From Transactions to Enterprises, A New Approach to Delivering High Performing Infrastructure.  Institution of Civil Engineers and the Infrastructure Client Group, March 2017.

4.     The Value of Everything, Making and Taking in the Global Economy.  Mariana Mazzucato, Allan Lane 2018                                 

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Thanks Simon, a thought provoking article.

After 30 years in construction (major infrastructure) it seems that project 'change' has the most significant impact on productivity, yet is rarely discussed or understood - other than for account or dispute settlement purposes. Manufacturing doesn't suffer from 'change' to the same extent. The (sadly typical) as-built v planned programme extract below hopefully demonstrates this.

Perhaps if we could better understand the top 20 causes and impacts of change on construction projects we could solve the riddle of low productivity? And also ensure we have the best-fitting contracting strategy to boot. This is certainly something I'd be keen to help with if anybody has similar thoughts.  

1740830420_As-BuiltvPlanned.JPG.9f28737821a4ebe471fc1058451986c3.JPG

 

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Ian,  many thanks for your comment.  I agree that change has a significant impact in reducing productivity, but I suggest that change is just one aspect of the wider problem of instability in our design and construction process.  Back in the 1990s, I was privileged to work for Sir John Egan and he used to tell us that you can't improve a process until it is predictable.  At around that time BSRIA published an excellent report titled Improving M&E Site Productivity - you can still buy a copy on their website.  The report presents a body of data that shows how productivity on site is reduced by people standing around waiting for things - information, materials, tools and for the previous task to be completed.

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Thank you Simon for your insight, significant shift in Client and procurement techniques needs to be at the heart of stimulating improved productivity in construction. Whilst focus remains on strict tendering rules, output costs and compliant tenders we continue to drive out opportunity, better outcomes and innovation. We need a shift towards longer term partnerships, win-win relationships and Client's open to a shared risk based approach.

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Simon, thank you for responding and sharing some really interesting observations.

Taking the view that you can't improve a process until it is predictable - I guess it fits that if we tackle the top 5, 10, 20 causes of change that impact every project we can improve predictability.  

My picture illustrates change smashing process into a state of chaos - this is an oft repeated real-life example of an as-built v planned programme for a major infrastructure project (unsurprisingly late, over-budget and in dispute).  

Is this the cause or the effect of instability in the design and construction process? Perhaps a bit chicken and egg but a fascinating subject area.

Unfortunately my budget doesn't extend to £60 for the book - but would be interested to know if it looks at the 'why' people were standing around, or 'why' the previous activity finished late (my hunch is that it doesn't go that far)? 

 

 

 

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Hi Ian, an additional insight into Simon's view around wasted time and labor is the lean construction theory. Perhaps you could refer to Prof. Rafael Sack's work on lean construction, where the reasons for "why" people are standing around or previous work finishes late are explained. The simple reason could be seens as the a lack of site planning and control as construction tasks are often not assigned with clear liability to people and materials are delivered late (tools cannot be found on time). 

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Ian, many thanks for your comment and I am sorry for the delay in replying.  Unfortunately our website doesn't notify us when somebody has posted a comment.  The BSRIA report does explain the immediate causes of people standing around on construction sites and this analysis has been confirmed by several studies amongst the lean construction community.  The typical cause of people standing around on construction sites is that they are waiting for something they need before they can start work - tools, materials, information or for the previous task to be completed.  And, in my opinion, the root cause is inadequate management of the work by general contractors and their sub-contractors.  To be fair to the general contractors, decades of being asked by their customers to accept large risks has encouraged them to transfer risks to their sub-contractors and discouraged them from getting involved in their sub-contractors' management of the works.  And to be fair to the sub-contractors, the general unpredictability of the construction environment has limited their appetite for investing in modern production management systems.  As a result, about half of the available man-hours worked on construction sites in the UK and the USA are wasted.  

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Hi Simon.
 
