Inflation, budgeting and construction costs

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Inflation, budgeting and construction costs

INFLATION, BITDGETING

RND

A.S. Rakhta and

A.J.

INTRODUCTION

Inflation is a continuous rise in general price l e v e l s in an

economy- There are several i n d i c a t o r s of i n f l a t i o n , f o r example: changes in wholesale prices, r e t a i l prices, industrial prices, and I m p l i c i t p r i c e s 05 gross national e x p e n d l t u r e s . &st the most commonly

used indfcator of inflation is the consumer prPce index (CFL).* The

CPI is a composite price Index of a fixed "basket" of consumer goods

and services at the r e t a i l l e v e l ; changes In it _{over time r e f l e c t}

changes in the general p r f c e l e v e l .

In the b u i l d i n g industry, too, there exist several measures o f building castiprice i n f l a t i o n . This is because the output of t h e

buildlng industry is not hmogeneous and is so diverse in stze,

function, and q u a l i t y t h a t one composite c o s t index cannot be used for all types of buildings.

In Canada, three t y p e s of building c o s t indices have been

developed and publZshed by S t a t i s t i c s Canada, the p r i n c i p a l agency

r e s p o n s i b l e for economfc data development and diasemination. Ttzey are:

i n d i c e s of i n p u t prLces (material prlces, wage rates etc.), indices of output p r i c e s (new hausing prices), a n d p r i c e indices of capital

expenditures .2

Each of these measures h a s i t s own purpose and problems in d e r i v a t i o n ; they should not be used interchangeably. Care should be taken to select the most appropriate measure. For any contract

e s c a l a t i o n clause, for instance, input p r i c e I n d i c e s and n o t autput

price indices should be used.

Movements in these measures may not correspond exactly and "lag" and "lead" relationships may ex-lst between them. For example, an increase in general inflation may not be followed i m e d i a t e l y by

increases in b u i l d i n g material costs, while changes i n wages may f o l l m relatively qulckly. Even with-fn building materials as a group, prices of some rnateriah may change faster than others. However, it is l i k e l y

that changes in the general Level of prlces or the CPI dl1 affect all building c o s t components sooner or later.

One purpose of this paper is to examine which materials or groups of materiala respond more quickly to a general rlse in prices,

*For a d e t a i l e d d i s c u s s i o n on CPI: and other measures o f inflation, see

as compared with the response of changes in wage rates- The paper wfll a l s o analyst the impact of general inflation o n increases in material and labour c o s t s , and will examine the implieations o f differential price movements in various building cost components for buflding contractars, designers, and owners.

IMPACT OF INFLATION

ON

There is no s l n g l e or simple explanation for the continuing existence of i n f l a t i o n , Broadly speaking, however, i n f l a t i o n is caused

by two s e t s of forces: "demand-pull" and "cost-push".

Demand-pull inflation occurs when the demand for all t h e

goods and servfces avatlable in a society exceeds their s u p p l y at a

given price; thls exerts upward pressure on prices. Cost-push

i n f l a t i o n occurs when oae f a c t o r of production, say labour, t r i e s to improve I t s share of n a t i o n a l _{income more rapidly than is warranted by} 2mprovernents in i t s productivity. These cost (wage) increases, when passed on to t h e consumer, result i n higher prices. These, in turn, g i v e rise t o demands for e v e n higher wages, and so the vicioas circle continues. This circle t e n d s to be reinforced by expectations of future price increases. Other factors of ten cited f o r inflation include the recent increases i n energy prices and higher profit mark- u p s than can be f ustif i e d .

