INFLATION IN CONSTRUCTION INDUSTRY 1

MITIGATING THE EFFECT OF INFLATION IN CONSTRUCTION COMPANIES: A

CONSULTATION PROJECT FOR SKANSKA CONSTRUCTION COMPANY

Student’s Name
Instructor’s Name
Course Date
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PART II: INTERVENTION

The main aim of this section is to present interventions that will ensure Skanska’s

profitability amidst current inflation. The first part presents an analysis to confirm or disprove

the given hypothesis that inflation will persist in future. What follows are two interventions to

increase profitability based on findings from analysis. The last section outlines Key Performance

Indicators that will be used to assess efficiency of the interventions and the time frame to

appraise performance.

Analysis of Hypothesis ‘Inflation will Persist’ Using Inflation Expectation Framework

This report uses both Market-based Inflation expectation and population surveys to test

the hypothesis that inflation is likely to persist. If analysis confirms this hypothesis, the company

will have a fundamental basis to accelerate construction schedules and reduce exposure to

inflated prices in future.

Market-Based Inflation Expectation

Market-based inflation expectation is based on performance of inflation swaps held by

investors. These instruments are directly affected by inflation and therefore provide a relatively

reliable measure of future inflation conditions. A buyer of inflation swaps hedges against

inflation by paying a fixed amount which will be adjusted for accrued inflation at contract

maturity (Rodriguez and Yoldas, 2016). The buyer of these instruments receives a CPI adjusted

return after a given period, often after 5 or 10 years. To derive long term inflation expectations,

this study compares the 10-year Treasury yields against 10-year inflation protected securities

whose yields are tied to prevailing CPI at maturity. If investors expect a higher inflation, the

demand for 10-year Treasury Inflation Protection Securities will increase and the yields will

reduce. The break-even inflation rate which measures the difference between the two yields will
Inflation in Construction Industry 3

increase (Chien and Bennett, 2022). For short term inflation projections, the study uses 5- Year

and 5- Year forward Inflation expectation rate which compares similar variables but with a

maturity of 5 years.

The figures below portray these projections

Figure 1: 10-year break even rate Source; Federal Reserve Bank of St. Louis retrieved from FRED.

Figure 2: 5-Year break even rate source; Federal Reserve Bank of St Louis Retrieved from FRED

According to the figures, the future inflation expectation was very severe in 2020. A

recovery in business and investor confidence in the FED’s ability to contain inflation after the
Inflation in Construction Industry 4

pandemic restored the break-even inflation rate to original levels (FRED, 2022). Currently, the

break-even inflation rate has increased above pre-pandemic levels and implies that investors do

not expect the current inflation to persist.

Inflation Expectations from Consumers, Managers and Expert Survey

Prevailing sentiment from consumers, managers and economic experts present an

important measure for expected inflation. According to standard inflation theories, prevailing

expectations from households and firms are crucial determinants of future inflation (Adeney et

al., 2017; Lee et al., 2021). This conclusion is based on the fact that expectations about future

rates affect current market behavior which significantly influences how inflation develops

(Bonnatti et al., 2022). For instance, when firms expect inflation to persist, they increase their

purchases to reduce exposure to future prices and create a surge in demand. Consequently,

increased demand results to further price increments and inflation persistence. Similarly, when

households perceive that inflation will continue, they demand more wages from firms who

respond by increasing prices of products to offset additional expenses. A market feedback

mechanism may develop and contribute to further inflation. Thus, prevailing sentiments are

valuable to forecast future development of inflation.

This section heavily relies on the work of Andre et al. (2021) who conducted a

widespread survey on a sample of 1029 household respondents, 163 managers and 104 academic

economists who published articles on monetary economics. This research focuses on

respondents’ expectations to extrapolate future inflation conditions and support of disapprove the

hypothesis that inflation is likely to persist. According to the study, economic experts believe

that inflation will correct within 49-60 months. Households and managers also believe that the

prevailing inflation is temporary and will not persist for more than 3 years. On drivers of
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inflation, experts believe that the current rates are principally attributed to disruptions in global

supply chains and high demand due to fiscal and monetary policies. The current energy crisis and

labor shortage have a less pronounced effect on inflation compared to supply chain disruptions.

