Managing supply shortages and rising construction costs

As countries around the world counter the economic effects of COVID-19 by undertaking infrastructure projects and stimulating domestic construction, this has impacted global construction markets by creating:

• a shortage of some building materials;
• unpredictability in whether materials will be readily available when required; and
• upward pressure on labour and materials costs.

To tackle these issues requires a proactive approach from Contractors and understanding by Principals in how best to deal with these issues.

Managing shortages in construction materials

At present the Australian economy is experiencing a shortage of several building materials, which include:

• structural and engineered timber; and
• products containing semiconductors and other electronic componentry.

The reasons for these shortages are well documented and are expected to continue for the medium term. ABC News has reported that while domestic timber production is up 17%, there are major delays and soaring costs up and down the building supply chain due to a global timber shortage.

Some strategies to manage a shortage in construction materials include:

• ordering materials and equipment with long lead times early, anticipating a lengthy wait and factoring this into programing of the works and completion dates;
• pre-purchasing materials and storing them in a secure location;
• consideration of design changes to use alternate materials that are more readily available;
• making the date for commencement or completion of the works dependent upon the delivery of materials or equipment that are in short supply; and
• an extension of time provision which allows for delays in materials which are beyond the Contractor’s control.

Managing increases in construction costs

To combat the challenges associated with price increases in various construction materials some options are for Contractors to:

• provide quotations, tenders or estimates which are valid for a short period of time;
• bulk order materials in short supply and store them at an off-site location;
• nominate various items as a provisional sum items;
• contracting on an open book basis or cost plus basis; and
• nominating various materials to be subject to a cost escalation clause.

In terms of managing material costs the easiest option for a Contractor is to nominate items expected to be in short supply as provisional sum items or alternatively to contract on an open book ‘cost reimbursable’ basis. However, this will leave the Principal exposed to price fluctuations which may exceed its project budget. For residential projects which are subject to bank finance, this is unlikely to be acceptable.

Whilst bulk ordering materials and storing them off site may seem drastic, it is an option that may ultimately prove the most economic for Contractors and Principals in sizable projects. This option will generally require the Principal to agree to facilitate payment for materials to be stored off site before they are incorporated into the works. If material costs in several months’ time have substantially increased then the additional storage and security costs may prove a worthwhile investment by a Principal.

It needs to be kept in mind that the application of the above options may be limited by consumer laws. In Victoria for example, the Domestic Building Contracts Act 1995 (Vic) prevents cost plus contracts that are less than $1 million, and does not permit the use of cost escalation clauses in contracts that are less than $500,000.

Suspension on account of material shortages

If a project is suspended due a material shortage then the Contract needs to address how to deal with the time and cost consequences of this problem. When considering the cost consequences this includes cost consequences of mobilisation, remobilisation and demobilisation.

Should you have any queries or require any further information regarding strategies to deal with construction material supply issues, get in touch with the Gadens team.

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Authored by:

Daniel Middleton, Partner
Adrian Clifford, Special Counsel
Eylem Onal, Lawyer