I n f l a t i o n hits every sector of the economy, Includfng the building sector, where its principal- impact is through increases in wages and in the p r i c e of building materials. It w i l l also b e reflected in Increases in the p r i c e o f the f i n a l products. However,

the timing and extent of the Inflationary impact of wages and building material prices d l 1 n o t necessarily be the same. For example,

materials the supply of whlch cannot be easily increased, or which cannot be replaced by ather materials ( s t e e l versus concrete in e a r l t l -

storey structures), will have larger price increases than these whose supply is more responsive (wood studs versus metal- studs). The t l d n g of price increases for iadividual materials w i l l also depend on the market conditions under which they are produced. For instance, price increases dl1 be relatively more rapid and higher for materials produced by o n l y one or two companies, compared to those f a r which

many manufacturers compete for the available market.

Month-to-manth percentage changes in the i n d i c e s a £ f n f l a t i o n , labour costs, b u l l d i n g material costs, and t h e combined indgces of labour and materlal c o s t s , indlcate that no clear-cut

p a t t e r n o f "lag-lead" r e l a t i o n s h i p seems to exist between i n f l a t i o n end other variables, except that changes in bullding material casts tead to

f o l l m those in the CPT.* Fluctuations in buildfng material c o s t a are

much h i g h e r than in the CPI. However, over a long p e r i o d , the rates of change in grcwth of t h e (21 and of building material c o s t s do n o t

appear to be significantly d i f f e r e n t . Table 1 i n d i c a t e s that between 19 71-1980, t h e i n f l a t i o n rate, compounded annually, was 8.4%, compared with an 8.87% increase in b u i l d i n g materiaf costs. In absolute terms, the material cost; index ( a ~ s m l n g 100 in

1971)

Changes in materiaf c o s t s , unlike changes i n the CPI, are not unidirectional. They respond to changes in economic a c t i v i t y in both d i r e c t i o n s . For example durlng the period of rising economic activity

(1971-197J), the C P I in Canada moved up at a compound annual grcwth rate of 8.24%, compared w i t h an 8.72% rise in material costs. Retween 1978-1980, a period o f r e l a t i v e l y s l o w a c t i v i t y , buildtng material prfces increased by 8.11%, compared w l t h 9.47% for the CPI. However, material c o s t indices f e l l a b s o l u t e l y in some months between 1978-1980. This slow rise or absolute fall. in building material prices during a sluggish e c o n o d c s i t u a t i o n is one result af t h e inability of material

producers to pass on cost increases to builders o r contractors. 'Movements in material prices as a group may vary quite significantly from those of i n d t v i d u a l material prices. For example, between 1971-1980 the price indices f o r iron and steel rose by 1622, compared with 1 1 3 X f o r heating equipnent, 121% f a r cement, 138%

for

veneer and plywood, and 140% far paint and

Changes in wage sates in the building bndastry, as In most

a t h e r t n d u s t r i e s , are "sticky" downward

-

from 100 in 1971 to 236 in 1980, an increase of 1362, while the corresponding increase in the CPI was 110% and for material costs, 1 % However, fluctuations in wages over long periods are not ao common. This is because wages in the construction i n d u s t r y are

d e t e m f n e d by bargaining units and remain unchanged over t h e contract p e r i o d ,

EFFECTS OF INFLATION ON THE DEMAND FOR BUILT SPACE

In theory, if t h e prices o f a l l goads and services change at

the same rate, then t h e inflationary impact on t h e demand for those

goods and services will be zero. In practice, this does n o t occur. The prices of different goods and services move d i f f e r e n t l y , and sometimes in opposite d i r e c t i o n s , during i n f l a t i o n .

*However, t h e recent reopenkng sf the contract between Ford Company of America and the United Auto Workers (UAW) i n d i c a t e s t h a t a severe

A t a given l e v e l of income, the demand for built space should t h e o r e t i c a l l y decline w i t h an increase in price a l n c e l e s s of I t would he demanded at the hlgher price. But thls may n o t be so,