Households and managers reported that disruption in supply chains, high demand due to fiscal

stimulus and reopening of the economy are the most prominent drivers of current inflation. This

analysis suggests that consumers expect inflation to be more persistent in the near future

compared to experts. Managers response supported that sentiments on inflation affects current

monetary behavior when they reported that they have increased price pf commodities and

workers demanded more wages in response to inflation. These findings suggest that firms’ price

and wage setting decisions may potentially provide a channel for persistent inflation in the near

future.

Summary of Analysis of Hypothesis

The hypothesis for this consultation project was that inflation is likely to persist in both

short-term and medium-term projections. However, an analysis of both market-based inflation

projections and surveys of inflation expectations suggest that inflation will likely come to an end

in the near future. This finding is evidenced by the steady increase in both 10-year breakeven

inflation rate and 5-Year, 5-year forward inflation expectation rate. This increase suggests that

investors are not aggressive to buy inflation protection securities since they do not strongly

perceive that inflation will persist in future. Edelberg (2021) supports this finding and asserts that

although the current inflation is running high even after excluding volatile food and energy price,

the drivers are mainly pandemic related and therefore temporary and should not be extrapolated

into the future.

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Analysis of surveys from targeted experts, households and managers also seem to suggest

that the current inflation rates will not persist beyond 36 months. Experts agreed that the inflation

rate results from surge in consumer demand following fiscal stimulus and disrupted supply

chains that creates an imbalance in demand and supply (Andre et al., 2021). Academic

economists placed less emphasis on the role of increased energy and gas prices on the observed

inflation. If this opinion is true, then inflation may fail to persist. Both households and managers

believe that high inflation results from increased demand after economic re-opening and fiscal

stimulus. According to managers and households, factors such as labor shortage, prevailing

energy crisis and interest rates have a lower impact in driving the current inflation. The common

agreement among all three groups is that inflation is not likely to persist in the medium and long

term. However, since a significant number of managers reported that they increased labor wages

and prices of commodities, their actions may potentially provide a channel for inflation to persist

in short term projections.

Conclusively, an analysis of both market-based inflation expectation and the expectation

of consumers, managers and experts reveal that inflation is likely to end. This finding disproves

the project’s hypothesis. This analysis suggests that recommendations for this project should

have short time frame and account for eventual resolution of current inflation conditions.

Skanska needs to focus on optimizing performance for a period of about 12-24 months that

indicators suggest inflation will persist. Following this period, there is general consensus that

inflation might return back to normal levels below 6%.

Proposed Solution

Previous analysis and a qualitative test of the hypothesis reveal that inflation is not likely

to persist in the medium term or long-term horizons. However, sufficient evidence points that the
Inflation in Construction Industry 7

current surge in prices will continue in short term projections due to feedback mechanism created

as firms adjust their pricing and wage spending in response to increased prices. Thus, the main

problem for this consultation project is presented as follows:

• How can the company maintain profitability for the next 12-24 months amidst short term

inflation conditions?

The proposed two possible solutions are to this problem:

1. The company should accurately forecast short-term demand by computer aided

simulations to avoid construction projects that consume resources and remain unsold.

2. The company should initiate lean construction strategies and embrace innovation during

the period of inflation.

Solution 1: Demand Forecast

According to the financial report by Reuters, the losses incurred during the first two

quarters of the current accounting period resulted from unsold construction projects that followed

a sharp drop in construction demand (Ringstrom, 2022). This is evidence that the company has

inefficient demand forecasting models that are not responsive to abrupt economic and social

changes. There is need for Skanska to develop new models that respond rapidly to external

economic influences such as inflation, monetary conditions and changes in GDP. This project

proposes that the company should adopt the residential demand forecast model proposed by Kim

and Kim (2021) to ensure strategic planning in adverse inflation conditions.

