Integrated, industrial scale supply chains will boost construction sector resilience

Construction, like many other industries, draws from specialised trades and activities to produce the final product. Material suppliers, designers, construction contractors, the logistics team and service crews are all ‘links’ in the supply chain.

The Covid-19 pandemic has highlighted the risks of the ‘key supplier’ supply chain model shifting the focus in almost all industrial sectors to the need for supply chains that build in resilience. The construction sector experienced a lack of this resilience in the early days of Covid lockdowns in 2020 when the flow of building materials dried up in many countries, causing significant disruption to many infrastructure projects.

Manufacturing-based industries like aviation and the automotive sector have adopted a centralised system to manage their supply chains. In those industries, almost every phase from procurement of raw materials to production, quality control, packaging and distribution is under the control of one company or multiple partners. This integrated approach has increased efficiency, saved on costs, delivered quality that is more consistent and facilitated greater collaboration between each entity in the chain.

As construction becomes more industrialised, we can expect to see the growth of integrated supply chains which use digital technology to enable a manufacturing approach and deliver the benefits of increased productivity and sustainability. While the project-based nature of construction presents some challenges, the potential benefits of integration make it a shift worth pursuing.

What are the benefits of integration?

Implementing an integrated approach to supply chains has been a key driver of increased productivity and better overall performance, changing the way in which individual entities in the supply chain interact with each other.

Previously, manufacturers drove down the cost of purchased materials through aggressive negotiation and adversarial contract structures that shifted profitability from one link to another. This is a system leadership, rather than system integration, approach. More recently, some manufacturers have adopted more strategic partnerships with an emphasis on long term and repeated workflows, improved communication and optimising the performance of the entire supply chain.

In the construction sector, organisations with supply chains that have a higher degree of integration have experienced operational benefits over those with less integration. These include more predictability; lower costs; competitive advantage; improved project delivery times; improvements in quality, safety and sustainability; and greater flexibility in times of crisis.

What are the challenges?

The project-based nature of the construction industry presents the most significant challenge to integration. In general the designer, materials supplier, logistics team, subcontractors and head contractors are separate entities working across multiple concurrent projects and operations.

This project-based approach is driven in part by procurement approaches chosen by both government and private sector clients. Requests for tender contain scopes that are usually defined by the time they are released to the market, often with minimal input from bidders. It can be difficult for bidders to demonstrate the competitive advantages of an integrated supply chain approach within these defined scopes. While procuring entities’ stated focus may be best value for money overall, in practice this is difficult to measure and obtaining the lowest cost remains a key consideration. Packages of work are commonly split into trade packages rather than being organised in systems or by components, which introduce complexity in design coordination, assembly and installation.

Resource constraints, timing conflicts and other commercial pressures across different projects can also contribute to a fragmented supply chain. This in turn makes it harder to take decisions and make changes that benefit the final constructed asset without increasing costs or experiencing delays.

Choosing a structure for integration

The drivers for seeking greater supply chain integration should be established at the outset, as these will influence the means by which integration is achieved. Competition law in relevant jurisdictions may also influence the integration strategy – there is plenty of scope to structure and operate supply chains in a manner that maintains regulatory compliance, but this is something that should be addressed at an early stage.

It may be that the original equipment manufacturer (OEM) at the top of the supply chain is seeking greater control over, and involvement with, the tier 2 suppliers. There are two different models which give that increased level of control:

• ‘directed buy’, under which the OEM nominates the sub-component and directs the tier 1 supplier to source this component as a directed part. The tier 1 supplier contracts with the tier 2 directed part supplier. The cost of the directed part is usually defined by the OEM. However, the tier 1 supplier coordinates independently from the OEM with the tier 2 supplier; or
• ‘provided material’, under which the OEM purchases parts directly from the tier 2 supplier and provides them to the tier 1 supplier for manufacturing the component or subsystem ordered. The main difference between the two models for the OEM is that under the ‘provided material’ model it then owns the parts. This model increases visibility for the OEM along the supply chain and enhances the influence on the price and quality of directed parts. Potential risks for the OEM such as supply shortages can also be better monitored along the supply chain. The disadvantage for the OEM is an increase in responsibilities, including for quality control and logistics of the provided material.

Other approaches include ‘preferred customer’ clauses to ensure the OEM or tier 1 supplier is preferred in the event of supply constraints; direct licences, for example with software developers; and collateral warranties to give the OEM direct rights of recourse against suppliers. Although the terminology varies, these models and approaches can already be found in the construction industry.

Alternatively, companies in a supply chain may wish to form strategic alliances and partnerships to increase integration, by using collaborative contracting and more closely aligned incentives. Collaborative contracts focus on outcomes, ensuring all partners are incentivised to achieve the same results. They represent a move away from typical penalty-driven contracts with liquidated damages and termination rights to a structure that drives better behaviours.

Common ownership is not essential for an integrated supply chain, but greater consolidation and vertical integration of the supply chain not only minimises risk but also helps to drive future productivity. Today’s fragmented and multi-level contracting practices often hinder large scale changes in ways of working, rollout of digital tools, general investments and R&D.

