Features | Economy | East Asia

Engineering Survey

Few industries appear as well placed as the engineering services industry. According to consultants Booz Allen Hamilton, the world’s urban infrastructure will need an extra $US40 trillion of investment…

Few industries appear as well placed as the engineering services industry. According to consultants Booz Allen Hamilton, the world’s urban infrastructure will need an extra $US40 trillion of investment over the next quarter of a century, just to modernise water, electricity and transportation systems. This equates with more than a quarter of the world’s current capital stock. Throw in the need to improve the supply chains that underpin globalisation, and the demand growth starts to look spectacular.

According to the management consultancy McKinsey & Company, the investment required just in public transport worldwide is $US9 trillion. Already, $US3 trillion is planned by governments, as they seek to develop systems that can cope with the growing pace of urbanisation.

Although the sums are huge, the capital should not be too hard to find. Pension funds and, increasingly, sovereign wealth funds are attracted to the stable and long-term nature of infrastructure investment, which typically generate 10-13 per cent for toll roads, 8-10 per cent for rail and passenger lines, and 10-14 per cent for waste water plants.

The availability of skills, however, may be more of a problem. Whereas capital is mostly homogenous and can be readily moved across borders, the engineering services industry is fragmented and increasingly subject to skill shortages. According to the consultancy IBISWorld, the world’s four largest companies accounted for less than a tenth of global revenues in 2007. Engineering service companies tend to be either national or regional, and deliver a narrow range of services, despite a trend towards greater consolidation over the last decade. Only about a fifth of global revenues are generated by firms which have operations outside their country of origin.

The nature of the engineering business sits in stark contrast with the infrastructure projects themselves. Infrastructure development is highly capital intensive, and heavily reliant on financial management and raw materials pricing for success. The engineering business, by contrast, is highly knowledge intensive. According to IBISWorld, labour costs, mainly employee compensation and contractor payments, absorbed 60 per cent of the sector’s global revenues in 2007. In the pricing and management of infrastructure projects, labour costs are typically of less importance than the management of materials and finance. But for an engineering firm it is the major consideration.

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In terms of product segmentation, half are in design services in building and infrastructure projects, with 15 per cent in industrial processes and equipment and 15 per cent in environmental projects, according to IBISWorld. About two fifths of the revenues in engineering are generated in heavy infrastructure construction. Revenue growth has been steady, rising from -1.4 per cent in 2002 to 5.9 per cent in 2006. Employment is also growing at over five per cent.

Pre-design services, however, only account for 7.5 per cent of global product segmentation. This raises a question. It is in the pre-design phase that the possibility of more innovative solutions can be explored. Engineering may be knowledge intensive, but how innovative is the knowledge? There is little evidence that whole-system solutions such as that developed in the Brazilian city Curitiba, where an integrated approach to infrastructure development has resulted in sharp improvements to urban efficiency, are being pursued. Engineering services tend to be applied narrowly, rather than across different “silos” (areas of expertise). The industry has a “narrow range of specialised services”, according to IBISWorld.

The bulk of engineering services revenue comes from the developed world, but that is likely to be rebalanced. Two fifths of global revenue is derived from North America, 30 per cent from Europe and 19 per cent from North Asia. Australia is proportionately a lucrative market, generating about three per cent of global revenue, despite being only 1.5 per cent of the world economy.

While estimates on future infrastructure spending vary, the infrastructure backlog is generally thought to be about $150 billion in Australia, compared with about $US80 billion in the United Kingdom and more than $1 trillion in the United States. According to the 2001 Infrastructure Report Card prepared by Engineers Australia, the estimated $150 billion of additional investment will be needed to repair, upgrade and complete Australia’s road, rail, water and energy infrastructure. This equates with one per cent of GDP for at least the next decade (and this estimate was made before the mining resurgence in Australia).

Many other countries are also facing major infrastructure investment. Last year, India’s infrastructure outlay over the next five years was revised upwards from $US150 billion to $US475 billion. The Asian Development Bank estimates that India will have to invest $US1.6 trillion over the next ten years, which would equate with more than ten per cent of its GDP.

