Escalating prices expose contracts

Ani Ray, country manager for Simplex Infrastructure, says construction companies are bleeding.

Ani Ray, country manager for Simplex Infrastructure, says that staff retention problems and escalating prices threaten the viability of Gulf contractors.

I had taken my first sip of post-lunch tea when suddenly one of the engineers, who had recently completed a project, walked into my office.

He got straight to the point, saying that before he proceeded to the next project, he needed the company to provide family accommodation. And if not, he wanted to be transferred to the India operation. He'd only been with the company for 15 months.

Now the engineer's appeal (read demand!), has an implication in cost to the company amounting to more than 50% of his salary. And if such a case was agreed upon, there is no reason for us to deny the rest of the staff the same benefits. And this is just the tip of the iceberg.

Considering the huge cost increase and a forced slowdown due to a raw material crisis, construction companies are already bleeding. Along with ridiculous raw materials prices, they're also faced with the challenge of employee retention.

From an employee's point of view, there has never been a better time in the construction industry. The unprecedented real estate boom is not only in Dubai but across the GCC and an equal boom in India has made the traditional supply of resources scarce.

Many Indian companies are now moving to the Gulf to recruit high-and mid-level engineers who have gained experience by working on Dubai's iconic projects. They sometimes offer better salaries.

So does this mean the end for construction companies here?

On a very day-to-day basic level, the construction business is divided into developers, raw material suppliers and contractors. The first two are increasing prices based on text book jargon like ‘high oil price', ‘high GDP growth', ‘more demand in real estate', ‘demand outstripping supply', ‘a weak dollar' and so on.

Whereas, for contractors, their contract is a fixed lump sum irrespective of more than a 100% raw materials price rise.

To give you an example of what's going on: a well known GCC real estate company launched one of their projects in Dubai in early 2007 at US $16.3 per m² (AED60 per m²) and put a construction contract in mid 2007 at $6.8 per m².

Due to some reason (no fault of the contractor), the project wasn't cleared from the master developer and other authorities and so the contractors asked for a hike to $8.8 per m² accounting for cost escalation. The developer flatly refused and found some other gullible contractor.

At the same time apartment prices increased from the original $16.3 per m² to $23 per m².

Almost all over the world, construction costs incorporate a price escalation formula and mention base prices of key components. I learned it in my first contract 20 years ago.

But most developers in Dubai refuse to include the escalation formula in contracts, with a big percentage of them being totally unaware of it.

In the present scheme of things, the majority of construction companies are heading towards bankruptcy and could be forced to abandon their contracts unless something is done about it immediately.

Qatar's public works authority, Ashgal, has already begun to include price escalation in contracts; some developers in Dubai have started cost plus contracts but the bulk of them are still bystanders.

In my opinion, since Dubai has implemented the Escrow and Strata law to protect buyers, authorities across the GCC should include price escalation clauses in construction contracts before it can be eligible for bank financing in the interest of everyone, including buyers.

When construction companies don't have to be scared of threats for their immediate existence, they can afford to think long term and that is when staff retention and rewards take precedence.

Until then, they will be forced to follow in the footsteps of their clients to find a cheaper alternative; another engineer who costs less to save the day and to think again if tomorrow comes.

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