The impact of the COVID-19 rampage across the world has been unprecedented. The lockdown to ‘flatten the curve’ of the pandemic and the consequent economic slowdown have severely hurt the prospects of most sectors in India, including <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/industries/engineering-construction/">Engineering, Procurement, and Construction (EPC)</a>.  EPC, Transmission and Distribution (T&D), road construction, and building construction together form the country’s second-largest economic sector after agriculture and provide a large number of jobs. Even before COVID-19, many companies in this sector were already struggling with escalating debt and cost overruns. Some were barely hanging on to just enough earnings to cover interest payments on their debt. Now, the entire sector faces even more uncertainties related to project completion, new project financing, and future order flows.   <h2>Industry-wide problems</h2>When the central and state governments issued directives for lockdown, all companies were forced to stop operations completely. Even though the complete lockdown has been lifted, the fate of projects in the country remains in a conundrum. There are two major causes for this: <ul><li>Labour shortage: Despite the government allowing construction activity across regions to resume, including in red zones (where non-essential businesses are not allowed to operate), <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/research-and-publication/articles/epc-reborn-focus-on-flow/">EPC</a> companies are staring at an acute labour shortage - both unskilled and skilled.</li><li>Most construction workers are migrants who were left without work when the lockdown was imposed. When governments made arrangements for transport, many chose to return to their villages. Most contractors involved in site work consequently experienced a significant labour exodus.</li><li>This situation is now further complicated by the fear of infection; many workers are hesitating to return to work. Among these, the shortage of skilled workers is most acute, as projects cannot resume without them. Given this uncertainty, companies are facing a significant challenge in planning their site work.</li><li>Supply chain disruption: The absence of adequate labour to operate factories is also a major reason the infrastructure supply chain is in the doldrums. Lack of labour and consequent production stoppages/trimming at supplier plants have choked supplies. Moreover, having to enforce new health and safety guidelines in their plants is further stretching supplier capacities. Many are facing an acute shortage of working capital to restart or scale operations. Shortages of raw materials and lack of logistics/transport facilities, and the sealing/tightening of country/state borders have all added to the melee and culminated in the upending of the supply chain in this sector. Since the entire ecosystem is impacted, it will take time to resolve supply issues, and supplies will ramp up only in stages.  </li></ul><h2>Consequences</h2><ul><li>Delay of projects: Without the timely availability of labour and material, execution schedules will be disturbed and construction activity delayed, ultimately pushing deliveries of projects further. And any delay in a project will have a cascading impact on multiple contractual obligations in the ecosystem, since complex contractual arrangements, including back-to-back contracts between numerous, unconnected parties, or multiple independent contracts between related parties as part of a composite transaction, are typical of the infrastructure sector in India.</li><li>Financial issues: Lockdown and the consequent discontinuation of all project work at the site had a severe financial impact, as well. The pandemic has been declared a ‘force majeure event’; it would typically entitle a contractor to an extension of time (3-6 months) for the critical delay caused by the event without penalty on milestone slippage. Even so, there would typically be no compensation for expenses incurred for the duration of the stoppage of work. This means that all costs, including those incurred as damage to construction material, damage and rework of work fronts where preservation could not be done, depreciation on idle plant and machinery, cost of remobilisation of men, material and machinery, etc., would all have to be borne by the company. Even the relief provided by the Reserve Bank of India (RBI) in the form of a three-month debt moratorium will not compensate for these losses, especially since the funds will have to be repaid at a compounded rate of interest after the moratorium period.</li><li>This can be brutal for the firms in this sector since most are struggling to put together the working capital needed to reinitiate work. In the last 2-4 months, both billing and payments have suffered. This has deteriorated working capital turns, too.</li><li>The long-term outlook is bleak. The cash outflow is clear: interest payments on debt, site expenses, and other costs. The inflow of cash, however, is completely uncertain! Without a clear way forward, projects are inevitably delayed. And delayed projects mean crippling milestone penalties, delayed billing and delayed payments.  </li></ul><h2>The silver lining</h2>Unlike many other industries, this one enjoys a silver lining. Most companies in this industry have adequate order backlogs to convert into billing in the months ahead. Moreover, as India looks forward to kick-starting the economy, the government may roll out concessions or exceptions in the coming days to ease this sector. But the decisions companies take today (on resuming operations) will determine how effectively they can catch up on numbers lost during the lockdown period.  <h2>What not to do</h2>Given that assets are significantly leveraged (operational and under-construction) and there has been a sudden, significant impact on revenue, companies will be concerned about the liquidity needed to prevent payment defaults or debt restructuring. In such a scenario, the priority for any firm will be to manage its working capital (more aggressively than ever). Towards this end, companies might typically try to:<ul><li>Delay payments to contractors and vendors: If firms delay payments to contractors or try to negotiate better credit terms, the time it takes for contractors/vendors to ramp up will increase. Moreover, vendors operating with limited capacity and facing cash flow issues would prefer to serve customers with shorter payment cycles. Hence, delaying payments would hinder supplies. Supply delays can lead to reduced billing because a significant portion of billing is based on supplies, and interruptions in supply can lead to project delays. Reduced billing will put pressure on working capital and profits.</li></ul><figure class="image"><img style="aspect-ratio:3873/3847;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//image_1778501336.png" width="3873" height="3847"></figure><h2>Way forward</h2>Since such attempts to control costs can be severely detrimental to the revival and sustenance of operations, the only way to transition from the current issues rapidly, in a win-win manner, is to achieve the following two objectives: <ul><li>Increase working capital turns without changing vendor’s payment terms</li><li>Increase the rate of billing from the existing order backlog at a pace much faster than ever before</li></ul>Companies can only achieve these objectives by taking actions to cut down the execution lead time for E&C by at least 30%. This can be achieved by rapidly implementing a few simple Flow principles. <h2>Implementing the Flow Principles</h2>Flow in any system is limited by its constraints. In the current circumstances, the major constraint for a company is working capital. To kick-start operations and improve the flow of project tasks (and consequently projects) at the fastest pace possible, all decisions have to subordinate to this constraint, and all actions must be taken to ensure that the available liquidity is exploited as efficiently as possible. For this, the following principles have to be implemented. a) Limit the number of simultaneously open sites (work-in-progress, or WIP, limit) within a project based on the availability of labour/supplies:<figure class="image"><img></figure>As in the existing scenario, the company will have to start operations with significantly lower material and capacity than at the beginning of the lockdown; instead of trying to resume all pending work simultaneously, it will be judicious to limit work fronts. Application of thick resourcing (men, materials, etc.) can help quickly complete and bill these. The subsequent cash inflow can help the company complete other work fronts – a limited few at a time, based on capacity and available resources.  b) Alignment of departments through a global priority system: Care should be taken to choose the right projects to work on from the existing basket of open work fronts. These are the ones with the highest potential to realise as much cash as possible and at the earliest. A cross-functional team should revisit and re-evaluate all projects based on various factors such as which projects are near completion, which are urgent for the client, the client’s ability to pay, etc. Projects can be given a sequential queue number, and tasks can be picked up in the order of their queue numbers. If all coordinating departments, including design, purchase, etc., follow this clear global priority system and focus on work front completion, this can ensure synchronisation between all departments. Interruptions and delays will be dramatically reduced. c) Focus on the full kit (the complete assortment required for execution): Limiting the sites being worked upon will reduce the material and other requirements. But if these are not available when required, site work will be interrupted. So, before activating any work front, the full kit of men, material, equipment, designs, clearances, etc., has to be secured.  <ul><li>Ensuring labour availability: The first step needed will be to ensure that labour is available. Considering the current labour problems, this is likely to be an uphill task unless the company can support labour contractors with a significant problem they are currently facing – the dearth of cash. If the company makes a one-time advance to contractors (and thus fund their immediate cash concerns) and if the company can make more frequent payments to the labourers (e.g. weekly), cash-strapped contractors and workers will find this attractive, more so because most companies would be trying to get contractors to reduce rates or will be negotiating for longer credit periods. </li><li>Ensuring supplies and equipment: Even if labour is available, without adequate or timely availability of supplies, execution can be disrupted. So, it is in companies’ best interest to recce the supplier base (particularly the key, but smaller ones) to understand their supply-related obstacles. Based on this assessment, the companies can, if necessary, extend assistance to overcome any financial or operational obstacles in the way of resuming smooth supplies. However, when placing