A health pandemic, followed by a supply chain pandemic, leading to an inflationary pandemic. The big worry for infrastructure players is that the next stop is a bankruptcy pandemic.
The continued volatility and financial disruption of the past few months have certainly not been easy for infrastructure players. We are seeing infrastructure planners and owners struggling to budget for projects that will take years to deliver and decades to finance. As costs rise, return on investment equations rapidly change. As inflation bites, so does affordability.
What's worrying infrastructure owners and investors is that, more often than not, the price risk in today's contracts flow down to the developers and contractors. For years, costs had remained fairly stable and price risk was generally considered a symptom of poor cost management. It only made sense that those with the greatest control over cost discipline should also hold the cost risk.
But, today, the link between risk and discipline has become unhinged. No amount of cost or price discipline can protect margins during times of inflationary shocks, supply constraints and volatile commodity price gyrations. And few contractors understand how to properly price inflation and cost volatility into their contracts. U.S. consumer price inflation hasn't topped 4 percent in more than 30 years(1) which means few developers have any real experience dealing with the issue. Not surprisingly, many infrastructure planners, owners and investors are dreadfully worried that their supply chain is about to go bust.
Yet this is not the first time the world has experienced inflation and supply issues. Some markets - such as Turkey and Venezuela have been suffering through high inflation for years. Any Baby Boomer reading this article will likely remember running dozens of different price scenarios, based on different inflation assumptions, across their investments (business and personal) in the early 80's. In those days, U.S. inflation topped out at 13.5 percent. Yet, still, things were built, investments were made, and infrastructure was delivered. The trick now is to remember how uncertainty was factored in historically.
Over the coming year, we expect to see owners and investors start to rethink who should actually own the cost and price risk on their assets and investments. Strong trust and cooperation between public and private sectors, owners and contractors, developers and operators, and buyers and suppliers will be key. For some, that may lead to a style of contracting that more closely resembles `open book' than in the past, while still maintaining a level of price discipline between the contractor and the owner. The challenge will likely be to maintain price discipline while allowing for prudent risk sharing.
At the same time, global supply chains are shifting in response to geopolitical risk and pressure (see trend 8). Contractors and developers may need to start rebuilding their strategic procurement functions, led by a greater focus on price and cost discipline and robust scenario planning capabilities. Governments may need to find the fiscal space to invest in infrastructure in order to boost economic activity (frankly, they may have no other choice).
To be sure, supply chain bankruptcy would be a worst-case scenario this year. But the risk of not building anything at all would be much, much more dangerous over the long-term.
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