Building society

The private and public sectors are both extremely active in major projects while seeing fluidity in the market. They have seen the demise of three significant main contractor players at the same time, with certain contractors south of the border venturing north for the first time, or returning to the Scottish market after a gap of many years .

Innovative forms of procurement, particularly in the public sector, are on the increase in the neverending search for cost and time certainty for projects.

The private sector
Although we have seen a dip in new office developments, this has been more than compensated for by the continuing strength of the residential market.

Commercial developers which previously would not look at the housing market are embarking on joint ventures with housebuilders for ‘mixed used’ schemes. This is evidenced by schemes such as the Granton Harbour, Glasgow Harbour and Edinburgh redevelopments.

Housing association demands for social housing are being met by housebuilders as part of private housing developments. For example, in the Gorbals in Glasgow, luxury flats with an asking price of up to £300,000 are about to be built side by side with new social housing.

Within retail we are also seeing the refurbishment of out-of-town shopping developments, for example the huge amount of investment in, and development of, the Almondvale Shopping Centre in Livingston, which is bang in the middle of Scotland’s central belt. These all present great opportunities for contractors.

The public sector
The extent of construction activity in the Scottish public sector will be affected over the coming years by a number of factors. There is a need for substantial investment in worn-out infrastructure. In the utility sector, this is likely to be led by Scottish Water through its innovative strategic partnering arrangement with Thames Water and United Utilities, plus six contractors. The asset procurement, worth some £1.2bn, will be carried out over the next four years through a joint venture vehicle called Scottish Water Solutions.

The health sector will also see extensive activity. Smaller projects are likely to be funded by the Treasury, but larger ones, such as the implementation of the Greater Glasgow Health Board’s strategy for Glasgow, the new Forth Valley Acute Hospitals NHS Trust and larger elements of the Fife Health Board’s Rights for Fife, will be implemented through private finance initiatives (PFIs). The combined capital investment here is also likely to be in the region of £1.2bn, with procurement having already commenced in Glasgow with the new ambulatory care centres and the Forth and Fife projects coming out to procurement in the course of this year.

The factors that are at play in local authorities combine investment through PFI and traditional funding. In 2001, the Scottish Executive announced a capital investment programme through PFI to regenerate Scotland’s schools. The value of the investment announced was of the magnitude of £1bn. This was bolstered in 2002 with a further investment of £600m being announced. Current projects in the course of procurement are of the order of £700m.

Transport projects will also provide a key plank of capital investment. The Glasgow Southern Orbital road and M77 extension are currently being built through a PFI. The next major road investment will be the M74 extension, which will join up the M8 south of the Kingston Bridge with the M74 to the east of Glasgow. Apart from the obvious transport benefits, this project, with a capital value of some £400m, is seen as critical to the future regeneration of the east end of Glasgow.

Regeneration projects are also high on the Scottish Executive’s agenda. The Scottish market lags behind England here, but pathfinder projects have been announced and models of procurement are in the course of development. Projects are likely to centre round the major population centres, with city councils in Glasgow, Stirling and Edinburgh taking the lead. These will see plenty of opportunities for private sector participation in the areas of housing, office and commercial development. As can be seen, large elements of the capital funding programme are dependent on PFIs.

However, recent changes in the funding of local authorities will see additional capital programmes being procured through traditional procurement routes. The prudential funding regime sees some of the constraints imposed on capital procurement being removed and local authorities will be less reliant on PFIs as a means of funding.
Essentially, prudential funding allows local authorities more discretion in deciding how much of their annual funding support from the Scottish Executive can be allocated to capital expenditure.

The contractors
This last year has seen the demise of three major players in the Scottish construction market: Melville Dundas, Lilley and Ballast. The combined effect can be likened to the Rush & Tompkins receivership in the early 1990s. Subcontractors are very wary at present. Rumours of further insolvencies are rife. Payment bonds which for a long time have been seen as a luxury and which were never granted and seldom asked for are now back in vogue. Some specialist contractors and subcontractors have blacklisted certain companies that would otherwise employ them. This is a real shift in the balance of power.

It is difficult to find a theme common to all three companies that may have caused them to fail. They were undoubtedly operating, as are most contractors, on little or no margins. Any overrun on a major job can and does have disastrous consequences for a contractor which does not either itself or through its parent have deep enough pockets.

It is important to recognise that the market in Scotland for construction started to change in the mid to late 1990s, when many of the major UK contractors backed out of Scotland or construction altogether – Costain and Taylor Woodrow are just two examples. This gave the medium-sized construction companies and those operating locally opportunities to bid for and win jobs that were previously beyond their reach. The challenge for such companies was whether they had the skills to survive in this larger market, with the potential risks attendant to taking on such large contracts. This remains the case.

These latest insolvencies occur in a market where demand, particularly on the civil engineering and PFI/public-private partnership front, is potentially immense. A number of these major projects coming to the market at the same time, and with similar time-frames, simply exacerbates the potential capacity problem. The fact that contractors which had not previously operated in Scotland are now tendering is testament to demand outstripping supply.

Lindy Patterson and Michael McAuley are partners at Dundas & Wilson