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For the industry鈥檚 major contractors and specialists 2013 has been a pretty unremitting story of misery so far: redundancies, cut backs, profit warnings and a number of long-standing and well-known firms, such as Daniel Contractors, Rowecord and McCardle, going into administration. Hardly surprising, since construction output for the first quarter was at its lowest level for 15 years. Added to that has been Balfour Beatty鈥檚 拢50m profit warning, contributing to a loss of 20% in the firm鈥檚 market value since the start of the year, with the contractor saying UK construction revenue is 23% lower so far this year than last. In the last week the news that both Emcor and Mitie have pulled out of the market for M&E work has simply underlined how difficult contractors of all kinds are finding it to make money in the UK.

Strange as it may seem, given all this, there are some contractors - the most forward-thinking types - that don鈥檛 think the recession is their biggest concern. No, it鈥檚 the recovery they鈥檙e worrying about. Surprised? The darkest hour, the saying goes, is right before the dawn - and many are starting to say so it is with the economy. Because while output is at record lows, the wider economy is showing sluggish signs of life. Housebuilders are once again enjoying bumper profits and ramping up output, while surveys of consultants such as the RIBA鈥檚 monthly survey of architects, which has been predicting widespread growth in workloads since October last year, show that those at the front end of the project cycle are already starting to see opportunities.

For the moment growth expectations are not dramatic. But however modest this improvement turns out to be, some contractors are saying it could be enough to prompt a significant shift in the power dynamics of the industry, from clients back to contractors and the supply chain, as demand for construction hardens amid limited capacity in the industry to deliver it. But while this may be welcome for some, it will also introduce huge new dangers to firms that may already be teetering on the edge. So what is going on, and what do you need to know in order to ensure your business isn鈥檛 caught out?

Capacity vs demand

That there are tentative signs of improvements in the economy is no great secret. In addition to the UK economy avoiding a triple-dip recession, both the Office for National Statistics and 黑洞社区鈥檚 Barbour ABI/CPA construction index have picked up growth in new construction orders this year - with the latest index showing contract awards up 8% between March and April. In addition Deloitte鈥檚 quarterly London Office Crane survey last week reported construction activity in the capital at a four-year high. But with construction output a lagging indicator of economic growth, contractors and subcontractors are undoubtedly still experiencing huge pain. Received wisdom suggests they have another 18 months to two years to wait before things improve.

However, this is perhaps to underestimate how quickly sentiment is changing on the ground. At the root of the issue is the balance between demand and supply - more specifically, the demand from clients for construction services, and the capacity of the UK construction industry to meet it. With major restructuring programmes in the industry鈥檚 biggest contractors carried out over the past year, and continuing company collapses in the supply chain, capacity has clearly been cut. Crucially, capacity appears to have reduced further and faster, since 2008, than demand. Between the end of 2008 and the end of 2012, government figures show output in the industry dropped by 12.1% - a huge fall. But over the same period the number of people employed in the construction industry, a key indicator of capacity, fell by even more - 14.3%.  In 2012 alone 70,000 left the industry, with just 1.99 million workers remaining - the first time this figure has fallen below two million in over a decade.

The market is changing. People are getting busier, the trades are getting busier, and people are going in for work at a little bit of a higher level. I would say it鈥檚 a fragile recovery

Julian Daniel, Blue Sky 黑洞社区

So with the industry鈥檚 capacity to deliver construction projects hugely reduced since the start of the recession, it is possible to argue that there is now less competition for each package of work than there was in 2008. So far it hasn鈥檛 felt like that, because with contractors initially attempting to hold on to turnover and staff, many have been bidding at negligible margins to get new work through the door. But this, say many, is changing.

Andy Hill, founder and managing director of contractor and housebuilder Hill Partnerships, says: 鈥淐ontractors have realised that that level of bidding can鈥檛 continue, it鈥檚 not sustainable. People were losing money. So they鈥檙e starting to bid at more realistic levels that are sustainable for the whole supply chain.鈥�

