Managing Risk: Supply Chain Disruptions and Market Price Volatility in the Construction Industry
Cost Volatility and Longer Lead Times for Materials
Over the past year, the construction industry has experienced a sharp rise in the price of common construction materials due to impacts to production, delays in the supply chain, and hoarding of materials. For example, the Associated General Contractors of America reported that costs for general contractors have risen by nearly 13% from April 2020 to February 2021. Similarly, until very recently, lumber and plywood saw a 62% price increase, steel prices increased by 20%, diesel fuel prices increased by 114%, and copper and brass prices spiked 37%. These markets remain volatile, with recent reports of rapid price decreases for certain materials.
Contributing to price volatility, shipping and transportation deteriorated initially due to flagging demand in supplies and industry decision-making regarding inventory control, and now is struggling to keep up with surging demand.
As a result, project owners and contractors not only face threats of higher prices and longer lead times at the outset of projects, but also uncertainty regarding pricing and scheduling impacts throughout construction.
Risk Allocation In An Uncertain Market
Project owners, contractors, and design professionals need to anticipate unexpected project cost volatility, potential supply shortages, and longer project durations. They can do so through project planning and contract provisions that address these issues.
- Project Planning. Project owners, design professionals and contractors should be actively communicating about marketplace indicators and trends, and committing to approaching the challenge of a volatile marketplace in a cooperative manner, recognizing that allocating the risk of all price volatility of materials and delays to one party may stall or cancel the project. The parties should focus on procurement strategy that considers current industry data, including the current health and near-future prospects of the contractor’s existing supply chain.
- Alternative Materials. Project owners, design professionals, and contractors should remain open to the use of alternate materials and sourcing options, and create contract provisions that allow for the same. For example, if lumber supply is too uncertain and the cost is too high, they should consider the relative stability of supply and cost differential of alternative materials such as bamboo or concrete, assuming such alternative materials satisfy code requirements and performance specifications for your project.
- Contract Provisions. Contracts should be clear regarding (1) the contractors’ responsibility to account for supply chain and price impacts known at the time the contract sum and schedule are negotiated, or for design professionals, at the time the specifications and other construction documents are prepared, and (2) the parties’ relative responsibility for unanticipated cost increases and supply chain disruptions/delays. Balancing of interests may be addressed through a combination of (1) establishing a contract contingency for price escalation or covering some or all of the cost of acceleration efforts to mitigate supply chain delays in guaranteed maximum price contracts, (2) using change orders with an appropriate cost allocation in stipulated sum contracts, (3) allowing for the partial absorption of unavoidable cost increases of materials through adjustments in labor rates or reduction in the contractor’s fees, (4) requiring the design professional to specify materials, equipment, and systems from manufacturers or suppliers where there is no evidence of supply chain disruption at the completion of the construction documents, or to redesign at the design professional’s cost if it failed to take into account known supply chain disruptions or price escalation, and (5) providing for price triggers, which, if and when reached, require the purchase of materials to cap the price increase.
While this is not an exhaustive survey of mechanisms to address risks of supply chain disruptions and market price volatility, it highlights the importance of project owners, design professionals, and contractors to cooperate as they consider and address these realities before entering into the construction contract. The failure to do so may result in sidelined projects or disputes when unanticipated disruptions to supply chains and price escalation occur.
- Related Industries