orders, the focus should be on the materials needed for the chosen work fronts (remove value targets from purchases). At the same time, effort should also be made to conserve working capital as much as possible. For instance, idle equipment/supplies from work fronts that are not being worked on could be transferred and used before fresh orders (requiring more capital outlay) are placed. </li><li>Ensuring compliance to COVID-19 norms: The COVID-19 era will be defined by social distancing and sanitisation norms. The government may take stringent action against infrastructure companies if the norms meant to prevent the spread of infection are violated. There can be disruption if such government-imposed restrictions are violated. Thus, it is in companies’ best interest to include actions to be taken/processes to be put in place to ensure that their sites and site offices do not violate norms as part of the safety full-kit requirement. <o:p></o:p></li></ul>d) Issue resolution through active task management: The above steps will ensure that projects proceed without interruptions and are completed faster despite productivity losses due to reduced capacity, thereby maximising billing. However, every now and then, execution can be held up due to a lack of timely decisions or issue resolution. Therefore, to reduce the elapsed time for such activities and decision-making, a system of active task management can be instituted – a process of predefined issue resolution frequency rather than the usual process of intervention close to committed dates. This will enable faster financial and operational closure of projects. A similar system can also be put in place to ensure active follow-up with government agencies, that clearances are forthcoming, and that bills are cleared as quickly as possible. These flow rules help reduce project lead time. And the lower lead time, in turn, leads to a higher billing rate. The <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/research-and-publication/articles/right-for-accounting-wrong-for-project-management/">working capital requirements</a> and their variability will also drop. Organisations implementing the Flow Principles have been able to increase the working capital turns by many folds. Even after the financial and operational parameters of the company return to normal, the Flow Principles should be adhered to ensure that the company continues to enjoy shorter lead times, better working capital cycles and higher profitability than the rest of the industry.

Key Takeaways

The COVID-19 pandemic brought the world to a standstill, including India's robust engineering and construction sector. Read this article to learn how infrastructure companies can manage a revival despite working capital woes.

Bridging the pandemic chasm

The impact of the COVID-19 rampage across the world has been unprecedented. The lockdown to ‘flatten the curve’ of the pandemic and the consequent economic slowdown have severely hurt the prospects of most sectors in India, including <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/industries/engineering-construction/">Engineering, Procurement, and Construction (EPC)</a>.  EPC, Transmission and Distribution (T&D), road construction, and building construction together form the country’s second-largest economic sector after agriculture and provide a large number of jobs. Even before COVID-19, many companies in this sector were already struggling with escalating debt and cost overruns. Some were barely hanging on to just enough earnings to cover interest payments on their debt. Now, the entire sector faces even more uncertainties related to project completion, new project financing, and future order flows.   <h2>Industry-wide problems</h2>When the central and state governments issued directives for lockdown, all companies were forced to stop operations completely. Even though the complete lockdown has been lifted, the fate of projects in the country remains in a conundrum. There are two major causes for this: <ul><li>Labour shortage: Despite the government allowing construction activity across regions to resume, including in red zones (where non-essential businesses are not allowed to operate), <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/research-and-publication/articles/epc-reborn-focus-on-flow/">EPC</a> companies are staring at an acute labour shortage - both unskilled and skilled.</li><li>Most construction workers are migrants who were left without work when the lockdown was imposed. When governments made arrangements for transport, many chose to return to their villages. Most contractors involved in site work consequently experienced a significant labour exodus.</li><li>This situation is now further complicated by the fear of infection; many workers are hesitating to return to work. Among these, the shortage of skilled workers is most acute, as projects cannot resume without them. Given this uncertainty, companies are facing a significant challenge in planning their site work.</li><li>Supply chain disruption: The absence of adequate labour to operate factories is also a major reason the infrastructure supply chain is in the doldrums. Lack of labour and consequent production stoppages/trimming at supplier plants have choked supplies. Moreover, having to enforce new health and safety guidelines in their plants is further stretching supplier capacities. Many are facing an acute shortage of working capital to restart or scale operations. Shortages of raw materials and lack of logistics/transport facilities, and the sealing/tightening of country/state borders have all added to the melee and culminated in the upending of the supply chain in this sector. Since the entire ecosystem is impacted, it will take time to resolve supply issues, and supplies will ramp up only in stages.  </li></ul><h2>Consequences</h2><ul><li>Delay of projects: Without the timely availability of labour and material, execution schedules will be disturbed and construction activity delayed, ultimately pushing deliveries of projects further. And any delay in a project will have a cascading impact on multiple contractual obligations in the ecosystem, since complex contractual arrangements, including back-to-back contracts between numerous, unconnected parties, or multiple independent contracts between related parties as part of a composite transaction, are typical of the infrastructure sector in India.</li><li>Financial issues: Lockdown and the consequent discontinuation of all project work at the site had a severe financial impact, as well. The pandemic has been declared a ‘force majeure event’; it would typically entitle a contractor to an extension of time (3-6 months) for the critical delay caused by the event without penalty on milestone slippage. Even so, there would typically be no compensation for expenses incurred for the duration of the stoppage of work. This means that all costs, including those incurred as damage to construction material, damage and rework of work fronts where preservation could not be done, depreciation on idle plant and machinery, cost of remobilisation of men, material and machinery, etc., would all have to be borne by the company. Even the relief provided by the Reserve Bank of India (RBI) in the form of a three-month debt moratorium will not compensate for these losses, especially since the funds will have to be repaid at a compounded rate of interest after the moratorium period.</li><li>This can be brutal for the firms in this sector since most are struggling to put together the working capital needed to reinitiate work. In the last 2-4 months, both billing and payments have suffered. This has deteriorated working capital turns, too.</li><li>The long-term outlook is bleak. The cash outflow is clear: interest payments on debt, site expenses, and other costs. The inflow of cash, however, is completely uncertain! Without a clear way forward, projects are inevitably delayed. And delayed projects mean crippling milestone penalties, delayed billing and delayed payments.  </li></ul><h2>The silver lining</h2>Unlike many other industries, this one enjoys a silver lining. Most companies in this industry have adequate order backlogs to convert into billing in the months ahead. Moreover, as India looks forward to kick-starting the economy, the government may roll out concessions or exceptions in the coming days to ease this sector. But the decisions companies take today (on resuming operations) will determine how effectively they can catch up on numbers lost during the lockdown period.  <h2>What not to do</h2>Given that assets are significantly leveraged (operational and under-construction) and there has been a sudden, significant impact on revenue, companies will be concerned about the liquidity needed to prevent payment defaults or debt restructuring. In such a scenario, the priority for any firm will be to manage its working capital (more aggressively than ever). Towards this end, companies might typically try to:<ul><li>Delay payments to contractors and vendors: If firms delay payments to contractors or try to negotiate better credit terms, the time it takes for contractors/vendors to ramp up will increase. Moreover, vendors operating with limited capacity and facing cash flow issues would prefer to serve customers with shorter payment cycles. Hence, delaying payments would hinder supplies. Supply delays can lead to reduced billing because a significant portion of billing is based on supplies, and interruptions in supply can lead to project delays. Reduced billing will put pressure on working capital and profits.</li></ul><figure class="image"><img style="aspect-ratio:3873/3847;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//image_1778501336.png" width="3873" height="3847"></figure><h2>Way forward</h2>Since such attempts to control costs can be severely detrimental to the revival and sustenance of operations, the only way to transition from the current issues rapidly, in a win-win manner, is to achieve the following two objectives: <ul><li>Increase working capital turns without changing vendor’s payment terms</li><li>Increase the rate of billing from the existing order backlog at a pace much faster than ever before</li></ul>Companies can only achieve these objectives by taking actions to cut down the execution lead time for E&C by at least 30%. This can be achieved by rapidly implementing a few simple Flow principles. <h2>Implementing the Flow Principles</h2>Flow in any system is limited by its constraints. In the current circumstances, the major constraint for a company is working capital. To kick-start operations and improve the flow of project tasks (and consequently projects) at the fastest pace possible, all decisions have to subordinate to this constraint, and all actions must be taken to ensure that the available liquidity is exploited as efficiently as possible. For this, the following principles have to be implemented. a) Limit the number of simultaneously open sites (work-in-progress, or WIP, limit) within a project based on the availability of labour/supplies:<figure class="image"><img style="aspect-ratio:3996/4058;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//image_1778501398.png" width="3996" height="4058"></figure>As in the existing scenario, the company will have to start operations with significantly lower material and capacity than at the beginning of the lockdown; instead of trying to resume all pending work simultaneously, it will be judicious to limit work fronts. Application of thick resourcing (men, materials, etc.) can help quickly complete and bill these. The subsequent cash inflow can help the company complete other work fronts – a limited few at a time, based on capacity and available resources.  