Built space services are provided by products

(i,e. buildings) which last f o r many more years than consumer goods and durable products such as automobihes. Resources spent on built apace are, in practice, investments. If the i n v e s t o r or builder-owner f e e l s

t h a t returns from his investment in buildlags wtll exceed those

available in alternative fnvestment o u t l e t s (investment certificates, common stocks, etc.), he will invest in built space, e s p e c i a l l y if the prices are rising. His return on investment in built space c o n s i s t s o f two components: cash flow In t h e form of rent, if he leases hls

b u i l d i n g , or opportunity rent, ( r e n t he would otherwise pay if he did not own the house) if he uses his building himself; and appreciation in

the value of built space through rising prices. Even if the net of the f i r s t component (cash flow minus mortgage payments) is negative, he expects a s i g n i f i c a n t increase in the market value of his a s s e t t o o f f s e t his negative cash f l o w , and he w f l l make investments in real e s t a t e in the f a c e of r i s i n g mortgage payments. ?%is has recently happened 5n the major urban centres in Canada, where demand f o r housing soared in t h e mldst of record h i g h mortgage rates.

The psychology of continuing inflation may, therefore, d i s t o r t the working of a free market economy and shift resources to more speculative activities, thereby depriving ather sectors of the

economy. of needed resources.

High i n f l a t i o n rates affecting t h e market for new buildfngs may bring about an increase in the i n c i d e n c e of renovation or majar repair t o existing buildings. As new buildings become more expensive, an Investor or b u i l d i n c a w n e r can meet his need for b u i l t space by renovating, r e t r o f i k t i n g , a l t e r i n g , or r e p a i r i n g existing built space facil.Zties. This trend has recently been noticed in most European and North American countries.

ALLOWING FOR INFLATION AT THE DESIGN STAGE

Cost c o n t r o l during t h e design process requires deriving some target, or budget figures for the major subsystems of the building, and then monitoring the evolving design so t h a t it remains w i t h i n the c l i e n t ' s o r employer" budget. The budgetary d e t a i l should evolve with the develaping design. For example, the i n f t i a l bullding cost estZmate

w i l l probably be based upon a review of h i s t o r i c a l records f a r simtlar buildings, s u i t a b l y updated, and expressed in d o l l a r s per square metre multiplied by the area to b e built. However, at t h e c o m p l e t i o n of the design, k t dl1 be necessary to quantify all of t h e resources required and c o s t t h e m . Between these two stages are several l e v e l s of d e t a i l which may be used depending upon the sophistication of the d e s i g n office. A courmonly used cost control d e v i c e is elemental cost

of t h e different elements); thls p e r m l t s the comparfson of the costs of dFEf erent b u i l d i n g s .

Table 2 shows a t y p i c a l elemental c o a t a n a l y s i s * * The

o p t i o n s available to t h e design c a s t controller in forecasting

elemental costs, either to a tender d a t e or to completion date, are very l i m i t e d a t the design atage. A common method I s to estimate a

trend l i n e to the published p r i c e i n d i c e s and to use a single

m u l t i p l i e r of p r o j e c t e d cost changes on all rates. However, this is unrealfstic for several reasons.

F i r s t , each element shown in Table 2 entails very d i f f e r e n t k i n d s of work, i n v o l v i n g d i f f e r e n t combinations of the use of labour, capital and materials. Substructure work, far example, usually implies excavatian w i t h large e q u i p e n t , and then the placing of concrete

foundations. H o w e v e r , the Lnstallatlon of mechanical and electrical services, for example, requires diverse and expensive materials and is complex, i n t r i c a t e work. It is unlikely that both substructure work and services work would be a f f e c t e d in the same way by i n f l a t i o n ,

Second, the costs of substructure work and services work are incurred at quite different stages i n the conetructian; they could b e separated by several months of inflation.

A b e t t e r approach is to make a cash f l o w p r o f i l e , derived from the program a£ the work to be carried out, and to apply the approprtare monthly inflation factor to it. The problem with this approach i s that at t h e d e s i g n stage the program of construction work is ill d e f i n e d , slnce it is not for the design team t o tell the

constructor how a n d when to carry out t h e c o n s t r u c t i o n .