For larger industrialised companies, acquisitions and mergers offer a method of aligning their capabilities with the new supply chain, bringing a range of functions in-house and recruiting direct labour to replace subcontractors.

How to integrate

Process planning

In the ideal scenario design, manufacture, assembly, site work and related processes will follow a consistent and defined structure – a ‘design for manufacture and assembly’ approach. Early involvement is needed from multiple links in the supply chain to document processes and communicate issues as they arise, and project coordination groups can be set up for this purpose. This approach reduces the risk of failures of one component or system bringing down the whole project.

The work of building a resilient supply chain extends well beyond immediate priorities. Considerations can range from the commercial, such as minimum terms, volumes and exit payments, through to technical issues around supply sources for core materials, IP and labour.

Implementing standardised technology across the supply chain will assist in the move towards greater integration. It facilitates greater communication and transparency, which in term allows faster and more responsive decision-making. An integrated digital platform can assist in collecting and communicating data at key steps in the construction process as well as real time fulfilment, asset tracking and whole of life monitoring, allowing better control of the supply chain.

Using a building information modelling (BIM) model can encourage more decision-making early on in the process and minimise disruptions due to changes in design or construction issues. For example, successfully integrating a five dimensional BIM model which incorporates time and cost with the supply chain allows companies to link activities, from formulating the initial concept to producing the finished product.

As head contractors innovate and digitise, they must bring the supply chain along with them. Balfour Beatty’s approach to innovation includes the development of an app that streamlines occupational health reporting and a paperless receipt system for transactions. These have immediate, tangible benefits for the supplier along with longer term productivity gains, and help to encourage integration.

Achieving greater resilience

In some jurisdictions, there are a limited number of suppliers for key resources, or shortages in skilled labour. There has been a trend in recent years to use key suppliers to drive economies of scale. This can lead to the supply chain becoming highly reliant on a small number of entities, and prone to severe disruption if those entities experience any issues.

The Covid-19 pandemic revealed the risks of over-reliance on a single source for supply chains, with multiple examples of weaknesses in the global supply chain causing disruption around the world. For example, the global shortage of semiconductors was initially caused by factories in China stopping production during the pandemic and was compounded by a simultaneous, and unforeseen, upsurge in demand as lockdown forced people into remote work and remote learning. The automotive industry has been hit particularly hard, illustrating the scale and complexity of modern supply chains.

The blockage of the Suez Canal in March 2021 increased the pressure on the shipping industry at a time when ships were already in the wrong place and ports remained close. The insolvency of Greenshill Capital and potential issues with its subsidiary, the steel supplier InfraBuild, have led to significantly higher steel prices for the construction industry. Around the world lockdowns and restrictions on the movement of people have affected staffing levels in logistics hubs and led to widespread shortages on supermarket shelves.

As the world moves out of the initial phase of the pandemic, companies are reviewing their supply chains and looking to prioritise value and resilience over lowest cost and greatest efficiency. This may be a small price to pay for better resilience in the long term. Businesses need to ensure that their contracting policies and procurement practices enable this more mature purchasing behaviour.

Alternative logistics solutions can provide real diversification and ensure a greater level of resilience. For example, under the consignment model, the supplier operates a stock at the customer site where products are stored and then called up on demand, reducing delivery times and the risk of production downtime. In a multi-sourcing model, a product is sourced from alternate suppliers to increase competition and mitigate supply risks. Companies are also moving to more local ‘nearshoring’ or ‘reshoring’ models to avoid disruption from global events.

In a fully integrated model, it will be important to incorporate and coordinate logistics throughout the design, planning, manufacture and site work processes. Industrialisation involves moving to predominantly off-site manufacture, putting a greater emphasis on transport and logistics, so robust controls are required to ensure timely and effective deliveries and avoid damage in transit.

Construction contracts need to provide appropriate relief for delays caused by issues in the supply chain. The future drafting of force majeure and excusable delay clauses will be impacted by the experience of dealing with Covid-19 – these clauses often provide for specific consequences relevant at the time the contract is entered into together with the specific relief that the parties intend. Clients are likely to expect their suppliers to pursue mitigants such as alternative local suppliers before an entitlement to relief arises.

Driving quality, sustainability and good practices

Integrated supply chains have a role to play in driving good practice and ensuring consistency of approach to environmental, social and governance (ESG) criteria . In an integrated supply chain, commitments to ethical and sustainability issues including reduction of waste, decarbonisation and elimination of modern slavery can be defined and monitored across the whole chain. These factors may also be influential when businesses are choosing their commercial partners.

Better planning across the whole supply chain brings higher quality, as it allows for consistent compliance checks and fewer defects in the final product. Integrated supply chains can also help to promote a shift in emphasis from lowest cost to longer term outcomes, including ESG criteria.

Where data on the whole chain is held on an integrated platform, it is much easier to obtain a ‘whole of project’ view on factors such as energy and fuel use, use of materials, reuse and recycling and carbon emissions. The ability to report in this manner is likely to be a requirement of organisations investing in sustainable construction projects, for example Australia’s Clean Energy Finance Corporation.

As well as reporting regimes, supply chain contracts may include mechanisms to drive progress such as milestones, key performance indicators and even incentives based on achieving ESG targets. They should also include remedies to ensure compliance.