“What is my biggest fear?” asks one Abu Dhabi-based contractor. “Liquidated damages. On big projects, the risks are so great that if you call it wrong, you could literally go out of business.”

The contractor’s concerns are serious. Contractors may be enjoying double-digit margins, record growth and an abundance of projects to choose from, but the risks involved in building projects are bigger than ever. Major companies are now taking on schemes worth more than $1bn and the consequences of failing to deliver could be catastrophic.

Losing revenue

Liquidated damages, or contractual penalties for not completing on time, are understandably the primary concern, but other factors can be equally damaging, such as loss of revenue that could have been earned by employing the same resources on another project, or damage to the company’s reputation. “If a project fails it is a disaster, especially in this market, because you could have been using your resources elsewhere to generate profits,” says the Abu Dhabi-based contractor.

The fast-paced nature of projects in the Gulf puts the contractor in an even worse predicament. Although the region’s real estate boom is well-established - especially in Dubai - for many it still has a transient feel. Questions such as ‘when will the boom end?’ persist, and with memories of slowdown in the late-1990s, the feeling that the good times are only temporary means that clients are desperate to deliver their projects to a market that is still buoyant.

Timing is therefore crucial. Projects are rushed, and construction timetables are squeezed in both directions. Designs are frequently incomplete before construction starts, and at the other end of the process, projects are handed over and open for business before they have been properly completed.

With margins for error so slim, contractors must get it right onsite first time, as any delay in the delivery of supplies or subcontracts could delay the whole project. Although the supply chain has managed to keep pace with growth across the region, there are temporary imbalances where the demands of contractors simply cannot be met.

In the UAE in March, contractors were forced to wait for cement deliveries as ready-mix companies struggled to meet their orders. The shortages were caused by plants being forced to close down for maintenance after three years of operating at full capacity. At the time, the market expected the shortfall to last four to six months, before the government stepped in and scrapped import duties on cement and rebar (reinforcement steel bars) to encourage imports into the country and ease the shortfall in supply, although few expected any softening in prices.

Supply problems do not just apply to raw materials. Work on the record-breaking 800 metre-plus Burj Dubai tower was delayed in late 2006 and early 2007 after the nominated cladding supplier, Swiss firm Schmidlin, went bankrupt and deliveries of cladding were not made. Although a joint venture of the local Arabian Aluminium and Hong Kong-based Far East Aluminium was brought in to replace the original supplier, work on other packages that were dependent on the cladding works had to be accelerated and, more recently, the client, Emaar Properties, stated that the opening of the tower would be delayed by nine months.

A more thorough due diligence process of its nominated subcontractors may have avoided the problems experienced on the Burj Dubai. But other projects, using solvent suppliers, have also faced cladding-related delays. Traditionally, contractors have leveraged their long-term relationships with suppliers to ensure that their deliveries are made on time, but as the volume of projects mushrooms, these relationships have become less influential - everyone is busy and has the same demands for materials.

In-house support

To maintain their leverage over the supply chain, some contractors are taking it in-house and establishing divisions or sister companies that can supply or support their contracting activities. Dubai-based Al-Shafar General Contracting is one example. The company now has a variety of group companies engaged in almost all major construction disciplines.

“Over the years, we have opened several companies to support Al-Shafar General Contracting,” says Bishoy Azmy, chief executive officer of Al-Shafar. “With the amount of work available at the moment, handling subcontractors is a nightmare. With access to our own companies, we do not have to enter that hellish scenario.”

By avoiding confrontation, investing in the supply chain also promotes the concept of partnership, which is becoming increasingly popular across the region. “It saves a lot of the time and effort that is spent arguing with subcontractors,” says Azmy. “Everyone is starting to realise that partnership and co-operation is the way forward, and when a company takes a share in a ready-mix company, there is no need for cheating and arguing as they both have the same management.”

UAE-based Amana is another contractor that is benefiting from vertical integration. The company, which specialises in large-span buildings such as warehouses and specialised pipework, supports these divisions with a steel-fabrication business.

“The number one reason for investing in the supply chain is to ensure reliable deliveries,” says Riad Bsaibes, chief operating officer at Amana. “Amana Industries produces about 1,500 tonnes of steel products a month, and Amana Buildings uses about 30,000 tonnes, so we do not have enough to meet all our requirements. But on fast-track jobs where every day counts, and deliveries can take eight to 12 weeks, it means we have access to supplies when we really need it. The second and third reasons are to div-ersify and balance the company’s revenue streams and reduce costs, but that is not always the case.”

Acquiring support

A quicker way to garner support is through acquisitions. Over the past three years, Dubai-based Arabtec Construction, which is working on the Burj Dubai, has invested in companies through its parent, Arabtec Holding, that will support its contracting business. It recently bought a 55 per cent stake in steel fabricator Gulf Steel Industries, and in 2005 it acquired Arab Austrian Ready Mix Concrete Company from Al-Hamed Development Company, another UAE-based contractor.

