Clasificación de IDS

7.5.1 This section deals with the relationship between demand and the capacity of the heating and ventilating industry to meet that demand from 1945 to 1996. The interface between demand and capacity can be seen in terms of the costs of inputs, the prices of outputs and the resulting changes in profits of firms in the industry.

7.5.2 The benefits and problems of prolonged excess demand in the heating and ventilating industry were reflected across the whole construction industry in most years in the period from the beginning of the Second World War until 1973. The issue became one of finding sufficient resources to meet demand rather than the more usual concern of over-capacity in the construction industry chasing too little work (Powell, 1996, p. 166).

7.5.3 At the beginning of the 1950s supplies to the heating and ventilating industry were still causing difficulties. For example, steel was in short supply and prices of heating installations and mechanical ventilation systems were rising (AHVDEE, 1952 p.30). Nevertheless new jobs continued to be commissioned. Increased costs of raw materials, labour, and transport were blamed for the price increases of the components used by heating and ventilating contractors but they were nevertheless able to pass on these higher costs to their customers.

7.5.4 Firms often received only partial deliveries of materials instead of the bulk orders they required. These partial deliveries were often spread over a number of months causing delays and further inefficiencies (AHVDEE, 1952 p.32). For example partial delivery of materials and components would impact on labour and administration costs for the contractor as labour was moved from site to site depending on the availability of materials and

components. This disruption to work would have also raised costs and squeezed profits, even without a rise in the unit price of material inputs. Labour costs are a function of rates per hour, number of hours worked and the porosity of the working day\ and it is the porosity of the working day which is most affected by late or incomplete deliveries.

7.5.5 Apart from direct costs, overhead costs also apparently rose by more than 10 per cent in real terms in 1951, according to the Council’s report in 1952. The reasons for the rise in overhead costs were given as ‘very heavy increases in [the] cost of office materials, certain

transport and postal increases, etc.’ (AHVDEE, 1952, p. 121). It is, nevertheless, quite likely that material shortages led to increased administration costs as more effort and time were required to organise work over and above normal practices. It is also worth noting that the Council recognised that there had not been a particular pressure from the unions, who had ‘not been unreasonable in their demands’ (AHVDEE, 1952, p. 121). This indicates that there may have been little wage pressure on profits in 1951, as wages would undoubtedly have been the major cost item (within the cost of sales) in the profit and loss accounts. Thus, in spite of shortages of skilled labour, the heating and ventilating labour market remained steady.

7.5.6 Nevertheless, by 1952 the President of the Association highlighted the manpower problem as the greatest issue facing heating and ventilating contractors, due to the demand put to the industry (AHVDEE, 1952, p.xxxiii). The lack of wage pressure may have been more of a reflection of depression in other parts of the economy and the construction industry other than heating and ventilating. Thus, it would appear that the rise in costs could well have been largely due to the high levels of demand for heating and ventilating systems, which in turn caused disruption to supplies of materials, as sites competed for available resources. Such disruption to work also adversely affected labour productivity, which would have raised the cost of labour even without any increase in wage rates.

7.5.7 Indeed, the AHVDEE President later wrote that many considered that if the rise in prices had continued, central heating and mechanical ventilation would have priced

themselves out of the market (AHVDEE, 1952, p. 30). These high prices did, however, appear to generate a healthy level of profits for the contractors themselves. This conclusion appears to be supported by the implication unwittingly admitted in the same commentary that few would have wanted to return to cut price competition brought on by a trading slump

(AHVDEE, 1952 p.31). In fact price became secondary to obtaining delivery of components in the first place (AHVDEE, 1952, p.31). Presumably even if the cost of heating and

ventilating systems rose greatly in 1952, they would still have constituted a relatively minor proportion of the total cost of construction, and therefore added relatively little to the final building costs. More significant would have been the cost increases caused by the

prolongation of and delays to construction work due to late delivery of materials.

7.5.8 On the other hand, in many cases, it was reported that heating and ventilating

contractors were squeezed by rising costs and a contractual obligation to absorb the increased costs in the original tender price (AHVDEE, 1952, p.32). In those cases where contractors were able to pass on their increased charges there would not necessarily have been a

particular problem, except perhaps in their cash flows. However, if contractors were unable in some cases to pass on their higher costs, this may have reflected a relative weakening in their bargaining position in the recession of 1951.

7.5.9 By the end of the 1950s it was reported that “competition became noticeably keener,” especially for contracts in the upper price brackets. This statement appears to imply that profit margins were being reduced in order to win these contracts, since the reviewer at the time felt that “commitments entered into might yet prove to be an embarrassment to the contractors concerned,” (AHVDEE, 1960, p.46). At the same time it was noted that,

did not always pass on their cost increases (AHVDEE, 1960, p.46). This would indicate that manufacturers too were facing increasing difficulties in maintaining their sales growth, and were accepting lower profit margins. Increasing competition from abroad as well as productivity increases, which enabled them to increase output at a rate greater than the growth in the market also placed downward pressures on manufactures’ profit margins.

