Subcontractor Default Insurance Carriers will take note of 4 Autodesk Construction Outlook Report findings

As the Autodesk Construction Outlook report confirms, the old adage remains true, “Subcontractors do not die from starvation; they die from overeating.”  For those of us who have endured several construction market recessions, we know that subcontractor default risk increases post-recession.  During recessionary periods, which we’ve certainly seen in the last twelve months, subcontractor working capital, which goes towards absorbing overhead, becomes strained when the workload is reduced. While many subcontractors took advantage of the PPP loans that were available in 2020, that additional support is not likely to continue. As market activity increases coming out of the pandemic, subcontractors will be hungry for new work to replenish that working capital.  However, taking on more work with less working capital can lead to disastrous results, including failure to meet payroll, failure to pay second tier vendors, and at worst bankruptcy. Reviewing subcontractor financials on a more frequent basis, often referred to as con-qual (continuous qualification) will be important as General Contractors evaluate their ability to take on more work. The four points below show that con-qual is critical as we move through 2021.

Point 1: Non-residential new construction starts were down 33%

Autodesk reports that from April to September of 2020, non-residential new construction starts were down 33%.  That means less revenue for subcontractors, and less working capital.  Because the duration of the pandemic impact is unknown, subcontractors are reluctant to reduce overhead and other costs. What happens if the starts that were delayed all come back at one time? Subcontractors must be staffed appropriately in that case. The unknown duration of the pandemic impact and the reduced number of starts put a squeeze on many subcontractors and makes them hungry to engage when the market recovers.

Point 2: Bidding activity is now up 36% from pre-pandemic levels

Enter a market rebound. Autodesk reports January 2021 bidding activity is up 36% from pre-pandemic levels.  That number demonstrates market wide demand, and hopefully a full recovery and then some. But, that drastic change can be troublesome. Hungry businesses now have something to eat.  Many general contractors are getting a substantially higher number of bidders than they have in the past.  Subcontractor pricing is driven down, which in turn squeezes their profit.  These factors lead to further reduction in working capital, exactly at a time when the capital is needed. Subcontractors additionally may be willing to take on more risk in their subcontracts, which can be problematic in a time where supply chain disruption and material price escalation is impacting many trades.

Point 3: Supply chain disruptions may last 18-24 months

Enter a risk for which there is no playbook – what is happening to our supply chain? Some Amazon packages come early; some don’t come at all.  And the construction industry is no different.  Autodesk refers to the Institute for Supply Chain Management (ISM), who reported that 95% of those surveyed are experiencing supply chain disruptions, and that the impact is expected to last 18-24 months.  Subcontractors have responsibility for timely performance, but with a disrupted supply chain, they may struggle to keep up.  Many defaults arise out of a subcontractor’s failure to adhere to schedule, so disrupted supply chains in themselves often cause an increase in defaults. Couple that with decreased working capital, and it will be hard for subcontractors to deploy additional manpower to accelerate through a delay caused by a disrupted supply chain.

Points 4: Material Cost Variability is here to stay

And if those 3 points were not enough, how about if we throw in some material price variability?  Autodesk reports that the pandemic-related temporary close in production facilities may decrease supply in the coming years, which will increase pricing.  Because the pandemic is now a known event, and no longer an unforeseen condition, subcontractors will have to base their pricing on the best data available.  But will that be the cost 2 years from now, when the purchase occurs?  It is difficult to tell.  And that risk will likely sit squarely on the subcontractor.

Hopefully, the construction market continues to rebound as the US emerges from the challenges of the pandemic.  But that re-emergence will surely come with some challenges for each of us to take note.  Thank you to Autodesk for your fine research and information presented in the 2021 Autodesk Construction Outlook which can be found here (https://construction.autodesk.com/precon/2021).