A better approach still is to c o n s i d e r , separately, the

i n f l a t i o n In materials and labour canteat of each element of work, and

weight the construction inflation multtplies in proportion to the

c o n t r i b u t i o n made by labour and c a p i t a l to t o t a l work. However, unless the t o t a l work c o n t e n t i s a v a i l a b l e , which is unlikely at the design stage, simplifying assmmprians as to the a p p r o p r i a t e weighting of lahour content to material content must be made for each element.

Unfortunately, there is l i k e l y to be a great v a r i a t i o n in the r a t i o for work i t e m s even within the same elemental category. A common

assmptien is to take a 50150 weighting and although t h i s is rarely accurate (see Table 3 1 , it is still a better approach than t h e single

i n f l a t i o n Index.

As destgn c a s t control is often weak in accounting fox inflationary factors and hence in psedicttng c o s t in the future, it

becomes necessary to consider in d e t a i l the ability of the c o n t r a c t o r

*

(substructure, superstructure, services etc.) which form a useful basis

t o estimate for i n f l a t i o n . His position is slightly d i f f e r e n t In t h a t at l e a s t he is normally a b l e to work from f d l y developed design

d e t a i l s , and h i s commercial success or faflure depends on his experthae in this area.

CONTRACTOR COST CONTROL

The Canadian Construction AssocEation has twice considered and rejected the incorporation of i n f l a t i o n escalation clauses i n the standard forms of b u i l d f n g contract, most recently in late 1979. Since then, the CPI has gone E r m 199 in December 1979 t a 266 fn August 1982.

The following r e a s o n s for the r e j e c t i o n of e s c a l a t i o n clauses are o f t e n mentioned by contractors.

(a) The employer (client) expects and deserves a firm price.

This is particularly important when the employer is the public clkent since it is d i f f i c u l t to get approval f o r uncertain amounts* It is particularly important because of the unpleasant experiences o f ' c o s t

plus' contracting Ln, the past.

(b) Explicit recognition of inflation in contracts would do L i t t l e r o k e e p r n f l a t i o n down. It: is f e l t that tmpreved i n d u s t r y practices can reduce the harmful effect of i n f l a t h n upon

p r o f i t a b i l f t y .

In order to consider further the validity of these arguments

and to explore in d e t a i l t h e impact a f inflation upon the contractor, the process o f c o s t estimation by a contractor should be examined.

Most contracts tnvolve the use of a ma3n or general

contractor who does l i t t l - e of the work w i t h h i s owa operatives but sublets specific items o f the work to speclalLst sub-trade contractors. Typically, t h e extent o f t h e sub-contracting could be 80% of the t o t a l

value of the main contract. Each of the sub-contractors usually

competes with h i s r i v a l s f o r the work packages from the main contractor and hence each mst allow for i n f l a t i o n A n his b i d . When the general contractor receives the sub-contractorsr bids he aggregates them, adding his own marglns for the supervision of the sub-contractors, prof f t aad overhead, p l u s any work whf ch h l s own labour is undertaking. The total then becumes the contract bid. In practice the tendering process is o f k n carried out in a f a i r l y s h o r t t h e (3-6 weeks), and in

this frant5c period much work must be done,

It is asaumed, although it is not always the case, that the f u l l design drawings and specifications ate a v a i l a b l e for the

contractors to measure and quantify exactly the amounts of work for which they are tendering. There may be several thousand se-parate items of work in a modern building. For each item, the labour c o s t , material

c o s t , equipment c o s t , overhead and p r o f i t must b e determined and multiplied by the appropriate unit c a s t rates,

The proporrions of these in each i t e m of work vary enormously, as may be seen f r o m the sample rates shown in Table 3.

The skill of both general and subcontractots lies in d e r i v i n g s u i t a b l e rates f o r these unit c o s t s , s i n c e i t 5 s generally assumed t h a t in a well dncumented design, the work quantities are determinf stic.

