How Dutch infrastructure companies are defying low profit margins

The profit margins of Dutch building (residential and non-residential) construction companies have increased significantly in recent years. Growing demand for new construction, the renovation of homes and commercial buildings, combined with more efficient construction processes (through digitalisation and industrialisation), have allowed companies to increase their margins.

In the infrastructure sector, on the other hand, which covers roads, railways, bridges, sewers, electrical grids, and so on, margins were already relatively low 10 years ago and have remained low.

1. Large infrastructure companies have incurred losses on large risky projects in recent years, where costs got out of hand. This has had an impact on the overall returns of the entire Dutch infrastructure sector.
2. The number of clients is limited in the infrastructure sector, primarily consisting of municipalities, water authorities and Rijkswaterstaat (Dutch Directorate-General for Public Works and Water Management). This limited pool of clients gives them buying power, which keeps profits low for construction companies in the infrastructure sector. Due to declining volumes, competition has further intensified, putting pressure on prices and margins.
3. Infrastructure companies generally have more machinery at their disposal compared to building (residential and non-residential) companies. This is evident from the higher average annual investments they make, particularly in machinery and transportation vehicles. This makes infrastructure companies more capital-intensive and increases fixed costs. As a result, variable costs are relatively lower than those of building companies. This brings additional risks when order books are poorly filled. Taking on projects below cost due to a lack of profitable contracts, just to cover a portion of the fixed costs, therefore happens more frequently in the infrastructure sector, which further erodes profit margins.

Remarkably, despite lower volumes, high investments and consistently low profits, bankruptcies have not increased. In 2022, fewer than 20 companies in the infrastructure sector went bankrupt per 10,000 companies, compared to more than 120 in 2012. This decline roughly aligns with the decrease in bankruptcies in other subsectors of the construction industry.

We think there are three reasons why bankruptcies have not increased despite lower profits and declining volumes:

• The infrastructure sector is generally less volatile than other subsectors in construction. Governments often adopt countercyclical budget policies and tend to invest in infrastructure when the economy is experiencing a downturn. This results in fewer fluctuations in demand and limits the number of bankruptcies.

• Prices in the infrastructure sector are more frequently indexed compared to the building sector, allowing building material price changes to be passed on in such cases. Government agencies are often the clients, and they are not quick but more willing than, for example, those in residential construction, to negotiate price adjustments when costs exceed the budget. Although these negotiations are not always easy, they can help to prevent bankruptcies.
• The increase in new contract forms (e.g. two-phase approach) allows companies to better assess and distribute risks. Although these alternative contract forms still represent only a small portion of the market, they can help companies better protect themselves against financial risks. Most Economically Advantageous Tender (MEAT) bidding can also prevent competition from being solely based on price.