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Construction Economics: The Supply - Demand of Contracting
In the study of economics, there are many models used to illustrate key concepts. Some of the models were created to explain real world behavior. One of these practical models, in our opinion, shows the dynamics of the construction industry. The model is the Supply – Demand Curve and it is insightful in explaining the business of contracting.
Once understood, the Supply - Demand Curve shows some difficult realities of contracting. It illustrates the problems and opportunities in the industry. That is, how good and bad contracting can be as a market and a profession.
As a concept, the Supply – Demand Curve for construction services shows how both supply and demand of any industry reacts to a price change. For a construction firm, it means how does the demand for construction services and the supply of contractors react with a change in the cost of construction. In essence, how do clients and contractors behave when price goes up or down. We will use the Supply – Demand Curve Model to explain, some of the economic issues of the construction industry. First, let’s make clear three definitions:
Price is the Owner's Cost – In other words, when contracting prices are high, we mean that the market sees a high cost to build. When cost is low then contractors have dropped their bid prices (and presumably decreased profit margins)
Supply is the Number of Contractors. For simplicity purposes, we will keep our discussion contained to this point. However, please understand that the number of contractors drives capacity. A changing number of contractors affects the amount of construction that can be installed.
Demand is the willingness for people to pay the average price quoted by contractors. Clients want construction services at that cost.
We will not to discuss current prices, their level or future pricing movements. What we will discuss is how a price change affects demand and supply. When we state the word cost, it is not the cost of material or labor to the contractor, it means the cost of our construction services to the market.
The purpose of this article is to take a macro or global view of the industry. For business planning, this is an important item. It answers the question: what will I do if demand drops. What is my plan “B”? Alternatively, how do I take advantage of a price increase thus an opportunity for more profits?
The supply curve is flat. That is the supply or number of contractors does not greatly increase due to an increase in price (profit). Furthermore, it doesn’t decrease due to a drop in price either. People who are contractors will stay in the construction business. They might make their business smaller but they will still own a construction firm.
For the remainder of the article, please email us at mstevens@stevensci.com. To order the book, go to Stevensci.com, Amazon, Borders, Barnes and Noble, Browns Stationer's (UK), Reiters, Walden Books and other fine book retailers. You will find a section in the book outlining "Supply - Demand" . Remember, Stevensci.com bundles the book with 60 Excel Templates and an On-Line Course, a solid value.
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Matt Stevens is a management consultant who works only with construction contractors. He has performed training and business consultation for the contracting community since 1994. Matt can be reached at mstevens@stevensci.com.
search terms: Pre-construction, post-mortem, lessons learned, fFnancial Management, Accounting, Market Trends, Bid Strategy, Pricing, Strategy, Estimating
Posted by Matt Stevens at September 1, 2005 9:26 AM
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Comments
very good,nice job
Posted by: joy at November 27, 2005 11:24 PM