Life after debt

Diversity may have won Britain’s Got Talent but it is also the latest buzzword in the boardroom as the construction industry frets about crunching cuts to public sector spending after the next election. Just how seriously should industry – contractors in particular – fear the next regime? And what can contractors realistically do to protect themselves against declining public sector spending budgets?

A cursory glance at contractors’ revenues and order books shows that typically as much as 75% is now coming from the public sector (I’m citing Carillion, Balfour Beatty, Kier, Costain … the list goes on). Five years ago that ratio was nearer 50%. In definitional terms it is worth noting where companies identify revenues from “regulated industries”. When not separately identified, these tend to be lumped in with the public sector since they have evolved from the public sector through privatisation and are still subject to tacit spending controls and obligations set down by government regulators.

The drivers and outlook for regulated industries such as water, gas, electricity, telecoms, waterways and so on look more secure in general than direct government work. If anything, the government may be more determined to impose higher regulatory expenditures on these industries in view of faltering budgets elsewhere and a desire to protect employment in the construction industry.

Now, returning to core public spending. The dire state of public finances will have to be addressed in the medium to long term and the only feasible solution is a combination of tax increases and expenditure cuts, perhaps allied to a small dose of inflation. The numbers are daunting. Official public sector debt will rise by £503bn over the next five years to more than 1 trillion by the end of 2013. The borrowing forecast is highly optimistic and is based on GDP growth recovering towards 2.5% by 2011. This excludes most of the £500m government bail-out of the banks, since loans and guarantees are not included, nor are the nationalisations of Bradford & Bingley and Northern Rock. The total UK “real” debt is expected to rise to £2.1 trillion by the end of 2013. This would amount to a staggering 92% of GDP, or 161% if you include bail-out costs and nationalisations. The government faces an enormous struggle to finance this debt and the consequences of not reducing it is potentially a period of hyperinflation that crucifies the value of savings and, potentially, the currency.

History tells us that it is easier to cut ‘impersonal’ capital budgets that the more human aspect of current account spending

We can only hope that the government swings the axe on spending budgets, leaving the capital side as unscathed as possible. However, history tells us that it is easier to cut “impersonal” capital budgets that the more human aspect of current account spending. At the very least, the government’s range of specific aid measures in construction and housing over the past 12 months – totalling perhaps £4bn on a leveraged basis – is likely to be reclaimed. Beyond that, it is not difficult to speculate that capital budgets should be cut by 15-20% after 2010, which would set a precedent in terms of scale. Optimists will point to the fact that no government has cut capital budgets by more than 10% in any post-war recession. But these are unique times and I wouldn’t bank on that record being maintained this time around.

So here is my roll-call of the best defence mechanisms for life after 2010:

• Absolute focus on service and delivery – keeping customers happy is cheaper than chasing new ones
• Ensure jobs are delivered on time and budget – give clients no reason to replace you
• Ensure the cost base is right. Dynamically manage this – companies take more irrational decisions when profits are under greatest pressure
• Focus on the waste, energy and nuclear sectors where possible. These markets look ripe for higher work volumes over the next five years
• PFI/PPP will surely be a preferred delivery route for any government with strapped finances. I would expect this sector to be expanded progressively.
• Lateral expansion. Examine adjacent markets relevant to the skill base and also geographic ones
• Vertical expansion. Target the next level down in terms of contract size and client. It may be less profitable but is penetrable and squeezes the smaller, often maverick, players out
• Overseas expansion. We have the skills base to compete overseas and several markets are more accessible than imagined. The key lies in choosing a good partner to gain quick access.
• And always remember, cash is king. Chasing work with little prospect of positive cash flows through the life of the contract is a recipe for disaster.