Sub-contracting and the Australian economy
Sub-contracting — entering in to a service or project contract ‘downstream’ from a main or principal contract — is a crucial component of the Australian economy. Perhaps most well-known in the construction industry, sub-contracting is actually ubiquitous in all industries and segments of the economy: sub-contracting is common in cleaning and facilities management, IT contracting, manufacturing and mining. Often, this occurs where the principal contractor has a need for a specialized skillset for a particular job, but it is seen as unnecessary to put new specialists permanently on the payroll.
Sub-contracting is hugely beneficial to the Australian economy as a whole:
- As mentioned, sub-contracting allows specialization and therefore efficiency gains: Principal contractors can agree with their clients to perform carry out certain tasks or projects despite not having every possible skillset on their payroll
- Scaling flexibility. By utilizing sub-contractors, it is easier for a principal contractor to scale their business up and down as economic needs dictate. While an individual sub-contractor losing business will hurt that specific contractor, there are not the same flow-on effects from a principal contractor going out of business (which will mean staff of the principal contractor, as well as multiple sub-contractors losing their jobs)
- Job creation — smaller firms may not have the experience or financial resources to win a large contract. But smaller contracts through sub-contracting can be an invaluable ‘in’ to the industry.
Challenges for sub-contractors
However, despite these positive broader economic impacts of sub-contracting, sub-contractors do face some challenges in the Australian marketplace. Many of our clients are subcontractors or suppliers large corporates. In our observation, some of the biggest problems for sub-contractors are:
- Sub-contractors carry a large share of the risk: Even though the sub-contractor has no influence over the head contractor, if the head contractor goes bust, the sub-contractors won’t get paid. (see further discuss see chapter 3 of the Murray Review of Security of Payments Laws in the Building and Construction Industry). This risk can be compounded where the sub-contractor must lease or finance expensive equipment. Managing this risk is essential for sanity and financial health of owners of business
- Over-reliance on one customer/client. This is especially true in the construction industry and flows from the ‘large project’ nature of the work.
- Disparity of bargaining power/unfair contractual terms. In the construction industry, for example, whichever contractual terms the head contractor agreed to will effectively bind their sub-contractors. And while in theory the sub-contractors could negotiate terms, usually the terms are presented as non-negotiable
- Stiff competition in sub-contractor heavy industries. For example, competition in the construction industry often means that head contractors bid too low, meaning any unexpected costs can make it difficult to pay sub-contractors
- Vulnerability to international supply chains — in industries highly dependent on physical products, the business can be at the mercy of international supply chains. Events like the War in Ukraine can have significant flow-on effects. This is compounded by the fact that Australia’s physical isolation means there is an inherent limitation in finding alternative suppliers.
- The industries where sub-contractors predominate can be inherently tough: Ultimately, running a construction business or a trucking firm is hard work, and can require long, gruelling hours. It is never going to be ‘easy’ running a business in one of these industries.
What support do sub-contractors need?
What might help sub-contractors deal with some of these challenges?
- Legislative protection. This has occurred with the rise of ‘security of payments’ legislation across Australian states, guaranteeing, to varying degrees, that sub-contractors in the construction industry get paid (read more in the National Building Service update on the “The Construction Industry and Insolvency Law”).
- Appropriate legal and financial advice before entering contracts. Business owners need to understand whether the contract is fair, or whether they should be pushing against certain terms or conditions. The difficulties that construction companies had with fixed price contracts during the inflationary period following Covid-19 showed a failure to manage foreseeable risk.
- Appropriate business structuring advice for subcontractors themselves. For example, sub-contractors can be advised on the best way to protect the assets of their business and whether a trading trust may be appropriate.If sub-contractors operate through one company, thereby putting “all their eggs in one basket” – they should revisit this business structure.
Who can help?
So, who is best suited to help sub-contracting businesses manage their way through these issues:
- Accountants and accounting software are a core part of the puzzle. Having up-to-date, real time financial information, particularly with respect to cashflow is crucial to identify any issues as they arise.
- Construction lawyers (or other specialty industry lawyers) who can advise on appropriate contractual terms and asset protection
- Participation in industry associations to keep up-to-date with industry practice and opportunities.
- Business coaches who can help the businesses owners balance their personal efforts efficiently and install sensible systems to mitigate risk
The sub-contractor success journey
Sub-contracting businesses have every reason to be positive about their prospects: While they face unique challenges, these challenges can largely be overcome by sensible planning and putting the right processes in place. To ensure success, it is important to:
- Always review the viability of the business model, and be ready to pivot if necessary (e.g., how likely is a property downturn in the future affecting new builds?)
- Give more careful consideration to pricing of work and forward estimates for costs
- Manage payment under contracts with regular milestone payments
- Protect your assets – don’t run the entire business through one entity that holds all assets and contracts and liabilities.