THE ECONOMIC SUSTAINABILITY OF THE BUILT ENVIRONMENT PROFESSIONS BUILT ENVIRONMENT INDABA 11 NOVEMBER 2010

1. THE ECONOMIC SUSTAINABILITY OF THE BUILT ENVIRONMENT PROFESSIONS  BUILT ENVIRONMENT INDABA 11 NOVEMBER 2010

2. Presentation structure Purpose of study Porter�s Five Forces Model The Macro-economic environment Sectoral overview of the professions Emerging policy issues and policy considerations Conclusion

3. Purpose of the study Key objective was to understand the factors and forces that would shape the economic sustainability of the BE professions going forward, with reference to the following: Importance of professional practice as economic activity Factors that impact on the health and sustainability of the built environment The key commercial drivers of each profession The market structure of the built environment Issues of supply and demand within the professions Impact of regulations on the health and sustainability of the professions and role of the CBE.

4. Porters Five forces modelKey concept: Competitive rivalry or industry competition which determines the profitability of the industry is an outcome of the four forces; the power of suppliers, the power of buyers, the availability of substitutes and the existence of barriers to entry. Government is also an important force in its own right which shapes the structure and therefore the competitive outcomes in an industry.

5. Context  Supplier power: The principal suppliers in the built environment professions industry are the qualified professionals themselves, generally organised into small consulting firms and thus the health of the educational pipeline is of particular importance to this market. The five major factors that determine the relative power of the forces are Concentration levels, degree of substitutability, amount and/or potential of vertical integration. Excessive supplier power can lead to higher prices. Buyer/customer power: In the same way that powerful suppliers can drive up prices, powerful buyers can reduce profitability of firms by demanding price discounts. In the case of the built environment, buyers primarily represent the private and public sector clients that demand the services of built environment professionals. The five major factors that determine the power of the buyer are concentration and size of buyer, importance of buyer in terms of cost and quality, degree to which the service is standardised (impact substitutability), cost, practicality and opportunity of buyer to switch suppliers and possibility of vertical integration initiated by either buyer or supplier of services.

6. Context (cont�.) Threat of entry (Barriers of entry force): If there are barriers to entry, the profitability of the sector will be maintained (usually at above normal levels). Factors which constrain and determine barriers of entry are Economies of Scale (impacted by Market Concentration significantly), Product differentiation, Capital requirements and Switching Costs. These forces determine the market structure, with extreme market outcomes of monopoly and maximum profit extraction which leads to decreased social welfare and the opposite perfectly competitive market structure which is belied by normal profits and optimum social welfare. Market structure has therefore a direct bearing on social policy objectives of poverty alleviation through income redistribution, it is therefore imperative that the profit motive of maximising profits against decreasing social welfare is kept in check and a sustainable profit and therefore market structure needs to be agreed to. Threat of substitutes: A service which perform the same or similar function as an industry�s product (service). Within the BE professions it is those professionals who are not registered, not a member of a specified profession (e.g. Estate Agents who perform property valuation services) and inter professions substitutability (engineer performing the work of a Project Manager). Substitutes will exert downward pressure on cost and therefore pricing and will then drive down profitability. The existence or non-existence of close substitutes determines the elasticity of demand for a service, meaning the responsiveness of the demand for the service to its price with inelastic demand obtaining when the demand for the service is non-responsive to price and elastic demand being responsive to the price.

7. 5 forces contextualised? Cont�.. Competitive Rivalry: the extent to which existing firms compete with each other is one of the greatest drivers of industry profitability and ultimately the sustainability of a profession(s). This resultant force responding to the confluence of the four forces will determine the market structure of the industry (within the spectrum of Monopoly, Monopolistic competition, Oligopoly and Pure competition Market Structures) and depends on the following factors; number of competitors and degree of concentration, rate of growth of the industry, degree of differentiation and cost structure in determining the relative outcome of competitive rivalry.

8. Public policy considerations Supplier power: A functional skills pipeline, will lead to increase and security the supply of professions leading to relative decrease in cost of professional services. At the firm level which employs the BE professionals, the concentration levels are of concern, which might lead to undesirable market structures need to be kept in check to keep barrier of entry at acceptable levels so not to frustrate new entrants and in the South African context enable transformation. Buyer power: The consumers of professional services need to balance the economic leverage to attain sustainability of professions in a responsible manner (in particular the public sector as a homogenic consumer block of professional services that can co-ordinate its procurement practices). Whilst using their considerable economic leverage in a more deliberate manner to achieving public policy priorities like transformation. Barriers to entry: Ensure that barriers to entry (manifest in the market structures of the various professions industry's) do not frustrate the industry transformation goals of the state and that appropriate trade-offs are pre-determined in the equation of profit maximisation vs social welfare benefits. Threat of substitutes: Ensure that only registered professionals practice to protect the public interest. Government: In here the public policy imperative of transformation, responsiveness by the professions to the national agenda will shape and influence either positive or negative policy response(s).

