Cost to Be a Contractor

Feb. 12, 2007

You’ll find it easier to take numbers when you are actually sitting in the middle of a super market. Actually, it’s not difficult to give them either.

Of course, this philosophy mainly applies to highway and bridge contractors. About 10 years ago, they were the ones in the thick of the best selection at the best prices. Material and labor costs were stable, and ripping off numbers for project bids seemed routine. This super market was booming with business.

You’ll find it easier to take numbers when you are actually sitting in the middle of a super market. Actually, it’s not difficult to give them either.

Of course, this philosophy mainly applies to highway and bridge contractors. About 10 years ago, they were the ones in the thick of the best selection at the best prices. Material and labor costs were stable, and ripping off numbers for project bids seemed routine. This super market was booming with business.

Three years ago, however, the livelihood of America’s contractor was hit square in the gut. First came the rise in steel prices, then the cement shortage. Last year, fuel prices soared and asphalt became scarce in some areas.

“I wouldn’t say these are hard times,” Brian Deery, senior director, highway and transportation division, with the Associated General Contractors of America (AGC), told Roads & Bridges. “Probably the best word is ‘risk.’ These are more risky times. One bad job could put a contractor under.”

In the first of a three-part series on the Cost to Be a Contractor, Roads & Bridges looks at what the average highway and bridge builder is up against in what has turned into an unpredictable market.

More for less

It all starts with a bid. For a while, suppliers were locked into prices for long stretches of time. This made calculating a final bid free of predictions. Today the process has grown in complexity.

“It’s been very difficult for contractors because the suppliers that supply them with those materials are not quoting them hard prices anymore,” said Deery. “What they are giving them is what the price is on day of delivery. It makes it extremely difficult to put together a realistic bid. You have to use a crystal ball.

“It is a guessing game, but hopefully it is an educated guessing game.”

To help prevent significant losses during the course of a job, contractors have been inserting contingency clauses into their contracts. This extra cost in the project covers any uncertainty in the marketplace.

Public works officials, however, demand accurate pricing, pulling the contingency crutch away from the contractor, according to Deery.

The string of spikes make it nearly impossible to hit any kind of cost target. According to the Producer Price Index from the Bureau of Labor Statistics, material prices in 2006 were up an average of 10.8% compared with prices in 2005. “That’s on top of a 13% increase in 2005 and an 8% in 2004,” Alison Black, economist for the American Road & Transportation Builders Association (ARTBA), told Roads & Bridges. “Prices are up 30% compared to three years ago.” The average annual increase was about 2% during a 10-year span from 1993 to 2003, Black said, and many industry experts are calling this current stretch one of the worst in history.

“There were certainly some extreme cases of inflation [in the 1970s],” Ken Simonson, chief economist for AGC, told Roads & Bridges. “But what was so different is in the ’70s everything was going up so I think buyers expected when they bought a new bridge that they were going to have to pay more than the year before.”

To make the cost picture even clearer, all one needs to do is take a closer look at the Producer Price Index over the past 30 years. Between 1980 and 1989, the index went up an even 30 points, from 91.3 to 121.3. The pattern remained constant between 1990 and 1999, jumping more than 26 points to 148.9. The new millennium, however, has so far produced staggering increases. It has taken just five years to top the increase of the ’90s. Through 2005, the Producer Price Index stood at 176.6. According to Simonson, an index value of 176.6 means the mix of material and components (such as diesel fuel) had a price at the producer level that was 76.6% higher than it was in 1982, when it stood at 100.

As mentioned earlier, steel opened the floodgates. A few years back, President George W. Bush approved tariffs on foreign steel in an effort to protect domestic producers. Despite the protection, 40 companies in North America went bankrupt from 2000 to 2003. With the lack of foreign supply and an increased demand worldwide, particularly from China, contractors in the U.S. were scraping for every last piece of steel at staggering prices.

Cement’s dark days soon followed. Staring into a slowdown in the economy in the late 1990s and early 2000, cement producers in the U.S. stopped adding capacity. Then came the surge in housing in 2003 and ’04 along with growth in retail, office and hospital building construction, and there was the resurgence in highway and bridge work. While the cement binge was taking place here, China and India were fueling demand abroad. The fact that the U.S. producers put an end to capacity growth put the contractor in another pinch. Due to environmental constraints it was extremely difficult to start new facilities, which forced the highway- and bridge-building industry to buy much of their cement from the foreign market, which came with high transportation costs.