Demand Forecast model

According to Kim et al. (2021), accurate demand forecasts are crucial in construction and

potentially increase responsiveness, competitiveness and efficient procurement system that

minimize wastage. Inadequate demand forecasts result in resource wastage and general lag of
Inflation in Construction Industry 8

non-demanded projects. To this end, the authors propose a System Dynamics Model (SDM) to

forecast demand and account for multi-layered and mutually complicated social and economic

dynamics (Kim et al., 2020). This system relies on electronic computer simulations to predict

future demand. Skanska should adopt this method since it accounts for a wide array of factors,

and subsequent simulations account for dynamic and cyclical relationships between numerous

variables that conventional systems often overlook. The next section offers a detailed outline of

these variables.

Parameters in the Demand Forecast Model

The advantage that this model possesses over conventional models is the ability to select

many variables that influence overall construction demand. Kim et al. (2021) presented the

parameters to be used in this model in the summary table below:

Parameter Description
1. Population Total Number of People
2. Working Population Total Number of Workers
3. Households Total Number of Households
4. Urbanization Rate Ration of urbanizations to total population
5. Money supply Broad money in the economy
6. GDP Gross Domestic Product
7. Interest Rate Interest on 365-day certificate of deposits
8. Household debt Total Liabilities accrued by households
9. Gross government debt Amount of debt owned by government
10. Consumer Price Index Measure of overall inflation
11. Home price index Variation in prices paid by Home-owners
12. Construction cost Index Measure of variation in prices for
construction material
13. Construction capital stock Market value of construction assets
14. Depreciation Rate Percent rate of reduction in value for assets
Table 1: Parameters for Simulation Program; Source Kim and Kim (2021).

As observed, the table highlights some parameters that most demand systems overlook,

yet played an important role in the observed drop in demand for construction projects. The

developers weighted all these variables based on the relative influence on construction demand
Inflation in Construction Industry 9

anchored on statistics for initial demand. These parameters in the POWERSIM software which

prompts forecasters to input the values on the system and click “RUN SIMULATION”. The

output includes the overall projected cost of construction demand in the economy per year. After

simulation, data analysts must use existing data to evaluate the total market share of Skanska

Company and obtain the projected construction demand specific to the company. This strategy is

important since it increases operation efficiency, maximizes productivity and forms a basis to

reduce unnecessary expenses accrued to construct a large number of projects at inflated prices.

Solution 2: Lean Construction Strategies

An accurate forecast of demand is only the first step to ensure profitability through

strategic use of resources. In order to further optimize operations, the company should adopt a

new framework for lean construction to eliminate wastage and increase profitability. By

definition, lean construction is a way to develop construction systems that minimize material,

time and effort wastage and creates maximum value (Kasiramkumar and Indhu, 2016). Building

upon the work of Sarhan et al. (2019), this section outlines the framework to implement a lean

construction strategy and provides a detailed procedure to achieve optimum construction

objectives.

The main advantage of lean construction is that the techniques significantly reduce

resource wastage (Sibiya, 2015). Resource efficiency is a critical objective for this project

following the current inflation rate that has steadily increased the cost of construction material,

equipment and labor. Wastage reduction directly correlates to cost reduction and an overall

increase in company profitability. To develop lean construction processes, the company should

initiate three steps derived from the study of Sarhan et al. (2019). The first step involves

identification of relevant factors that support lean construction. The next step is to establish
Inflation in Construction Industry 10

contextual relationships among the factors and identify critical factors. The last step pertains

successful identification of mutual influence and arrange the factors in hierarchy of importance.

Based on this analysis, the hierarchical requirements for this process are outlined below:

i. Leadership commitment to lean construction- Skanska’s top management should

motivate employees, contractors and suppliers to embrace a culture of lean

construction.

ii. Education and Training- The company should organize seminars and training

workshops to educate stakeholders and company employees on the fundamentals of

lean construction strategies, especially the six sigma principles to define, measure

analyze, improve and control all processes.

iii. Adopt alternative resource procurement strategies such as early contractor

involvement during project planning.

iv. Adopt new construction technology- This project proposes adoption of computer-

aided simulations and Building Information Modelling (BIM) to promote automation

and continuous collaboration throughout the project.

v. Initiate Last Planner System lean construction technique- This technique specifies

workload for each contractor and sub-contractor and the stages for individual work

input. According to this system, efficient workflow requires that one phase of the

project must be complete before the next phase begins in order to optimize resources

and labor hours. This strategy ensures efficient allocation of resources and labor since

each stakeholder is accountable to perform a specific role, with specific resource

allocation and within a given time period (Schimanski et al., 2020).