7.5.10 The changing trends in trading conditions were reflected in the comments of the Council Report for the year ending March 31st 1959, which also suggested that profits could be squeezed at the upper turning point of the business cycle.

'"As our Industry,(sic) in the main, supplies services for other Industries, its trading activities follow the trend in industry in general... In this our Industry followed the general pattern o f the trade o f the country which, although in many spheres registering an increase in turnover, showed net profits smaller than those o f the

previous y e a r .(AHVDEE, 1960, p. 111).

7.5.11 Thus, although Figure 5.7 shows the recession of 1960 in the heating and ventilating industry was relatively minor, a steady increase in capacity was not matched by demand. This ultimately led to a profit squeeze, especially in an industry such as heating and

ventilating, where demand is not price sensitive and lower prices and profit margins do not necessarily lead to increased demand and output.

7.5.12 The Annual Report for the year ending 31st March 1965, noted a confidential analysis prepared for the National Incomes Commission on profit margins in various trades between

1956/57 and 1960/61. This report showed a downward trend in the profit margins of heating and ventilating contractors, which the HVCA considered serious. Figures from the Inland Revenue showed that profit margins relating to the construction industry were as low as 5 per cent (HVCA, 1965, p.32-3). It is, however, not clear whether the profit margins referred to were gross or net. In any case at 5 per cent they appear high by the standards of the 1990s, though the difference in profit margin compared to the 1990s may have been due to the greater use of fixed assets by contractors in the 1960s compared to the 1990s. The higher the proportion of fixed assets to total assets the greater the profit margin tends to be.

7.5.13 In the Contractor’s Review of the year to mid 1963, competition in the heating industry remained intense (AHVDEE, 1963 p.37). This level of competition led to price- cutting, which eroded the “very small margin of net profit,” and trading profits began to fall as a result. The reviewer at the time pointed out that there seemed to be an inability to restore prices to a level at which they showed a reasonable return on capital employed. According to the reviewer this was due to two sets of causes. Firstly, due to the lack of confidence on the part of heating contractors, they apparently lowered their prices whenever there was a lack of inquiries, but they delayed raising them again when the number of enquiries increased. Perhaps a more likely explanation is that contractors sensed a lower level of enquiries, greater uncertainty and lower levels of business confidence, especially during the periods of slack referred to above, and priced more keenly as a consequence. The observation that contractors did not raise prices in response to an increase in enquiries implies that prices respond more to actual workload factors than mere speculative enquiries, which may or may not lead to work.

7.5.14 In other words, in general, price increases when the increase in real demand (as measured by output in construction industries) is greater than the increase in capacity. But this does not necessarily imply that profit margins or total profits also increase. Profit depends on the volume of sales and the difference between prices and costs. Profit margins may be low either because there is spare capacity causing firms to compete intensively or because industrial capacity is being fully exploited and input costs are rising at a faster rate than output prices.

7.5.15 However, other factors including contingencies, which do not readily fit into any deterministic model still need to be taken into account. For example, the purported

reluctance of heating and ventilating contractors to raise prices referred to above, may have been due to the “credit squeeze” policies adopted by government at the time and rising interest rates. According to the reviewer in 1963, these credit squeeze monetary policies tended to restrain manufacturers from raising their prices to heating and ventilating contractors, with the exception of certain steel tube manufacturers, who did increase their prices (AHVDEE, 1963, p. 3 8).

7.5.16 Similarly, the prices of inputs may be seen as exogenous contingent determinants of the costs of heating and ventilating contractors. In 1966 high interest rates, balance of payments problems and inflation formed the economic conditions perceived to be having adverse effects on the construction industry. In the same year the contract copper price, which is the price paid by manufacturers continued to rise. The increases in price were partly blamed on a number of political events taking place including the Vietnam war and the unilateral declaration of independence by Rhodesia, a major copper producer, which had prompted United Nations’ sanctions which reduced the availability of the metal. Moreover, industrial unrest in other copper producing countries was also reported. The contract price of Chilean copper rose from £336 to £496 per ton. The price of Zambian copper also rose on the London Metal Exchange, selling there on the open market instead of at the arranged contract prices, which had been used earlier. As a result the Ministry of Public Building and Works index for copper tube, (1952 =100), rose from 149 in November 1965 to 180 in March

1966 (HVCA 1966, p.28). Fortunately, by the following year the market for copper had regained some degree of price stability, but in the meantime the rapid increase in price had acted as a stimulus for technical change, in the search for a replacement of the material and a reduction in its use. A reminder, if one were needed, that firms like any economic agent can respond in many different ways to price changes and do not just accept prices as a given,

ceteris paribus.

7.5.17 At the beginning of 1970 wages and materials rose sharply, partly as a result of a catching up exercise following the break down of the government’s prices and incomes policy at the end of 1969. The HVCA reported that the rate of wage increases doubled t o l l -

12 per cent per annum in 1970. In spite of the continuing demand for heating and ventilating systems, very low profit margins in the sector were admitted by the HVCA. These low profit margins were an indication that firms were maintaining their output by reducing their mark ups. Indeed, in 1970 the HVCA described the situation as one of ‘cut throat’ competition, which the HVCA could do nothing to prevent as any measures it could take would run counter to the Restrictive Trade Practices Acts of 1956 and 1968 (HVCA, 1971, p.7 and p.22). Intervention in the market by the HVCA had become a particularly sensitive issue.