The company has made similar moves to secure subcontracting services. Last year, it acquired a 60 per cent stake in Abu Dhabi-based Target Engineering Construction Company, which will allow Arabtec to participate in oil and gas and marine projects. In 2007, it bought 55 per cent of mechanical and electrical contractor Emirates Falcon Electromechanical Company.

Contractors are not the only types of business looking to secure their supply chain. In a region ruled by fixed-price, lump-sum contracts, the client was typically well-insulated from the risks faced by the contractor in terms of cost escalation and materials shortages. But as the region moved from a buyers’ to a sellers’ market in 2005, contractors could afford to be selective, which meant that developers who had been difficult to work with in the past began to find it hard to secure contractors’ services.

Developers such as Dubai-based Emaar and Union Properties, which had existing relationships with contractors, large portfolios of projects, and were generally perceived as a good to work for, managed to weather this storm better than others.

Increasingly, the only option for clients was to look at alternative procurement methods such as direct negotiation and two-stage tenders to recruit contractors. Some developers took procurement to the next step and have established formal alliances with contractors and suppliers to give them access to the resources they need to ensure their projects are delivered on time and within budget. With a shortage of contractors in Abu Dhabi, local company Aldar Properties is one of the developers pioneering this approach.

In late 2006, it established a joint venture with the UK’s Laing O’Rourke to deliver its $14bn Al-Raha Beach development, and earlier this year it signed a similar agreement with Belgium’s Besix to deliver much of its $40bn Yas island project. Aldar has also looked at controlling critical elements of the supply chain, and in late March it formed a joint venture with Readymix Abu Dhabi to supply its development projects in the emirate.

Other companies have followed Aldar’s lead (see table right), but partnering agreements remain the exception rather than the rule, particularly in Dubai, where there is a strong pool of incumbent contractors.

The same cannot be said of Abu Dhabi and Qatar, where the demands that will be placed on the contracting industry far outweigh its capabilities. Abu Dhabi-based Al-Qudra Real Estate, for example, has, like Aldar, established joint ventures with project management firms and contractors. In Doha, Qatari Diar has formed a joint venture with France’s Vinci Construction Grand Projets for its Lusail development. Qatari Diar affiliate Barwa Real Estate also plans to invest in the supply chain to ensure its projects are not starved of the materials they need.

International expansion

Developers and contractors face a similar dilemma when it comes to geographical expansion. As margins for developers in the Gulf are squeezed by a levelling off of property prices and rising construction costs, the solution has been to invest in less mature markets where the margins are more attractive. As a result, companies such as Dubai’s Emaar, Sama Dubai, Limitless, Majid al-Futtaim Group and Al-Futtaim Group, Abu Dhabi’s Sorouh Real Estate, Al-Qudra and Aldar, and Qatari Diar, have all been keen to invest in development projects in North Africa, the Levant, South Asia, the Far East and the former Soviet Union.

At the same time, contractors do not want to be dependent on one market. While waiting for domestic opportunities to gather pace, Saudi contractors such as Saudi Binladin Group, Saudi Oger and El-Seif Engineering Contracting have expanded into markets where they can secure work. All three have won work in Dubai and Abu Dhabi, where the real estate boom is already fully under way and work is readily available.

Similarly, Kuwaiti contractors such as Mushrif Trading & Contracting have worked on projects in Abu Dhabi and Dubai, and both markets make a significant contribution to the company’s turnover.

Migration is also occurring in the opposite direction, with Dubai-based contractors keen to get into markets where there are new opportunities for growth. For many, Abu Dhabi is the obvious option. “We do not want to be just a Dubai contractor,” says Azmy. “So we are branching out into Abu Dhabi and we have secured our first project there.”

Qatar is another option. Dubai-based Al-Habtoor Engineering Enterprises has worked on the Doha City Centre project and is involved on the Dubai Towers, and in 2006 Arabtec secured a contract to build Waab City in Doha.

The least risky method of entering a new market is to work with an existing client. Al-Habtoor’s Dubai Towers contract in Doha is with Sama Dubai, and Arabtec has secured work in the Levant with Dubai-based clients with which it already has a relationship. In Syria, it is working on Emaar’s Eighth Gate project, and in Jordan it is working for Damac Properties.

To make the transition into these markets even smoother, Arabtec took these contracts in joint ventures with contractors that have existing operations in these countries. For example, in Jordan it is working with the local Engineering Enterprises Company.

Working with existing clients does not just benefit the contractor; it also gives the developer the assurance that its project will be delivered by a company it knows and trusts.

Several developers have formalised this arrangement by signing up for partnerships for all their projects around the world. Qat- -ari Diar’s partnership with Vinci does not just include its Lusail project, but also its projects overseas.

More collaboration is expected in the future. To date, the supply chain issue has only really affected Dubai, Doha and, more recently, Abu Dhabi. But as development in Saudi Arabia gathers paces, together with projects in Kuwait and further growth in Qatar and the UAE, the pressure on contractors and clients to control costs and guarantee delivery through diversification and alliances will grow.

Key fact:

The Gulf project market exceeded $2.1 trillion in April.

Table: Client alliances

Source: MEED