Tough Economic Times Ahead for Consulting Engineering Industry

The Consulting Engineers South Africa (CESA) Bi-annual Economic and Capacity Survey for the period July to December 2015, just released indicates that times are tough and getting tougher with industry confidence the lowest in 16 years. The report indicates that the consulting engineering industry will have to adapt to a low growth environment as the outlook for infrastructure spending is hampered by poor economic growth, lower than expected revenue by government, international economic instability and price volatility, and low private sector confidence. Over 540 firms employing just over 24 315 staff, who collectively earn a total fee income of R23.4 billion per annum, are members of CESA.

Three key factors continue to influence the global outlook these are the gradual slowdown and rebalancing of the Chinese economy; lower prices for energy and other commodities; and the gradual tightening of US monetary policy.
GDP growth in South Africa slowed to 0.6 percent q-q, from 0.7 percent q-q in the previous quarter. South African economic growth slowed from 1.5 percent y-y in 2014 to 1.3 percent in 2015. Growth was largely dragged down by a further contraction in the agriculture sector while construction recorded marginal growth of 1.1 percent in the 4th quarter (from 0.5 percent in the previous quarter).

Chris Campbell, CESA CEO believes, “Government needs a strong focus on the implementation of more of its strategic infrastructure projects as detailed in the National Development Plan in order to mitigate the decline in the economy and improve investor confidence.” He further reiterated that “Engineers in South Africa stand ready to partner with government in eradicating the leakage from the fiscus, not only through water which does not reach domestic households, but also through poorly spent monies or corrupt practices which have led to payment for poor quality and even non-existent services in the infrastructure space.”

Probably the most critical concern, and most significant downside risk to inflation and economic growth, for the domestic economy is the fear of a further sovereign credit rating downgrade and its effect on the industry. A lower credit rating means the cost of borrowing for the South African government will escalate, which means more tax payers money will be used to finance debt, with less available to spend on critical economic and social infrastructure. Currently government expects that 3.6 percent of GDP per annum will be used on interest expenditure, estimated at around R260 bn per year, equal to total public sector infrastructure allocations a year.

Fee Earnings – Softer growth outlook

Consulting Engineering fee earnings in the last six months of 2015 increased by around 6 percent, against an expected decrease of between 2 percent and 3 percent. Larger firms reported muted growth of 2 percent on average for the last six months, while stronger growth was reported by medium and smaller firms (up by 31 percent and 11 percent respectively). Although respondents expect earnings to fall by 5 percent in nominal terms during the first six months of 2016, compared with the second half of 2015. Campbell states, “Although the outlook is concerning it is encouraging to see that profitability among member firms has increased.” The percentage of fees outstanding for longer than 90 days as a percentage of total estimated income showed some improvement to 23 percent, from 24.5 percent and 24.0 percent in the previous two surveys. It is estimated that around R5,8bn in earnings is currently outstanding after the 90 day period.

Industry Confidence Levels – lowest in 16 years

Confidence levels fell to its lowest level in 16 years, and were significantly weaker in the last six months of 2015, compared to expectations in the June 2015 survey. Levels fell from an expected 56,0 percent satisfaction rate to 39,4 percent, and although business conditions are expected to improve slightly to a satisfaction rate of 48 percent (first six months of 2016) and 44 percent (last six months of 2016), levels are well below the average of the last five years. Satisfaction amongst firms are at historically low levels, surpassed only by the 1998/99 recession caused by the Asian financial crisis.

Gross Fixed Capital Formation slow in medium term

Gross fixed capital formation (GFCF) as a percentage of GDP averaged at 20,7 percent in 2014, but slowed to 20,6 percent in the 1st quarter of 2015, compared to an average of 21,1 percent in 2013. The NDP has what may seem a somewhat unachievable target of 30 percent contribution of GFCF to GDP by 2030. All economic indicators currently suggest that investment in relation to GDP is likely to slow over the medium term, due to slower government spending, financial constraints experienced by SOE’s and continued weak private sector confidence.