The oil market has been a volatile one for decades. One of the worst hurricane seasons of all time put U.S. refineries out of commission for almost a year, and with tension tightening in the Middle East, the timing could not have been worse. The end result was crippling increases in diesel fuel and asphalt prices. Further clouding the future of asphalt producers is the installation of cokers at refineries.

“[Cokers] will produce more gasoline, diesel and jet fuel but will not leave any liquid asphalt at the end of the refining process,” said Simonson. “That means some asphalt paving contractors are going to have to scramble to find new sources of supply perhaps much farther away and at much higher delivery costs.”

Crushed stone also has presented some challenges. According to ARTBA, 651 million tons were used in 2005, and 40% of that was for road construction.

“Domestic output in 2005 really only increased 3.7% and imports were holding steady,” said Black.

There is some relief in sight, but materials costs will continue to increase over the next couple of years. The steel tariffs have been lifted and the steel-making capacity in the U.S. has been on the rise recently, causing prices to level off in 2006. Simonson said if economic growth is somewhat slower in the U.S. in 2007 it could force steel prices down even further.

Helping tame the fierce rise of cement costs is the push to end an antidumping duty on Mexican cement. In March 2006, the U.S. and Mexico signed an agreement to reduce the duty from over $26 per metric ton to $3 per metric ton. The duty will be completely eliminated in April 2009.

“Meanwhile, the U.S. cement industry has been starting to build more capacity, and that will come on the scene gradually over the next four years,” said Simonson.

Oil prices also are on the decline, but it is uncertain how long that will last.

Unhealthy levels

Materials are worthless if you do not have the right mix of people. Filling out payrolls is becoming increasingly difficult for the highway and bridge contractor.

With state DOTs downsizing and shifting more responsibilities onto the contractor, more pressure is being placed on the road and bridge builder to hire and retain employees who have traditional construction trade skills and to hire and retain workers with engineering degrees. According to a recent study conducted by the National Asphalt Pavement Association, titled Hot Mix Asphalt: Visions 2005 and Beyond, many skilled workers in the U.S. are rapidly reaching retirement age while at the same time the job growth rate in the construction industry is expected to be 9% a year through 2008.

Furthermore, the U.S. Bureau of Labor predicts that by 2010 the U.S. will be short 10 million workers, with much of the shortage being felt in the IT, health care and education fields. The demand will only pull qualified skilled workers from the construction field. The NAPA study also notes there are a decreasing number of 18- to 24-year-olds attracted to the construction industry and that the average age of those entering the building field is 28-32.

ARTBA conducts quarterly surveys, and in the latest one 30-50% of respondents report some type of labor shortage. Black also points to a healthy economy further complicating work force issues for highway and bridge contractors, saying the industry is competing with the retail and service sector for qualified applicants.

“We have changed to more of a service-based economy and we have more people going into those jobs,” she said.

To help fill the holes, many contractors have turned to the hiring of Hispanic workers, who require more training at a higher cost.

As for industry wages, some are reporting steady numbers while others are anticipating an increase. ARTBA’s quarterly survey is not showing any signs of a raise, but those at AGC see a different future.

“As inflation hits the economy, as costs are going up, people want to be paid more to compensate those costs,” said Deery. “As labor agreements are up for renewal there are expectations that they will be asking for higher wages.”

Taking care of workers is an additional concern. With insurance costs skyrocketing, some contractors have formed what Deery refers to as off-shore insurance companies. Also called captive insurance companies, the practice involves a group of contractors pooling funds together for coverage.

“That’s another incentive to increase safety training, because if there is an injury on a jobsite everybody suffers,” Deery said.

“In general, contractors are looking at their safety practices more closely. They’re looking at wellness programs. They are looking at doing things like stretching exercises to avoid injury.”

About The Author: Bill Wilson is the Editorial Director of Roads & Bridges. He can be reached at [email protected].

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