The Registrar of Restrictive Trade Practices was investigating collusive tendering in the construction industry at that time, and having uncovered anti-competitive practices amongst electrical contractors was about to probe the heating and ventilating market (HVCA, 1971, p.24).

7.5.18 In 1971 market pressures on heating and ventilating contractors remained, with firms willing to charge extremely low prices in order to gain work (HVCA, 1972, p. 8). In spite of attempts to combat rising prices, the rate of inflation continued to increase in the early 1970s.

Oil prices rose four hundred per cent paving the way for other price increases. As industrial and commercial consumers switched to alternative sources of energy in the early 1970s, demand for heating and ventilating contractors remained high, although the HVCA still reported low profit margins in the sector (HVCA, 1974, p.9^ These low profit margins provide evidence of a profit squeeze caused by input costs rising as full industrial capacity was approached. However, this is not to say that other factors were not also responsible for the squeeze on profits or indeed their complete erosion.

7.5.19 In 1974 the HVCA pointed out that the rise in costs due to inflation had eroded much of the profitability of many of the existing contracts. According to their costing survey firms were operating on a 2.5 per cent profit margin or mark-up in 1974, which meant that heating and ventilating contractors were often in effect trading at a loss with inflation running at over 20 per cent per annum (HVCA, 1975, p.7 and p.24). For example, any delays in payment would have eroded any real profit based on such low margins.

7.5.20 The general economic situation in 1974 declined further according to the HVCA in the aftermath of the 1973 energy crisis. A balance of payments deficit of over 6 per cent of GDP added to the gloom and lack of economic confidence. In 1974 firms were trading on low profit margins at a time of relatively high inflation and credit restrictions, which constrained demand. These conditions were seen as responsible for some of the liquidity problems faced by contractors at the time (HVCA, 1975, pp.25-6).

7.5.21 The HVCA also saw the removal of statutory prices and wage controls in July 1974 as a threat. To a large extent they were justified as basic wages rose by over 30 per cent per annum (HVCA, 1975, p.7 and p.24). The resulting economic uncertainty led to a decline in demand for construction, which also adversely affected demand for heating and ventilating. Capacity exceeded demand as firms experienced difficulties in maintaining both real prices and output. There followed efforts by government to reduce inflation, but with the upturn in demand in 1977 the rate of inflation began to rise again, with interest rates at 14 per cent and wage increases averaging 15 per cent per annum.

7.5.22 In 1980 the rate of inflation, which had been as high as 21 per cent was reduced to 14 per cent per annum. The Bank of England responded by cutting in stages the Minimum Lending Rate fi'om 17 per cent to 12 per cent. This had the effect of reducing the exchange rate of the pound from $2.40 to $2.00, with the lagged effect of raising material prices such as copper, essential for heating and ventilating contractors (HVCA, 1981, p. 8). Given the state of the construction market, higher material costs were to a great extent absorbed by heating and ventilating firms keen to obtain work in a recession. Some areas such as the South East continued to demand the services of heating and ventilating contractors, although

the HVCA again reported a squeeze on profit margins, this time caused by over-capacity in the market (HVCA, 1981 p.8 and p.26).

7.5.23 Following the recession in the early 1980s improvements in the construction market began to gather momentum as output recovered. Demand and tender prices increased but so did the building costs of materials and labour. As a result profit margins in construction remained relatively low throughout the 1980s (HVCA, 1989, p.8).

7.5.24 By 1991 many heating and ventilating contractors were reduced to finding work at almost any price in order to survive. Like many specialists in the construction industry, competition between them led many heating and ventilating engineers to tender at

unprofitable prices. According to the HVCA’s own state of trade survey, only 13 per cent of respondents claimed that tender prices were viable (HVCA, 1992, p.9). Low profit margins were sustainable only as long as output increased. If the output of contractors declined even slightly, many firms would have found they had few cash reserves available.

Concluding remarks

7.6.1 It can be seen from the above that many factors other than cost affect the profitability of firms in the heating and ventilating industry. Clearly the cost of labour and materials are central in the pricing of work. However, prices in the heating and ventilating industry do not necessarily greatly influence the aggregate level of output of this relatively small sub-sector of the building industry. It is difficult to see what alternatives to the expertise of heating and ventilating engineers clients could use. Plumbing firms offer a similar but more limited

service. Therefore clients would require heating and ventilating engineers regardless of expense, provided the price was determined in a competitive environment.

7.6.2 At the same time, because heating and ventilating only represents one element of a building, any reduction in price would not significantly increase the quantity of heating and ventilating services used. The quantity is determined by predetermined specifications and general construction demand, over which heating and ventilating firms have little control. Therefore it may be assumed that the price elasticity of demand for heating and ventilating engineering taken as a whole would tend to be relatively inelastic, though of course the price