b) Alignment of departments through a global priority system: Care should be taken to choose the right projects to work on from the existing basket of open work fronts. These are the ones with the highest potential to realise as much cash as possible and at the earliest. A cross-functional team should revisit and re-evaluate all projects based on various factors such as which projects are near completion, which are urgent for the client, the client’s ability to pay, etc. Projects can be given a sequential queue number, and tasks can be picked up in the order of their queue numbers. If all coordinating departments, including design, purchase, etc., follow this clear global priority system and focus on work front completion, this can ensure synchronisation between all departments. Interruptions and delays will be dramatically reduced. c) Focus on the full kit (the complete assortment required for execution): Limiting the sites being worked upon will reduce the material and other requirements. But if these are not available when required, site work will be interrupted. So, before activating any work front, the full kit of men, material, equipment, designs, clearances, etc., has to be secured.  <ul><li>Ensuring labour availability: The first step needed will be to ensure that labour is available. Considering the current labour problems, this is likely to be an uphill task unless the company can support labour contractors with a significant problem they are currently facing – the dearth of cash. If the company makes a one-time advance to contractors (and thus fund their immediate cash concerns) and if the company can make more frequent payments to the labourers (e.g. weekly), cash-strapped contractors and workers will find this attractive, more so because most companies would be trying to get contractors to reduce rates or will be negotiating for longer credit periods. </li><li>Ensuring supplies and equipment: Even if labour is available, without adequate or timely availability of supplies, execution can be disrupted. So, it is in companies’ best interest to recce the supplier base (particularly the key, but smaller ones) to understand their supply-related obstacles. Based on this assessment, the companies can, if necessary, extend assistance to overcome any financial or operational obstacles in the way of resuming smooth supplies. However, when placing orders, the focus should be on the materials needed for the chosen work fronts (remove value targets from purchases). At the same time, effort should also be made to conserve working capital as much as possible. For instance, idle equipment/supplies from work fronts that are not being worked on could be transferred and used before fresh orders (requiring more capital outlay) are placed. </li><li>Ensuring compliance to COVID-19 norms: The COVID-19 era will be defined by social distancing and sanitisation norms. The government may take stringent action against infrastructure companies if the norms meant to prevent the spread of infection are violated. There can be disruption if such government-imposed restrictions are violated. Thus, it is in companies’ best interest to include actions to be taken/processes to be put in place to ensure that their sites and site offices do not violate norms as part of the safety full-kit requirement. <o:p></o:p></li></ul>d) Issue resolution through active task management: The above steps will ensure that projects proceed without interruptions and are completed faster despite productivity losses due to reduced capacity, thereby maximising billing. However, every now and then, execution can be held up due to a lack of timely decisions or issue resolution. Therefore, to reduce the elapsed time for such activities and decision-making, a system of active task management can be instituted – a process of predefined issue resolution frequency rather than the usual process of intervention close to committed dates. This will enable faster financial and operational closure of projects. A similar system can also be put in place to ensure active follow-up with government agencies, that clearances are forthcoming, and that bills are cleared as quickly as possible. These flow rules help reduce project lead time. And the lower lead time, in turn, leads to a higher billing rate. The <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/research-and-publication/articles/right-for-accounting-wrong-for-project-management/">working capital requirements</a> and their variability will also drop. Organisations implementing the Flow Principles have been able to increase the working capital turns by many folds. Even after the financial and operational parameters of the company return to normal, the Flow Principles should be adhered to ensure that the company continues to enjoy shorter lead times, better working capital cycles and higher profitability than the rest of the industry.

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Discover the impact of COVID-19 on India's engineering and construction industry, challenges faced, and strategies for recovery.