Estimating the Cost of Labour

Labour c o s t s are probably the most d i f f i c u l t c o s t component for a contractor t o p r e d i c t s i n c e they depend upon labour p r o d u c t i v i t y , which is a complex and variable quantfty. Also labour costs are

difficult to e s t i m a t e because many buildfag tasks are performed by crews, or composite gangs of labour, 5n which some members contribute d i r e c t l y to output o f the unit of work while others contribute

i n d i r e c t l y but are nevertheless essential to the completion of the task. For example a m s o n r y c r e w consists of the bricklayers and the labourers who serve the bricklayers.

Estimating labour costs therefore involves estimating the t i m e required for each t y p e of labour necessary to Lhe task and

establishing an hourly rate for each. The actual work content of the task also a f f e c t s the e s t i m a t e d costs since productivity of the crew is affected by the proportion of start up and fin3shlng time and by the

e f f e c t of the learning curve.

The c o s t of labour to the contractor i s not simply the hourly

wage rate for the t y p e of operative, Account must also b e taken of the f r i n g e benefits provided and the statutory contributions which the

employer m u s t make to cover p e n s f o n plans and unemployment insurance. The actual labour overhead v a r i e s from one crew operative to another

s i n c e , for example, different trades have different f riage b e n e f i t s . (This indirect wage cost can amount to 25% o f the d i r e c t wage bill.)

Currently, the conmon p r a c t i c e across Canada is to negotiate twn-year agreements w i t h o u t cost-of-living allowances. Hence the contractor f a c e d with estimating for a project some t i m e i n t o the future has to use judgment, p l u s any informal eommuntcation w i t h the unfon labour agent, to predict future wage settlements. One likely consequence of hlgh i n f l a e k o n dl1 be the r e d u c t i o n in duration of such agreements or the introduction of some agreed annual cost-of-living escalation clause.

The Cost of Materials

Of a l l the components of c o s t w h i c h the estimator must consider, the material cast is probably the easiest to determine. It will normally have four components, as shown below:

MATERIALS

I

I

'r

I

BASIC COST HAULAGE OFF-LOADING

AND STORAGE ALLOWAWCE Of these, the basic material c o s t and haulage charges are particularly sensitive to i n f l a t i o n . In the case of bulky items such as precast

concrete panels or large elements of the mechanical system, t h e haulage cost can comprise a large portion of the material cost and t h i s w i l l vary w l t h price increases in the transport industry.

Materials suppliers are perhaps the group most In favour of i n f l a t i o r r p r o o f i n g c o s t s , since the time horizon o v e r which they are prepared to make f i r m price quotations is reduced considerably in times of high i n f l a t i o n , Prior to 1973, almost a l l material price

quotations were guaranteed for twelve months. Now s u p p l i e r s are much more careful and prefer to quote prices only at time of shipnent. A

point whfch has emerged frequently in discussions with contractors is that suppliers or wholesalers are now carrying much smaller inventories of stocks. This p r a c t i c e requires more precise planning by the

contractor as to when the m a t e r i a l w i l l be required but the supplier

can give a Elm price stnce t h e inflationary effects upon specific m a t e t l a l s can be more e a s i l y estfmated.

However, large contractors may try to avoid przce inflation by buying materials earlier than they are needed, and s t o r i n g them.

(If the materiala are clearly marked for the specific project and actually stored on the site, then most contractual forms allow a valuation payment in advance o f their incorporation i n t o the work.)

Another consequence of material p r i c e escalation would be the

tendency of successful contractors to take over some materials

manufacturers and suppliers, as has happened in some cases in Europe.