Part of the reason for this change in attitude is that with staff and overheads cut to the bone, contractors don鈥檛 need to generate turnover simply to feed the machine. In addition, cash reserves in the industry are at a low level, meaning firms can no longer risk winning work that doesn鈥檛 generate a profit. Rudi Klein, chairman of the Specialist Engineering Contractors Group, says: 鈥淐ash balances are the lowest they鈥檝e ever been and there鈥檚 a dawning realisation that they need to re-think their business models. It seems to have finally entered contractors鈥� heads to be more selective as they鈥檝e got nothing to play with.鈥�
Hence Balfour Beatty鈥檚 publicly stated decision to bid for less UK work in order to drive up margin. One chief executive at another major contractor says: 鈥淲e鈥檙e bidding a fraction of the volume of projects we were bidding a year ago. We鈥檙e only going in where we know we鈥檝e got a really good offer and we can make a good margin.鈥�

Julian Daniel, former head of construction at Lend Lease and now managing director of construction specialist Blue Sky 黑洞社区, says: 鈥淭he market is changing. People are getting busier, the trades are getting busier, and people are going in for work at a little bit of a higher level. I would say it鈥檚 a fragile recovery.鈥�

These factors taken together are leading to inevitable speculation about the impact on tender prices. 鈥淭he reality is inflation will follow, and clients are starting to see inflation coming through in bids,鈥� adds Daniel.

For example, last week Land Securities in its annual results said it was remaining 鈥渧igilant鈥� on monitoring construction costs, which it said 鈥渨ill increase rapidly with a sustained upswing in activity鈥�. Emma Cariaga, development director for the firm鈥檚 London portfolio, says: 鈥淥ur view is that construction costs will increase quite rapidly. As developers start to come back into the market costs will rise, although who knows exactly when that will be.鈥�

Richard Steer, chairman of consultant Gleeds, says he is just starting to see the same thing: 鈥淲ith the failure of numerous subcontractors and main contractors, when an upturn in workloads materialises prices will go up due to a shortage of skilled providers. However, as it has been a particularly difficult and long recession, things will still take two years before they look very much better for contractors.鈥�

The possibility of rising prices shouldn鈥檛 be overstated - it hasn鈥檛 yet filtered through to official forecasts, with Davis Langdon, for example, predicting flat tender prices for 2013 across the UK. But the increasing likelihood of it is starting to change attitudes throughout the supply chain. The chief executive at a major contractor, for example, says: 鈥淭he boot is suddenly on the other foot in terms of our relationship with subcontractors - we really need them. And likewise with clients to us; the clever ones are starting to court us, knowing there鈥檚 limited capacity in the market. 鈥�

An upturn allows subcontractors to be increasingly selective about which contractors they choose to work for, potentially allowing them to turn down work or submit higher prices if they don鈥檛 trust the client to pay on time, or without quibbling. SEC Group鈥檚 Klein says: 鈥淭he main contractors are starting to realise there鈥檚 a limit to which they can beat up the supply chain.鈥�

Cash balances are the lowest they鈥檝e ever been 鈥� It seems to have finally entered contractors鈥� heads to be more selective as they鈥檝e got nothing to play with

Rudi Klein, SECG

While all this raises the prospect of better times to come, it also brings with it serious dangers. In particular main contractors that have won fixed-price work at low cost at the bottom of the market may find themselves struggling to deliver it as subcontract prices harden - putting their businesses at risk.  Subcontractors who have felt abused by main contractors鈥� payment practices during the recession may even indulge in score-settling if the relationship is not properly managed.

This risk is exacerbated by the fact any new work coming through at better margins will be mixed in with all of the other low margin work, meaning it will take a long time to feed in to greater profits, all the while requiring precious cash and investment in preliminary costs. In previous recessions recovery has actually been the most dangerous point of the cycle in terms of builders going bust. Blue Sky鈥檚 Daniel says: 鈥淭he risks are somewhat increased, particularly wherecontractors have bought work at sub-optimal levels and are still struggling to get paid.

鈥淐ontractors are also only going to expand on genuine opportunities, not on a hope of growth. That means capacity will recover slowly, increasing the tendency for contractors to try to deliver projects on a shoe-string. But there鈥檚 a risk to trying to operate with reduced resource - you鈥檙e more likely to run into problems on the jobs.鈥�

Daniel says contractors need to keep as close to their supply chain partners as possible, particularly as clever clients are very keen to know that 鈥渇irst division鈥� specialists are in their contractor鈥檚 supply chain. Falling out with a supplier can, in this situation, be a real barrier to winning work.

Given the danger to contractors during a rebound in work, it is important that now, more than ever, you attempt to work in partnership with your suppliers so they will help you when you need it. Which could - given the signs - be sooner than you think.