5 reasons why construction indices are essential tools for improving cost management

From grand-scale infrastructure projects, such as Crossrail, to more minor projects, like an extension to a health centre, construction indices are integral to all aspects of cost management. These include the initial choice of projects through budgeting, estimating, and managing of project delivery, to overseeing the maintenance spend throughout a building’s life cycle.

Over the years BCIS has developed indices for the specific tasks involved. BCIS has over 50 sets of indices* series that include:

• Cost indices for building, civil engineering and maintenance
• Specialist use indices such as:
  • ABI/BCIS House Rebuilding Cost Index (HRCI) 
  • RICS Community Infrastructure Levy index 
  • Plant and Equipment indices

^{*The four sets of Price Adjustment Formulae Indices (PAFI) contain over 200 individual indices}

The indices provide measures that quantify the relative changes in the prices of construction-related goods and services over time.

In viability studies and outline budget proposals, tender indices are used to bring historic costs and benchmarks to a common date and their forecasts can be used to predict cash flow. When costing detailed designs, cost indices are used to bring all costs to the base date and, again, BCIS forecasts can be used to predict cash flow and identify the risk of inflation. Through project delivery, cost indices are used to adjust valuations for inflation and cost scope changes, and are essential in valuing claims and disputes. 

Indices are required to prepare life cycle cost plans at Net Present Value (NPV) during the design stage, as well as converting the plans to maintenance and replacement budgets for facilities management. 

Here are our top five reasons why construction indices are essential tools for improving cost management on major or minor construction projects. 

Mitigate risk against super inflation

From the pandemic and subsequent lockdowns to war in Ukraine, the last few years have taught us there are many external factors – often unforeseeable – that can unsettle global markets and cause extreme fluctuation in prices. As a result, the period between the tendering stage and finishing the project can be subject to substantial price fluctuations.   

It is important to identify who is best able to account for this risk. It is a good principle to only ask the contractor to take responsibility for those risks they can manage. Including an inflation adjustment clause in a contract will allow the risk to be managed – the BCIS Price Adjustment Formulae Indices are designed to be used with inflation adjustment clauses in construction contracts to facilitate this.      

Construction costs move differently to general inflation

BCIS indices are based on costs of construction work and designed to be relevant to the construction industry. The most reliable and credible indices are updated regularly (monthly or quarterly) to reflect the current market. The methodologies for calculation of the indices vary, but the goal is to provide an accurate representation of price and cost changes over time for specific purposes.    

There is a temptation, to be resisted at all cost, to use a general measure of household inflation such the Consumer Prices Index (CPI) or other non-construction specific indices as a ‘good enough’ indicator of construction and materials inflation. As the graph shows, there have been months where variations between CPI and individual resource indices have been substantial.   

Therefore, the importance of using construction indices rather than CPI can’t be emphasised enough, as relying on CPI could result in dramatic cost variations that leave you substantially over budget.

Protect against insolvencies

The nature of payment and contract cycles in the construction industry has played a substantial role in the disproportionately high number of insolvencies in the past four years. Between January 2019 and August 2023, construction businesses accounted for 13.5% of all insolvencies. The tight margins many construction companies operate in exposes them to the risk of inflation, which could be mitigated by the use of index inflation adjustment clauses in their contracts.    

Even some of the largest contractors with turnovers of £700m aren’t immune. In August 2023, reports that Buckingham Group was on the brink of collapse – whose previous works included the Spurs stadium and ArcelorMittal Orbit – surfaced.   

The company blamed ‘deep losses and interim cash deficits on three major contracts’ for its problems. Since then, it’s collapsed into administration with nearly 450 jobs lost, due to the divisions administrators couldn’t sell on.    

In addition, JLR Group reported profit falling by more than 50% – its lowest level since 2015.  EY Parthenon – which has 20 years of profit warning data – says that the construction industry is particularly vulnerable to financial difficulty because of its exposure to contract cycles that leave them operating in tight margins.  

However, this doesn’t make such high levels of profit warnings inevitable, as they warn the contracts that trigger profit warnings often have ‘flaws in their inception and execution.’ This alludes to fixed-price contracts that, in a difficult economic climate, some contractors have understandably felt under pressure to accept. 

Calculating benchmarks for early cost planning    

It is important to have robust benchmarks based on historic costs to provide estimates of project costs before designs are fixed and resources committed to detailed design. Whether you are using your own project data or data from BCIS, it will need to be adjusted to a common date and updated to the tender date using appropriate indices.   

Life cycle cost planning   

Proper design decisions require a life cycle cost plan, which may or may not be used in procurement. Developing the plan requires predicting the cash flow of expenditure on construction, maintenance, operation, occupancy, and end of life, expressed as (NPV). The calculation of NPV requires the adjustment of future costs to current levels for both future inflation and interest rates. BCIS provides indices and forecasts suitable for this purpose.

Conclusion

Although the industry can’t control external factors that affect materials price rises, energy price rises or labour supply shortages, it is possible to mitigate certain risks with construction indices.    

With greater cost certainty comes greater cash flow management, and the ability to make better-informed decisions when entering into and managing contracts. This can also help contractors to more successfully manage supply chains and contract cycles. 

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