9. Key macro-economic issues Upward business cycle since September 1999 led to positive GDP growth and strong growth in investment in construction (i.e. civil, residential and non-residential building and construction) has doubled in real terms during this five year period, from R62.5bn in 2004 to R120bn in 2009. Growth led by strong infrastructure spend by the public sector, whilst Private sector investment, especially in the areas of residential and retail construction, has also been exceptionally strong during this time. The global financial crisis, and economic contraction in South Africa, has had a negative impact on construction activity. Overall, before tax profit margins in the construction industry (including both the built environment professions and construction activity itself) are estimated to have declined to 3.8%, from an exceptional cyclical high of almost 8% in 2007. Counter-cyclical Public sector investment has cushioned the sector to a certain extent as there has been a sharp contraction in private sector activity (although the ability of specialist firms to alternate between private and public sector work may be limited). Key issue is the cyclical nature of the construction industry and the importance of counter-cyclical public sector spending to preserve skills and capacity of the BE industry.

10. Key Findings - Architectural professions The architecture sector in South Africa is well established, with an estimated 1 300 practices of varying dimensions operating in the market. The majority of firms are relatively small, with more than half having fewer than 10 professionals, and the bulk of fees are derived from the private sector, with the public sector comprising only around one quarter of fee income. Supplier power is weak due to reliance on the private sector for bulk of professional fees. Was further weakened by non-registration requirements for design of structures below and above 500m� which increased intra-professional competition. Buyer power is strong, price discounting in the private sector rampant whilst the public sector open tender system elevates price competition above overall functionality and quality considerations. An alternative procurement methodology for the professions services is an raised as a critical emerging policy question requiring intervention. Limited barriers to entry, however established firms advantaged due to the time they have invested in developing reputation and client networks. �reputational capital� is therefore an artificial barrier to entry. Competitive rivalry is strong because the substantial number of firms are small to medium sized and the strength of the above forces. Has positive social welfare implications as competitive rivalry decreases the cost of architectural services, however, this needs to be balanced against the long term commercial viability. IDoW and Professional Fees policies are therefore important whilst open tender public sector procurement needs review.

11. Key findings � Engineering professions There are about 400 firms employing over 20 000 people, about half of which are professional engineers. The majority are employed in the consulting engineering sector. Listed civil engineering construction firms (contractors) are also a substantial employer and only a quarter of engineers are employed in the public sector. Supplier power is strong due to a chronic shortage of qualified and competent engineers. Drives increasing industry concentration to pool resources and skills and realise economies of scale. Buyer power is strong as the majority of consulting engineering industry fees are derived from the public sector, with price discounting becoming a trend. Public sector tendering process problematic, especially at local government level mainly due to lack technical competence and undeveloped technical tendering systems. Limited barriers to entry, however increasing concentration levels indicative/characteristic of a monopolistic competition market structure raise critical policy questions on desirability and potential trade-offs between the maxim of profit maximisation vs social welfare benefits (transformation). Competitive rivalry is generally strong but level of intensity varies with size of project, geographic area and the level of specialization of the firm involved. For the engineering professions, buyer power and constrained supply are therefore the most important forces that shape the market structure of the industry which has seen a trend towards higher concentration levels.

12. Key findings � Landscape Architectural professions The landscape architecture sector in South Africa is relatively small, consisting of up to 60 micro to small sized firms. Supplier power is strong due to a chronic shortage of landscape architects. Buyer power is strong with the majority of fee income from the private sector. Limited public sector procurement due to limited understanding of service offering. Barriers to entry in the industry are low, and a number of firms have entered the market in the last decade. However, the sector is still relatively underdeveloped and fragmented, so levels of competitive rivalry remain low. Buyer power, which leads to substantial price discounting, has significant impact on the commercial outcomes of the industry. This is due to the following: Services are perceived to be a luxury rather than as a valuable, practical input into the building process due to limited public awareness. Buyers (which are typically building contractors, engineering firms, and architects, rather than the party financing the building project) are relatively large in comparison to landscape architecture practices and so are able to exhibit considerable negotiating leverage. The substitution of registered Landscape architectural services for either unqualified or under-qualified landscape architects and architectural professionals.

