Many construction industry executives seem to believe that "runaway" inflation is the story of 2021 and not the theme for 2022. Today we are suspending speculation and simply recording the current construction inflation data collected by the Bureau of Labor Statistics. It is time to look inflation square in the face before we speculate on what we can do about it.
The annual construction input inflation rate came in at 19.6% for the year 2021. That is astounding. To put that metric in perspective, the nonresidential construction inflation rate was 4.4% in 2020 and 1.8% in 2019, an inflation rate that most contractors are more familiar with. We haven't had to manage our business in an inflationary environment that exceeded 5% for the last 32 years. That's a professional lifetime for most construction executives. They simply have never experienced hyper-inflation and are having a difficult time coming to grips with the concept or accepting the potent negative impact it will have on corporate profits. I am not the only one concerned about this.
AGC Reports Current Inflation Metrics
"Although the overall economy posted exceptionally strong growth in 2021 and appears to be headed for further expansion, the construction industry has experienced a much more uneven recovery. Until recently, lagging demand for numerous types of nonresidential construction prevented many contractors from fully passing on their added costs. Successive outbreaks of Covid-19 have disrupted production and delivery of goods, labor availability, and the mix of projects. This combination of supply chain bottlenecks, unpredictable costs and delivery times, and smaller bid price increases threatens to push some firms out of business...
No category of construction has escaped the extreme cost escalation... From December 2020 to December 2021, the increases in these input cost indexes ranged from 14.6% for new multifamily construction to 20.7% for commercial structures." (AGC, 2022 Construction Inflation Alert)
In March 2020, the inputs to construction were declining by 5% year over year, then suddenly began climbing to a 5% increase by year end. The year over year inflation rate increased throughout 2021 escalating to a runaway 24% by May and finally settling back down to 19.6% at year end.
The PPI (Producer Price Index) for Construction Inputs - December 2020 to December 2021:
- “Steel mill products more than doubled, rocketing up 127.2%.
- Plastic construction products shot up 34.0%.
- Aluminum mill shapes up 29.8%.
- Copper and brass mill shapes up 23.4%.
- Gypsum products, 20.7%.
- Lumber and plywood, 17.6%.
- Architectural coatings (paint), 13.9%.
- Asphalt felts and coatings, 11.8%.
- Concrete products jumped 8.5%, the largest rise in 15 years.
- The index for flat glass also posted an 8.5% gain (a 40-year high) before finishing the year with an increase of 7.3%.
In addition to materials that go into structures, prices for items and services used by contractors soared. For instance, contractors pay for huge amounts of diesel fuel—purchased directly to run contractors’ own trucks and off-road equipment, as well as indirectly in the freight charges or explicit fuel surcharges for myriad deliveries of goods and equipment, and the hauling away of dirt, debris, and equipment. The PPI for diesel fuel leaped 54.9% from December 2020 to December 2021, while the index for truck transportation of freight climbed 17.7%." (AGC Inflation Alert 2022).
We have not seen double-digit cost increases across the entire spectrum of construction inputs in our lifetime. While reading the statistics above, I fear that some contractors’ tendencies will be to (1) - doubt the negative impact when it comes to their company; (2) - doubt the accuracy altogether; (3) - stop reading this blog and go into denial by turning their attention to more pressing immediate concerns. This, in my opinion, is a natural but dangerous reaction. Let me repeat the quote from above:
"This combination of supply chain bottlenecks, unpredictable costs and delivery times, and smaller bid price increases threatens to push some firms out of business..."
The Spread's The Thing
Every month the Bureau of Labor Statistics asks a fixed group of contractors the amount of overhead and profit they would charge to erect a certain building. BLS combines the answers from a set of contractors to create bid price PPIs for new warehouse, school, office, industrial, and healthcare building construction, along with a weighted average of these building types for an overall index for new bids on nonresidential building construction. The 12.5% annual increase through December in the bid price PPI was far short of the 19.6% input price increase. As a result, contractors were absorbing more and more of the cost increases.
Construction profit margins are currently reported to hover somewhere between 3.5% and 5%. It doesn't take a CPA to calculate the gap between bid price increases and input cost increases - 7.1%. In this inflationary environment, being in denial will not prevent us from losing money. Only planning for runaway cost inflation and reevaluating contract terms will help prevent losses in 2022.