Balanced scorecard guru Robert Kaplan, in a 2014 HRB article, highlighted the dilemma here. If you want to reduce cost, don't cut costs. His point was that cost is an outcome measure that measures how well you manage the overall system. If you just take cost centres and cut their budgets, with no understanding of how your organisation adds value, the chances are you will end up cutting yourself out of business. Or increasing costs in order to serve your customers.
 
Same with productivity. If you try and make your projects more productive by sprinkling some productivity initiatives around your business, you have little chance of success. Systems theory tells us that the system performance is driven by how everything comes together, not how well individual parts do by themselves.
 
If contractors want to increase their profitability they need to add more value - not for themselves but for their customers. If the only value they add is by buying from someone else, adding a mark-up and reselling as a one-stop shop, then single-figure return-on-sales profit margins seems reasonable. That is all supermarkets make.
 
One opportunity for them is to manage the complicated work flows of a project much better than anyone else. Don't just put a project supply chain together, but manage it in a way that is an order of magnitude better than if you just let it sort itself out. This will deliver the project much faster, at lower cost, and probability with higher quality. On capex projects many clients do not want to get involved in doing this, leaving a niche for others to step into.
 
And I'm not sure it would be that easy to copy. Take for example M&S that could easily have copied some core aspects of Zara/Inditex's supply chain over the past 25 years. But it didn't, it relied on more conventional management approaches - including travelling the world in search of lower purchase prices - whilst Zara made much more profit from more local suppliers and great supply chain management.
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On 2/3/2022 at 11:27 AM, Simon Murray said:

Ian, many thanks for your comment and I am sorry for the delay in replying.  Unfortunately our website doesn't notify us when somebody has posted a comment.  The BSRIA report does explain the immediate causes of people standing around on construction sites and this analysis has been confirmed by several studies amongst the lean construction community.  The typical cause of people standing around on construction sites is that they are waiting for something they need before they can start work - tools, materials, information or for the previous task to be completed.  And, in my opinion, the root cause is inadequate management of the work by general contractors and their sub-contractors.  To be fair to the general contractors, decades of being asked by their customers to accept large risks has encouraged them to transfer risks to their sub-contractors and discouraged them from getting involved in their sub-contractors' management of the works.  And to be fair to the sub-contractors, the general unpredictability of the construction environment has limited their appetite for investing in modern production management systems.  As a result, about half of the available man-hours worked on construction sites in the UK and the USA are wasted.  

Standing around waiting is an interesting one,  because there are good and bad reasons for standing around waiting.

There is a saying in the critical chain/TOC community that you want 'Resources waiting for work, not work waiting for people".  The idea being that when work on the critical path/chain is ready to be started it should begin a milli-second after the previous task is completed.  You want to minimise queues of work waiting to be worked upon.  (Note not eliminate, some queue/buffer actually helps manage complex flow work).

To start working as soon as possible, in general you need some degree of excess resource - protective capacity.  This kind of waiting around is what you see with a Formula One pit crew between tyre changes.  The race is won because resource is waiting for the work to arrive.

Bad waiting is when you start work and discover something is missing.  An approval, a tool, a component or a specialist resource.  It is this stop-start working that wastes resource.  Lean Construction & Critical Chain explicitly address this with ideas like look-ahead, WIP limitation, 'full-kit' and policies about not starting a task until you have everything needed to complete. 

Construction practice often drive exactly the opposite behaviour with supervision practices and stage-payment rules.

Local productivity measures and clamping down on people hanging around can be counter-productive.  They can lead to keeping all your resources very busy and thinking this is productive.  All the while your critical path has to wait until a busy resource becomes free.  The resources seem to be very productive.  But your project takes 3 times longer than it needs to.

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Hi Ian,  I like your Robert Kaplan quote.  I think it was Lou Gerstner - the CEO who rebuilt IBM in the 1980s - who said "Nobody ever built a great business by cutting costs".  I will reply to your other comments when I have had a chance to think about them.

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