Equipment Cos ts

The estimation and allocatfon of equipment: c o s t s present some problems to the contractor. Equipnent includes a wide varlety of

i t e m s , from the largest tower cranes, through mechanical formwork, to hand taals. Some of them are clearly chargeable a s d f r e c t c o s t s to certain specific tasks, while others may be used for many d i f f e r e n t t a s k s , Task-specific equipment, such as the power tools used by a crew, are usually incorporated I n t o t h e labour c o s t for that task. Lgrger and more general items are priced by deriving a unit cost: rate

and mwltiplylng it by t h e time needed for the project. In the case of

large items such as tower cranes, the time taken to transport, s e t up and remove must a l s o be taken i n t o account. Major items of equipment may be h i r e d under short-term rental agreements or may be owned by the contractor and charged t o t h e partfcular project at a rate s u f f i c i e n t

to cover all owning and operating c o s t s . Among the factors affecting these owning and operating costs may be included: purchase price, resale value, useful l i f e , coat of capital, insurance and road taxes, operators' wages, fuel casts, coasmables (grease, tires, fflters,

etc.), site maintenance, and d e p o t overhauls.

To determine the possible impact of i n f l a t f o n upon the equlpnent costs, it is worth c o n s i d e r i n g the f a c t o r s affecting equtpment usage cost since it is on these that the equipment hire

company must base i t s rental c o s t s in order to b e competitive. In such cases, the price of equipment may be very sensitive to p r i c e

fluctuations-

Overhead and P r o f i t

Overhead c o s t s are the costs of being in business, The problem facing the contractor is one of deciding how to allocate them

accurately over hfs various p r o j e c t s . Some of them are directly

r e l a t e d t o specific projects, such as s i t e supervisary staff, temporary buildings and facilities, and site s e c u r i t y , while others cannot be allocated to s p e c i f i c tasks on the project,

More difficult to deal with are the head office operating

c o s t s . These include central administrative staff s a l a r i e s , o f f i c e

services and r e n t a l , and public liability insurance. They must be allocated to specific p r o j e c t estllmates In some way which w i l l reflect workloads. They are subject to inflation fn t h e same way as any other business.

The p r o f i t l e v e l is perhaps the most complex s i n g l e factor for the contractor to estfmate. Its assessment will r e f l e c t the sophistication of h i s fZm and the business acumen of its directors. There are many complex ways of applying p r o f i t l e v e l s . The d i a c u s s i a n

below illustrates the most important p o i n t s .

Most contractors d l 1 expect to make a certain l e v e l o f r e t u r n on the net a s s e t s whtch they employ on any project. T h i s usually means return on working c a p i t a l , which is the difference

hetween monthly expenditure on the work and monthly income for interim valuations. Working capital. must: also be funded from some source, usually equity capital, or l o a n c a p i t a l , or retained profits. Whatever t h e mix of these sources used, the actual levels of return required

w i l l be d i c t a t e d by money markets q u i t e independent of the building industry. Each contractor w i l l be competing for working c a p i t a l with

o t h e r industries, and wSll be competing £or loans w i t h other

companies.

Alternatively, the main contractor d g h t see himself as providing t e c h n i c a l expertise in the form of skilled personnel, l a which case he would look far a return on his wage and salary bill, Or he may simply consider t h e market for building s e r v i c e s and use a

p r o f i t margin which he thinks his o p p o s i t i o n w i l l allow him to use, to win the job and stay in business. A l l of these i n t e r p r e t a t i o n s are very s u s c e p t i b l e t o inflation,

TAE ECONOMIC PERFORMANCE OF CONTRACTORS

The r3sk of i n f l a t t o n on the p r o j e c t is lessened s i n c e each b i d is a composite of estimates from many separate f i r m s ; more than 30 separate sub-contractors on a t y p i c a l j o b . There is some statistical b a s i s to this " l a y i n g off'" of the r i s k often referred to by general contractors* The "Central Limit Theorem" suggests t h a t , with a large number of work items independently costed, any bias in _{the individual}

rates is likely to be absorbed i n t o t h e complete picture bn such a way t h a t the final distribntion is l i k e l y to be normal around the mean

v a l u e . Hence it is possible that i n f l a t i o n will be balanced o u t by

sorne sub-coatractors o v e s p r o v i d i a g and others underproviding. In

fact there seem to be no figures regarding the extent of dfspersion around the mean.