Inflation in Construction Industry 11

vi. Promote culture of teamwork throughout the project- The company should foster

collaboration throughout the project. For instance, the Last Planner System fosters

collaboration because all stages of the project are interrelated and interdependent.

vii. Establish long term relationships and collaborations in the supply chain instead of

transactional relationships.

viii. Ensure constant appraisal and process improvement.

This framework is designed to internalize the culture of lean construction throughout the

organization and avoid narrow focus on single projects. For instance, management involvement,

education and training increases competencies of lean construction approach across all

organization levels (Sarhan et al, 2019). Early contractor involvement facilitates innovative

planning by sourcing expert opinion at initial project phases. This way, alternative cost efficient

and innovative material will be considered before project initiation. Technological input is

another critical success factor in this framework. Efficient use of technology to forecast demand,

simulate the construction process, and foster interactive integration enhances process efficiency

(Rhodes et al., 2022). The overall goal of this framework is to promote optimum and efficient

use of resources.

Key Performance Indicators and Timelines

Performance indicators are effective measures of efficiency in processes and actions and

provides benchmarks to detect problems against pre-identified criteria (Sibiya et al., 2015). Well-

constructed KPI’s objectively appraise project performance based on both results and process

efficiency. This project will be assessed based on 9 KPI’s outlined below:

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KPI Description Timeline

Forecasts Successfully forecast of total demand 12 months
and determination of company market
share
Technology Usage Successfully install project simulation 1 month
software and Building Information
Modelling (BIM) systems
Training Successfully complete employee 5 months
training on Lean Construction
Accelerated Project Onset Delay period between approval of 6 months
project proposal and project
commencement is less than 2 months
Project Costs Project costs are 20% lower than initial 12 months
projects with similar specifications
Project Budgeting Disparity between project costs and 12 months
anticipated budget is less than 7% at
year end
Wastage reduction Total value of unused material at 12 months
project end accounts for less than 10%
of project budget
Operation Efficiency Less than 15% of completed projects 24 months
remain unsold
Profitability Company profitability increases by 24 months
30%
Conclusion

The post pandemic period has experienced notable shocks and accelerated rates of

inflation. Economic experts attribute such rapid advance in prices to a sudden surge in demand

following economy re-opening and fiscal stimulus amidst highly pandemic-disrupted supply

chains. For construction companies, inflation has resulted in increased operation costs due to

increases in costs of construction material and labor. This problem is further exacerbated by

global energy crisis that increases the cost of running heavy construction equipment. A

combination of these factors has resulted in reduced profitability for many construction

companies.
Inflation in Construction Industry 13

This consultation project is prepared for Skanska construction company to propose

solutions that ensure profitability amidst adverse inflation conditions. The literature review

section critically analyses the inflation condition in light of existing research and hypothesized

that inflation conditions are likely to persist. However, a test of this hypothesis using the

inflation expectation framework did not support the hypothesis and concluded that inflation is

likely to recede. However, the research suggests that inflation may persist in the short term.

Skanska construction company needs to initiate strategies that will ensure profitability during

this period.

This project proposes two solutions for Skanska construction company. First the

company needs to accurately forecast demand in order to avoid wastage accrued when

construction projects remain unsold. This project presents a computer aided demand forecast

model with 14 weighted parameters. The proposed model forecasts overall industry demand in

dollars and company specific demand can be extrapolated using the company’s overall market

share. Second, the company should initiate a lean construction strategy to increase cost

efficiency and reduce operation costs. This project outlines a detailed framework which entails

leadership commitment, education and training, identification of alternative sources, use of

technology, adoption of the Last Planner System technique in construction, and a culture of

collaboration throughout the construction project. The company also needs to create long term

relationships with suppliers and negotiate better pricing. To ensure success, the company needs

to evaluate this entire process constantly and identify areas of improvement.

Key performance indicators will assess the efficiency of the proposed intervention. These

measures include whether the annual demand was accurately forecast, level of construction

automation, successful employee training, accelerated project onset, reduction in project costs,
Inflation in Construction Industry 14

minimum disparity between budgeted and actual project costs, reduction in unused material and

an increase in company profitability. Since inflation is likely to persist in the short term, these

interventions are designed to produce short term results, within 24 months.

