Guardian Road Business Park in Exeter, in the south-west of England, is forgettable in the way all out-of-town office clusters are.

Its roads, punctuated by dozens of mini-roundabouts, criss-cross the square mile or so of gently sloping hillside. Beige corrugated hangars and glass-clad showrooms nestle behind neat hedges and slivers of lawn. There is not a pedestrian in sight.

Yet this unremarkable development, which overlooks the region’s main trunk road, has been at the centre of the storm that has swept through the UK’s construction industry for the past three years – and is mirrored across the rest of Europe.

Connaught and Rok, two of the UK building industry’s highest profile victims of the recession, were based within a few minutes’ walk of each other on the Guardian Road site. Then, during a fateful two months last autumn, both companies collapsed into administration.

The resulting fallout, which saw some 14,000 workers made redundant and hundreds of millions of pounds in debt go unpaid, left a trail of bankruptcy and financial hardship at the two companies’ many small trade creditors and subcontractors.

This domino effect along supply chains, combined with falling workloads and squeezed cash flow, has made construction companies acutely susceptible to business failure. Indeed, in the two years to the start of 2011, more than 6,000 building groups have fallen into insolvency in the UK – more than any other sector, according to data from PwC.

However, while the pressures of a declining market have taken a harsh toll on the European construction industry, the prospect of a recovery heralds new and equally perilous threats to the continent’s builders.

The shortage of work during the past three years has meant that a lot of companies have taken on contracts at minuscule margins, or even at a loss, simply as a way of creating cash flow and utilising workers.

“The idea has always been that they are then able to go to their supply chain with guaranteed work and orders and drive down costs to push up the overall contract margins,” explains Jonathan Hook, global head of engineering and construction at PwC.

The practice of so-called “suicide bidding” or “buying work” was a way for many companies to stay afloat during the hardest passages of the recession. Now though, with raw-material costs creeping up and subcontractors having been “beaten up” on rates for the past three years, the possibilities for clawing back profit margins sacrificed on the original contract are evaporating fast.

For construction companies, this poses a tough question: Does the need to keep generating cash outweigh the risk of taking on work which is likely to be lossmaking?

The larger construction companies can afford to take on work on low-margin or lossmaking terms for long periods, as many will be generating profits from contracts negotiated before the recession.

However, for the smaller companies, which typically work on short-term projects, the need to mitigate against the risk of misjudging inflation in the supply chain could prove fatal, as they are forced to overprice contracts or face possible financial collapse.

“The price pressures from beneath are going to be the biggest risk to the sector during the next two years,” Mr Hook says.

Construction companies, particularly building contractors, traditionally work on the basis of a large upfront payment for starting a project, followed by a series of smaller payments when the work reaches certain stages.

However, this low-risk model, which Ian Tyler, chief executive of Balfour Beatty, one of Europe’s largest construction companies by sales, has described as “building something with someone else’s money”, is under threat.

“As construction companies come out of recession, they should, in a good market, get a rapid injection of cash as advance payments are made,” says Jack Kelly, an infrastructure partner at Deloitte.

“The difficulty this time round could be that customers become unwilling to make such large advance payments, especially if there is a lot of competition and the need to offer upfront payments is less prevalent,” Mr Kelly adds.

Another concern for building groups is the fall in public-sector spending on new construction projects, with governments across Europe cutting investment on new schools, hospitals, roads and railways as they seek to tackle debt burdens.

The sector has always depended heavily on state sponsored contracts, but the past three years have seen public- sector projects account for an increasingly large chunk of workloads, as private spending on construction has fallen.

Now, though, with government spending on the industry expected to decline, competition is rife for getting on to framework agreements with local authorities and winning what little work there is.

As well as the pressure that increased competition creates for smaller builders, there is a flight to quality by customers. The upshot of this is that many of the biggest spenders on the industry will avoid using contractors that they perceive as lacking financial and operational muscle.

“Having strong relationships between customer and builder is going to be crucial, as people don’t want to put money into a project and then have the contractor fall over halfway through,” Deloitte’s Mr Kelly explains.

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