China is already spending $US150 billion a year, equivalent to more than four per cent of its GDP. Beijing is planning to build 97 regional airports at a cost of $US62.5 billion, for example. Russia, a smaller economy than Australia, is planning to spend $US1 trillion on infrastructure over the next 10 years.

The investment is increasingly coming from the private sector, according to Peter Busbridge, chief executive of Snowy Mountains Engineering Corporation. He says there are more private development funds available than in funding agencies and governments. “I think the processes of the Asian Development Bank are very bureaucratic. They are quite set in their programs and their agendas, and therefore their projects take long periods of time to gestate and be built. With private sector projects, once the economic hurdles have been achieved and the financial matrix of the projects are signed up, then it’s action.

“I suspect that there are a lot more savings within the world – super funds and the like – that are converting into infrastructure projects which are going to create wealth. And of course there’s a hell of a shortage of engineers to service that, so it’s a very challenging time for us all.”

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It is not just skills shortages that pose a problem. John Cooney, the Asian Development Bank’s director of infrastructure for South East Asia, says the prices of many raw materials are rising quickly. “Anything that involves basic industrial metals, and anything that involves petroleum, which is just about everything in construction, is rising. And labour costs are going up very quickly.”

Cooney says the effectiveness of private public partnerships (PPPs) varies. “There’s a huge potential and a lot of demand, but it varies from country to country as to how successful it can be. Singapore does virtually all of its public infrastructure as PPPs in some form or another. In Malaysia, it is largely done that way. The Philippines has done some, but in the Philippines, as well as Indonesia, the legal and regulatory systems are quite difficult and this tends to deter PPPs.

“Vietnam is moving in this direction [in power stations]. There are also some expressways being done through PPPs: metro systems for Ho Chi Minh city and possibly Hanoi.”

Cooney says there is a realisation that “the public purse just can’t finance” all the infrastructure development. He says much depends on whether the countries’ legal systems are sound, or the risks are measurable. “When I’ve asked people putting together PPPs ‘Why this country and not that country?’ they say ‘Because in this country we know how the law works, we know that the contractors are contractors. In that country we are not quite so sure.'”

Continuity beyond the current government is also important because of the long-term character of the contracts. “In a country like Vietnam, for example, there is continuity beyond governments because the government continues,” says Cooney. “In other countries where governments change, it isn’t quite so easy.”

Two obvious threats loom in the infrastructure sector that may deeply affect the engineering environment. One is the alignment of the global supply chains. According to a Boston Consulting report, imbalances in global infrastructure are emerging that may ultimately lead to gridlock. For instance, China is building 100 new container-loading berths that have twice the capacity of North American and European berths. Over the same period, only five new berths are planned for the West coast of North America. The report estimates that imports from China to America are growing at 18 per cent per year in value and at 12 per cent per year in the number of containers. BCG forecasts that the demand for port services will exceed capacity by 2010.

The second imminent threat is the potential sharp rise in the cost of capital, especially as it appears that there is a global credit squeeze. Because infrastructure projects are so capital intensive, even small changes in the pricing of capital can have damaging effects.

Yet there seems little prospect that the infrastructure boom in Australia will slow, or that the demand for engineers will ease. “Australia is heading into a super cycle, regardless of what the stock market’s doing,” says Dr Alan Broadfoot, chief executive of electrical products company Ampcontrol. “That super cycle is going to come from the real export boom of minerals. At the moment all we’ve done is increase the price of the minerals, we have not actually exported any more. The spot price of coal hit $200 a tonne yesterday, which is double what contracts were set at last year.

“The spend on infrastructure is going to have to be enormous. It’s not going to happen overnight. It’s going to be long-term and it could be a 15 year cycle so those decisions need to be made. The biggest growth industry in the world is going to be energy. It’s not about carbon emissions, it’s just about meeting the needs of the [world] economy to grow.

“I don’t believe the need for infrastructure is unique in Australia. I always say to be a good global player you need good local support, and the only way you can get that is to have a market that can support you. Australia’s disadvantage is that we don’t have a large local economy, but we are now getting the potential to provide base load work that can maintain our cash flow and help deliver the skills that we need for export.”