Inflation in Construction Industry 15

References:

Adeney, R., Arsov, A., and Evans, R. (2017). Inflation Expectation in Advanced Economies.

Reserve Bank of Australia Quarterly Bulletin.

https://www.rba.gov.au/publications/bulletin/2017/mar/pdf/bu-0317-4-inflation-

expectations-in-advanced-economies.pdf

Andre, P., Roth, C., Haaland, I., and Wohlfart, J. (2021). Inflation Narratives. ECONtribute

Discussion Paper, No. 127, University of Bonn and University of Cologne.

https://www.econstor.eu/bitstream/10419/249865/1/ECONtribute-127-2021.pdf

Bonnatti, L., Fracasso, A., Tamborini, R. (2022). What to Expect from Inflation Expectations:

Theory, Empirics and Policy Issues. Publication for the committee on Economic and

Monetary Affairs, Policy Department for Economic, Scientific and Quality of Life

Policies, European Parliament.

https://www.europarl.europa.eu/cmsdata/244615/2_TRENTO.pdf

Chien, Y., and Bennett, J. (2022, June 23). What do Financial Markets Say about Future

Inflation? Federal Bank of St. Louis. https://www.stlouisfed.org/on-the-

economy/2022/jun/what-financial-markets-say-about-future-inflation

Edelberg, W. (2021). What does Current Inflation tell Us about the Future? Brookings.

https://www.brookings.edu/blog/up-front/2021/11/16/what-does-current-inflation-tell-us-

about-the-future/

FRED. (2022). 5-Year, 5-Year Forward Inflation Expectation Rate.

https://fred.stlouisfed.org/series/T5YIFR

FRED (2022). 10-Year Breakeven Inflation Rate. https://fred.stlouisfed.org/series/T10YIE

Inflation in Construction Industry 16

Kasiramkumar, T., and Indhu, B. (2016). An implementation framework for integrated lean

construction system for Indian Scenario. ARPN Journal of Engineering and Applied

Sciences, 11(15), 9388-9394.

Kim, K., and Cho, J., and Kim, S. (2019). Model-Based Dynamic Forecasting for Residential

Construction Market Demand: A Systemic Approach. Applied Sciences, 11(3681), 1-17.

Lee, J., Powell, T., Wessel, D. (2022). Why are Inflation Expectations Important? Brookings.

https://www.brookings.edu/blog/up-front/2020/11/30/what-are-inflation-expectations-

why-do-they-matter/

Rodriguez, M., and Yoldas, E. (2016). Drivers of Inflation Compensation: Evidence from

Inflation Swaps in Advanced Economies. Working Paper for the Board of Governors of

the Federal Reserve System. https://www.federalreserve.gov/econresdata/notes/ifdp-

notes/2016/drivers-of-inflation-compensation-evidence-from-inflation-swaps-in-

advanced-economies-20161230.html

Rhodes, O., Rostami, A., Khodadadyan, A., and Dunne, S. (2022). Response Strategies of the

UK Construction Contractors to Covid-19 in the Construction of New Projects.

Buildings, 12(946), 1-18.

Ringstrom, A. (2022, May 4). Builder Skanska’s Q1 Profit falls Less than Expected. Reuters.

Sarhan, J., Xia, B., Fawzia, S., Karim, A., Olanipekun, A., Coffey, V. (2019). Framework for the

Implementation of Lean Construction Strategies using the Interpretive Structural

Modelling (ISM) Technique. Engineering Construction and Architectural Management.

DOI: 10.1108/ECAM-03-2018-0136

Schimanski, C. P., Marcher, C., Pasetti Monizza, G., and Matt, D. T. (2020). The Last Planner

System and Building Information Modeling in Construction Execution: From an

Inflation in Construction Industry 17

Integrative Review to a Conceptual Model for Integration. Applied Sciences, 10(3), 821-

830.

Sibiya, M., Aigbavboa, C., Thwala, W. (2015). Construction Projects’ Key Performance

Indicators: A case of the South African Construction Industry. Proceedings of the 2015

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