After a decade-long building frenzy, the drying-up of liquidity and the real-estate slump in late 2008 changed the dynamics of the Gulf construction industry. It has become a buyer’s market and contractors that were previously turning work away are scratching around for business amid a dearth of project awards.

The infrastructure projects that are moving ahead and their government-backed clients have benefited from improved contractor availability, along with lower prices for raw materials. Contracts that would have been awarded directly on a cost-reimbursable basis during the construction boom have been replaced by lump-sum or design-and-build deals awarded on a competitive basis, often from a list of prequalified contractors.

“The competition is intense; price is everything,” says the UAE-based manager of a major international consultant working throughout the Gulf region.

Competitive bids

Firms are trying harder than ever to ensure their prices are competitive and to build strong relations with clients. The desperate drive to win work in new markets is leading contractors to take on projects at minimal profitability. Traditionally, contracting margins are relatively low, at 2-6 per cent, but in the current market it is not unheard of for companies to budget just to break even to win a major new client - especially if this gives them a foothold into a previously untapped market.

“Our first acquisition in [Saudi Arabia] will be a key milestone, and will significantly contribute to our momentum”

Khaldoun Tabari, Drake & Scull International

Many are working to cut costs by improving the design and engineering of schemes. Innovative and efficient selection of processes and materials can have a major impact on price. Value engineering - scoping out a project with a view to eliminating unnecessary costs - involves ensuring that a project will meet its required function and performance standards at the lowest cost. Experts say up to 80 per cent of a project’s cost is determined in the early stages of design. In the new economic reality, contractors are increasingly undertaking value engineering and even bringing in consultants to do this for them. It most frequently happens on design-and-build contracts, where contractors take on all project risk by committing to undertake an entire construction project at a fixed price, in contrast to lump-sum turnkey schemes, where the client will engage an architect to produce the detailed design before tendering the construction contract.

By exercising more control over the design, contractors have more control over construction costs and can thus increase profits. Fixing the design and effectively freezing client requirements is essential in fixed-price contracting, since changes after the project gets under way can lead to massive cost overruns.

Another area where contractors are making savings is in the procurement of subcontractors and raw materials. The ability to procure materials both globally and locally in a cost-effective and timely manner is perhaps the most influential factor in shaping the bid price for a project. In 2008, when steel prices were rising rapidly to more than $1,000 a tonne, many firms decided to hedge against further increases by investing in steel futures. Others entered into partnerships with suppliers and some even acquired their own materials divisions.

UAE-based Arabtec, for example, purchased a 55 per cent stake in Sharjah’s Gulf Steel Industries. The strategy came in for question when steel prices dropped in early 2009 to less than $400 a tonne. But, as is the nature of commodities, the market has turned and the region is planning for prices to average $700 a tonne in 2011. Arabtec’s controlling stake in the firm could give it an edge when it comes to getting the right amount of steel for the right price.

Steel imports

Local steel capacity is on the rise, with Saudi Arabia’s Hadeed and Bahrain’s Gulf United Steel Company pushing ahead with expansion plans. But, as project prices come under pressure, some contractors are increasingly buying from Chinese and Turkish suppliers, which are importing low-cost steel into the region.

Major contractors are also taking particular care when selecting subcontractors and partners. Working with a strong civil works partner, for example, is vital in ensuring a project can be delivered at the right price.

Acquiring small subcontracting companies was common in the boom times, but today firms prefer to work closely with key supply chain partners, unless the acquisition is an avenue into a new market. Contractors are aware that the quickest route into a new country is to buy into a local firm.

“Everyone has been forced to reduce prices and there is lots of pressure on contractors”

UAE-based international contractor

In June, Omani contractor Galfar Engineering & Contracting bought a 26 per cent stake in Kuwait’s Shaheen al-Ghanim Roads & Bridges Contracting. This has given it a foothold in the Kuwaiti market, which made $2.12bn of contract awards in the first three quarters of 2010. The potential for contractors in Kuwait is vast. Earlier this year the government announced a $104bn infrastructure spending programme and firms present in the country are already reporting a pick up in the market.

UAE contractor Drake & Scull International (DSI) has also been on the acquisition trail, buying up firms in Kuwait and Qatar and now Saudi Arabia.
“Our first acquisition in the kingdom will be a key milestone for DSI, and will significantly contribute to our momentum as we venture forth in our growth strategy,” says Khaldoun Tabari, chief executive of DSI.

In early November, DSI was finalising the purchase of a mechanical, electrical and plumbing contractor in the kingdom and was in negotiations to acquire a civils specialist by the end of 2010.

Currency fluctuations

International contractors working across Gulf markets have additional risks to consider when pricing their projects. Exchange rate fluctuations have been dramatic over the past year.

“We have seen the euro fall and projects in Europe are no longer competitive,” says the UAE-based international contractor. “It is a dollar market here, so to some extent this hedged against the euro’s depreciation, but currencies are still fluctuating.”

European firms paid in dollars in the region have benefited from the dollar’s strength against the euro during the latter end of 2009 and the first half of 2010. In June 2010, the exchange rate hit a low against the euro of $1.19, down from more than $1.5 in 2009. But since then the rate has been recovering and contractors must find a way to ensure the rebounding currency does not erode profits.

In an effort to mitigate currency risk, some clients are opting to source a greater proportion of local finance for major projects. In Egypt, the country’s Public-Private Partnership (PPP) Central Unit is sourcing local finance packages for a raft of multibillion-dollar PPP schemes. Contractors will be paid in the local currency and international firms are expected to price the work in local currency, although this is optional.

The value of relationships with clients built up over time cannot be underestimated and not having such relationships can be a stumbling block for entry to some markets. In Saudi Arabia, for example, Saudi Oger and Saudi Binladin dominate the construction sector.

“Relationships are critical. Working with long-term partners means there are not so many troubles and claims,” says the UAE-based international contractor. But firms report that in general the contracting market, especially in Abu Dhabi, is open to new, good-quality, financially sound arrivals.

Reducing claims is critical to strong contractor-client relationships. Any claim has to be negotiated, validated and agreed. This can lead to payment delays and many contractors cannot afford cash to be tied up for 90 days while variations are resolved. Firms say outstanding payment issues remain a major concern in the current market, especially in Dubai, where some clients are now finding it hard to convince contractors to work for them.

Payment issues

Dubai’s troubled state-owned developer, Nakheel, for instance, is expected to approach the market for expansion and development of up to five shopping malls in 2011, including expansion of Dragon Mart and Ibn Battuta shopping complexes, but the news is being received cautiously by the industry. Contractors told MEED in October that Nakheel must provide payment guarantees, such as letters of credit or advance payments, as well as settling outstanding financial issues before they would consider working for the company.

Contractors in the region are striving to deliver high-quality projects at low costs, and the competition to win business does not seem to be abating. Clients are expecting more for less and only those contractors with sound supply-chain management, innovative design teams and strong client relationships are likely to stay ahead.

“Everyone has been forced to reduce prices … and there is lots of pressure on contractors,” says the UAE-based contractor.