Another factor t o be c o n s i d e r e d , and o f t e n mentioned by contractors a s a s a f e t y d e v i c e against a general or sub-contractor under-allowing for i n f l a t i o n and hence over-extending himself

financially and perhaps going bankrupt, i s t h e s y s t e m of perfosmance bonds and labour and materials bonds. These are insurances which t h e

wise e m p l o y e r demands of his contractors so t h a t in the event of thelr going bankrupt and being unable to finish the work, a bandlng company will guarantee t o have the work finfshed at no c o s t to t h e e m p l o y e r . Typically, 50% performance bonds are taken out since it is thought u n l i k e l y the contractor w f l l go bankrupt: before half of the work has been completed. However, in practice, the d i s r u p t f o n caused to the p r o j e c t by a bankruptcy, the delays and inconveniences of brfnging in a bondhg company are additional c o s t s t o the employer which are rarely considered.

If

-

-

Presumably, reasonable Indications of how well contractors estimate and a l l o w for I n f l a t i o n w i l l be given by examining the p r o f i t records of contractors during times of inflation. There are several

criteria* which could be used t o assess contractor p r o f i t a b i l i t y . Table 4 shows v a r i o u s c r i t e r i a used in a recent paper by t h e Canadian

Construction ~ s s o c i a t ~ o n . ~ Thls paper concluded that profitability in the period 1975-79

-

construction f l e l d

-

p r o f i t a b i l i t y of the industry. Further, i n 1979, profitability fell considerably more than the r e t u r n from i n d u s t r i a l bonds.

A d e w of the profitability of an industry may be obtained by considering another economZc criterion, the frequency of bankruptcies.

T a b l e 5 cornpares the number of construction industry bankruptcies with all bustness bankruptcies. Such figures, however, a r e d i f f i c u l t t o interpret. While the number of bankruptcies in absolute terms is c e r t a i n l y growing, they would appear to be increasing at a slightly lower rate than a l l b u s i n e s s bankruptcies. The proportton of t o t a l business bankruptcies r e p r e s e n t e d by the b u i l d i n g i n d u s t r y remains f a i r l y constant between 17% and 20%.

TREATMENT OF INFLATION IN CONSTRUCTION LM SOME OTHER COUNTRIES

I n f l a t i o n of p r i c e s is almost endemic in the modern world.

Other countries have faced the problems with building contracts and have d e v e l o p e d their o m solutions. M s t of these involve compensation

clauses within the standard forms of building c o n t r a ~ t s . ~

There seem to be several approaches t o measuring the e f f e c t o f i n f l a t i o n and applying compensatfon to work c a r r i e d out i n any t i m e p e r i o d . For example, one approach uses a "basket" of typical b u l l d i n g c o m o d i t l e s and services. The changes in weighted price index ef

various commodities and services in t h l s basket during any time p e r i o d provide the measure o f i n f l a t i o n in that period- The advantage of this

approach I s that it is fairly quick since It is n o t necessary to measure and quantify all i t e m s of work in the job. This approach has been favoured i n the United Stares where the Engineering N e w s Record Indices are based upon quantitatively d e f i n e d Inputs.

A furrher refinement, p s s s S b l e when a f u l l bill of quantities

i s available, measured by an independent consultant a s in t h e U n i t e d

Kingdom, is to place every single item of measured work in each project into one of a limtted number of categories and adjust the b i l l of

quantities p r i c e s as the index for each category changes. The formula price adjustment method u s i n g the indices published by the National Econamfc Development Office (U.K.) makes use of forty-eight work c a t e g o r i e s .

*The most important of them are: (1) comparison of r a t e of return on shareholders' equity in construction to what the shareholders can get o n an alternative no- or l w - r i s k investment, such as an average industrial bond; and (2) the cornpartson of after-tax returns in construction w i t h general i n f l a t i o n rates.