13. Key findings � Project and Construction Management professions There were 2�701 active registered professionals found mostly in Pure Project and Construction management firms, Multi-disciplinary firms that provide a wide array of services, Consulting engineering firms and Civil Engineering Contracting firms. Supplier power is strong. Registrations with the SACPCMP peaked in 2005 and has trended downward. However, most practicing professionals come from other BE professions, especially engineers, quantity surveyors and architects (inter-professions substitution). Buyer power is weak i.e. buyers do not have a significant downward influence on prices. The increasing complexity of projects and the incentive to deliver projects within cost and on time, the diversified private and public sectors income streams, business referrals/�reputational capital� and knowledge of service offering by large clients especially in the private sector increase the demand for project and construction management services relative to static supply. There are limited barriers to entry due to inter-profession substitution which leads to high Competitive rivalry. High competitive rivalry is however deceptive as the increasing demand for professional services and the pending introduction of IDoW will further increase demand. Increasing demand coupled with constrained supply will increase the cost of services.

14. Key findings � Property Valuing professions As of March 2009 there were 1�302 professionals and 1�300 candidates registered with the SACPVP. The industry is dominated by independent contractors/sole proprietorships or employed by financial institutions, listed companies, property development firms, municipalities and government departments. Supplier power is strong due to limited supply, in particular candidature to professional progression due to limited mentorship opportunities as many property valuers work as independent contractors and therefore enter into long term supply contracts with buyers. This acts as a significant barrier to entry into the industry. Buyers power is strong as financial institutions (registered banks, providers of mortgage finance and investment institutions) are the single biggest buyers of property valuation services, together with local authorities in line with the Municipal Property Rates Act (MPRA). Consumers of the professions services are able to negotiate valuation fees that are below the suggested fee guidelines published by the SACPVP. Barriers to entry are low as buyers substitute away from the services of registered property valuers for Estate Agents, Quantity Surveyors and Appraisers. The limited supply and long term supply contracts with customers lessens competitive rivalry but increase artificial barriers to entry and will hamper firstly, the sustainable growth of skills in the profession and secondly, economic transformation and the creation of economic opportunities for PDIs.

15. Key findings � Quantity Surveying professions There are currently approximately 1 700 professional and 1 000 candidate registered quantity surveyors operating in South Africa. The majority are employed in the consulting engineering sector, in listed civil engineering construction firms (contractors) and Quantity Surveying professional consulting firms. Supplier power is weak due to an adequate supply of professionals. However, a key issue is the limited supply of experienced quantity surveyors. One recent survey found that 55% of quantity surveyors had less than 5 years experience. Buyer power is strong and a survey indicated discounts of between 6% and 20% on the guideline fees and is made up of private and public sector clients. However, its unclear whether this indicates buyer power and/or, as Cruywagen and Snyman (2005) suggest, that the tariff of professional fees is �fairly generous as practices can afford to offer such a discount and are still making a profit�. There are high barriers to entry due to sourcing of work through established networks and contacts �reputational capital�. Competitive rivalry is generally strong due to fragmented market structure. However, �reputational capital� acts as a barrier to entry and might confirm Cruywagen and Snyman assertion discussed above which will decrease social welfare if found to be true.

16. Emergent policy issues from the discussion above which will guide deliberations in the commissions Human resource issues (skills supply constraints, lack of experienced professionals in some professions and bottlenecks in candidature professional progression). Problems with the public sector procurement system which calls for a special dispensation for the architectural professions procurement through the government procurement system. Barriers to entry, especially increasing industry concentration levels in the engineering professions industry characteristic of monopolistic competition market structure and how this can be leveraged to drive public policy priorities. There is substantial inter-professions substitution of services which might significantly affect public safety and calls for the speedy finalisation and implementation of the Identification of Work policy. Public education and awareness raising campaigns as a market making mechanism for the nascent and developing professions. Rationalisation of the built environment education system due to inter-professions substitution as a result of the duplication/overlap of core curricula in most of the built environment courses.

17. Conclusion The objective of the CBE is to engender the commercial viability of the professions for sustainable growth and the delivery of developmental outcomes through healthy competition that meets the transformation goals of the state. Healthy competition will ensure that barriers to entry are at desirable levels and the professions contribute to meeting the twin goals of socio-economic transformation and growth towards the elimination of poverty.

18. Thank you