Transformation of the Industry

The appointment of Black executive staff (including Black, Asian and Coloured) increased to 39,5 percent from 38,0 percent and 36,0 percent in the previous two surveys. The appointment of Black executive staff has steadily increased from 28,1 percent in the June 2012 survey. This shows real significant progress in terms of industry transformation. There has also been a steady improvement in the appointment of women at an executive level. Women (including all races) appointed at an executive level represented 11,0 percent of total executives, from 10,1 percent in the previous survey.

Industry Challenges - Procurement the biggest challenge

Regulation issues, including the procurement of consulting engineering services, remain one of the biggest challenges faced by the industry. Procurement is currently based on price and broad-based black economic empowerment (BBBEE) points, with functionality or quality having a minimum threshold, thus being largely price driven. This is affecting tender prices, as firms sometimes tender below cost in view of the diminished availability of projects. A further challenge to the industry is to find a way to standardize the procurement procedures applied by the different government departments. Procurement procedures should be standard for the country, or at least for the specific tier of government.
Unrealistic tendering fees remain a concern for members, while the extended time it takes in which to finalise a proposal is affecting profitability in the industry.
The quality of technical personnel is argued by some firms to have deteriorated, putting greater risk on the built environment sector. Skills shortage is regarded as one the most significant institutional challenges faced by the private and the public sector. CESA has offered their services to government to procure and implement projects.
Fraud and corruption is affecting the ethos of our society, with a lot of talk and little action accompanying the growing evidence of corruption. CESA is aware that members are under pressure from contractors and corrupt officials, to certify payment for work not completed. This is regarded as an extremely serious matter for CESA and as such will be relentless in holding those in power accountable.
Unlocking greater private sector participation is seen as a critical element to fast track delivery which will support engineering fees and as such engineering development in the industry. Private sector participation in this context refers to involvement on a more technical level (and not as a client), to improve municipal capacity and efficiency. Government must create an environment for the private sector so that it can play a much bigger role in infrastructure delivery. Many of the projects highlighted in the NDP can be carried out by the private sector through public-private partnerships.
Service delivery, especially at municipal level remains a critical burning issue. The consulting engineering industry is threatened by incapacitated local and provincial governments. As major clients to the industry, it is important that these institutions become more effective, more proactive in identifying needs and priorities and more efficient in project implementation and – management.
The involvement of non-CESA members in government tenders and procurement continues to threaten the standard and performance of the industry. Non-CESA members do not seem to comply with the same standards and principles as those firms that are members of CESA. This is further exacerbated by the notion that Government procurement entities have that procuring the services of a Profession Engineering Practitioner is the same as buying fruit from an informal trader where one bargains for discounted pricing. There also seems to be a gross misunderstanding and misapplication on the application of fee scales on projects, where the professional practitioner managing the funds as the Principal Agent, gets to claim the “lion’s share” of the fees, currently as is the case when the Professional is from the Quantity Surveying or Project Management Profession, whilst the Professional Engineering Practitioners who may be both Principal Agent and Technically responsible for design risk, is compensated substantially less. There should at least be equity in the responsibility and remuneration in the roles as Principal Agent across the professions and a separation of this role from that of the Engineering Practitioner who carries design risks and subsequent costs which are to be compensated for separately in any project.
Large local firms are tendering at rates on small projects that are not competitive for small local firms just to maintain a flow of cash. A practice which is counterintuitive to the commitment to transform the industry. Complaints have been received of some firms not producing proper as built drawings and not attending site visits. Clients, unfortunately, are not always properly experienced or educated to conduct proper procurement assessments and unknowingly award contracts to “unscrupulous” firms. While these occurrences may be limited to smaller rural areas, it remains an unacceptable practice.
Lack of attention to maintain infrastructure poses a serious problem for the industry. Not only is it much costlier to build new infrastructure, but dilapidated infrastructure hampers economic growth potential.

For a copy of the CESA Bi-annual Economic and Capacity Survey please visit http://www.cesa.co.za/node/21