Another approach which is p o s s i b l e fn the case of repetitive high volume b u i l d i n g projects, especially housing, is t o analyze a

large number of similar projects to determine t y p i c a l weightings for each of a large number a f separate commodities in the p r o j e c t , The

Israeli

W h i l e indexing of cornpensatton clauses appears a rational approach to adjusting prices for i n f l a t i o n , all methods suffer from

c e r t a i n disadvantages. F i r s t , it is very difficult to allow for all t y p e s o f costs by means of indexing, e s p e c i a l l y Indirect c o s t s , i.e. those not d i r e c t l y 15nked t o specific items of c o m p l e t e works, such as site orgaaizatfon and major equipnent costs. Second, they all requlre a conscious balanced d e c i s i o n between the c a s t of administering them on

the one hand, and the benefAts to be galned on the other.

CONCLUSION

The building f-ndustrp is complex, and is particularly prone to the effects of high general price i n f l a t i o n which is being

experienced throughout the western world. This paper has examined the mechanism by which i n f l a t i o n affects the c o s t of buildfngs in Canada.

I n f l a t i o n gives r i s e to uncertainty in both d e s i g n c o s t decisions and

c o n s t r u c t t o n cast decisions and this leads to instability and risk iri a process already bearing heavy risks.

The d - l f f i c d t y in accounting for i n f l a t i o n quantitatively, e s p e c i a l l y in the contracting process, has been i l l u s t r a t e d . D e s p i t e the analysis of s m quantitative data, the treatment of the effects of i n f l a t i o n on building construction has had t o be qualitative.

P a r t i c i p a n t s in t h e b u i l d i n g industry should make more efforts than in the past to take into account and understand the effects of general inflation on their respective activities.

REFERENCES

( 1 )

M.C.

_{. .}

( 2 ) S t a t t s t i c s Canada. Construction Price Statistics,

.

007, Supply and Services Canada, O t t a w a , various years.

(3) Statfatics Canada. Prices and P r i c e Indexes, C a t . No. 62-010,

Supply and Services Canada, Ottawa

,

( 4 ) W. Nevfns. Is There Money in Construction?, Construction,

Canadian Construction Association (July-August 1980), pp. 18-20. ( 5 ) A. Warzawski. Economic Decisions under I n f l a t i o n , Building

Research S t a t i a n , H a i fa, Israel, I n t e r n a t i o n a l Councll for Building Research, Studies and Documentation, Conference on Building Ecanodcs, Rome, June 1981.

( 6 ) Building Owners and Managers A s s o c l a t i o a International. 1980 Downtown and Suburban O f f i c e Bu3lding Experience Exchange, Washington, D . C .

(7) Building Construction Cost Data 1980, Robert Snow &an5 Company, Inc., Kingston, MA, USA.

TABLE 1

COMPARISON OF CPI AND CONSTRWCTION COST

ImIces

*

CPI Composite Material Labour

1971 100 t 00 100 100 X Increases 1971-1972 4 -8 10.1 9.8 10.4 1972-1973 7-25 11.90 12.93 10.13 1973-1974 10.91 9.33 9.32 9 . 9 3 *See Reference 2.

TABLE 2

ELEMENTAL COST ANALYSIS FOR DOWNTOW OFFICE BUILDING*

E l e m e n t Percentage o f Total Cost Substructure 6 Structure 1 3 Cladding 18 Internal P a r t i t l o n s 1 F i n i s h e s 9 Services

(a) k a t i n g , ventilat fon

,

air c o n d i z i o n i n g 18 Cb) Mechanical and

e l e c t r i c a l

Indirect Expenses 15

TABLE 3

Item Material tabour Overhe ad

& Profit

X I X

Installing Oil-Burning H o t

Water Boiler 80 8 1 2

Installing Glass Fibre I n s u l a t i o n in Roof Deck

P l a c F n g Concrete In Elevated Scab ( i n c l u d i n g f o r m and

s teel) 4 2 4 1 1 7

Pafnting Interior Plaster Surface ( P r i m e r f 3 coats]