The introduction

In 2017, the McKinsey Global Institute (MGI) highlighted the need for an upgrade in the construction industry, which, if successful, could eventually increase productivity by 50% to 60%, equivalent to an incremental value of $1.6 trillion per year globally.The call to action has sounded: The executives we spoke with are thinking about how to respond to the changes ahead.Increasingly, they recognize that there is no question of if or when construction will be affected.Change is already under way.At the time of the release of this report, the COVID-19 is progressing and accelerating its impact, propelling the construction industry into the "next new business model".

Executives are grappling with the economic turmoil, demand delays, and construction restrictions and safe operating procedures caused by the outbreak.But it is equally important for executives to keep an eye on changing models and industry shifts.This study examines how the entire ecosystem of buildings will change, how much existing firms are at risk, and how quickly they can act to adapt and build new industrial structures.We study the entire value chain through a top-down review of industry dynamics, a bottom-up analysis of company data, and executive interviews.In writing the report, we focused on addressing the most pressing long-term strategic issues for construction executives: where and how they would be affected in the value chain, and by how much, and what measures they should consider to prepare their companies for the future.

We hope these insights will help confirm the changes that are coming and provide a guiding light for construction executives around the world as they navigate their corporate transformation.

Content abstract

Construction and related industries create real estate, infrastructure and industrial structures.These form the basis of the real economy and are vital to our daily lives.From undersea tunnels to skyscrapers, the construction industry has successfully delivered challenging projects, but in many ways it has been underperforming for a long time.COVID-19 could be yet another crisis, wreaking havoc on highly cyclical industries.External market factors, coupled with the fragmented, complex nature of the industry and an aversion to risk, make change in the construction industry difficult and slow.The COVID-19 will greatly accelerate the disruption already under way.It's more important than ever for leaders to find guidelines for new formats and make bold strategic decisions to be winners in these times.

Many studies have looked at individual trends such as modular architecture and sustainability.This report assesses how a number of disruptive trends will combine to reshape the industry.Our research, based on more than 100 conversations with experts and executives, draws on our first-hand experience serving clients across the construction industry, as well as our review of the transformation of other industries and our judgment of what lies ahead.We identified trends and scenarios through a survey of 400 global industry leaders.Finally, we quantitatively model value and profits across the value chain based on current company data, and perform a future scenario analysis.We have a lot of evidence that disruption is going to hit the entire industry and is already starting to happen in a big way.

Our findings include:

Construction, the world's largest industry, has underperformed even outside the crisis.The construction industry accounts for 13% of global GDP, but productivity growth in the sector has slowed to a mere 1% a year over the past two decades.Despite significant operational risks in the construction industry, where schedule and cost overruns are the norm, profit before interest and tax (EBIT) is only around 5%.

Nine changes will fundamentally change the way construction projects are delivered, and other similar industries have already undergone many transformations.Sustainability requirements, cost pressures, lack of skilled workers, new materials, industrial production, digitization, and the combination of new entrants will change the value chain.Future changes include productization and specialization, increased control over the value chain, and more customer focus and branding.Consolidation and internationalisation will create economies of scale to accommodate higher levels of investment in digitisation, R&D and equipment investment, sustainability and human capital.

COVID-19 will accelerate the massive changes that have already begun.Our research shows that five to ten years from now, the construction industry will look very different.More than 75 percent of executive survey respondents believe these nine changes are likely to occur, while more than 60 percent believe these changes will occur on a large scale within the next five years.We are already seeing concrete signs of change: from 2015 to 2018, for example, the share of the permanent modular building market for new real estate construction projects in North America increased by 50%, and R&D spending among the top 2,500 global construction companies increased by approximately 77% since 2013.Two-thirds of respondents to the survey believe that COVID-19 will accelerate change, while half have already invested in it.

$265 billion/year profit pool waiting for the disruptor.The value chain of the global construction industry (about $11 trillion in added value and $1.5 trillion in profits) will change dramatically.Based on analysis by asset class and expert interviews, even when the economic impact of COVID-19 wanes, the disrupted market segments may have 40-45% of their existing added value at risk, which could be transferred, for example to off-site manufacturing, consumer surplus, or new sources of profit.If builders capture these transfer values, profitability could double from 5% to 10%.The scale and pace of change and the appropriate response in areas such as real estate, infrastructure and industrial structure have varied.Players who move quickly and manage to outperform their competitors at all can grab the lion's share of the $265 billion in new and transferred profits (15-20% of existing profits are redistributed within the system) and are valued more like a Silicon Valley start-up than a traditional construction company.

In order to survive and thrive, practitioners must respond.All participants in the building value chain need to develop strategies for coping with or leading disruption.This is especially true for engineering design, material distribution and logistics, general contracting and specialist subcontracting, all of which may face commoditization and a declining share of value in some sectors.Companies can try to defend their position and adapt to changing circumstances, or reinvent themselves to take advantage of these changes.

Investors need to be discerning about the changes in their investment fields, and there will be plenty of opportunities.Policymakers should help the construction sector increase productivity and provide better housing and infrastructure.If owners push for this change, they will get better buildings at lower cost.

 The core profile

Construction, which includes real estate, infrastructure and industrial structures, is the largest sector in the global economy, accounting for 13% of the world's GDP.Looking closely at its underlying profitability, it is clear that the construction industry has come under pressure in good times and even more so in crisis.We think there are nine changes that will fundamentally change the way we build.Companies that can adapt their business models will benefit, while others may struggle to survive.

Historically, the construction industry has not performed well.

From cityscapes and large-scale infrastructure to continuous innovation, the achievements of the construction industry are impressive.However, it has also been plagued by poor performance over the past few decades.

Annual productivity growth in construction over the past 20 years has been only a third of the economy's average.Risk aversion, fragmentation and the difficulty of attracting digital expertise slow down innovation.Construction is less digital than almost any other industry.Despite the high risk and many insolvency scenarios, profitability remains low, with margins before interest and tax (EBIT) of about 5 per cent.Widespread deadlines and budget overruns and lengthy claims procedures reduce customer satisfaction.

The economic impact of COVID-19 will be keenly felt throughout the construction industry.The wider construction-related industries will also be strongly affected, including suppliers of components and basic materials to construction companies, developers, owners, distributors, and machinery and software providers.At the time of this writing, a high degree of economic uncertainty prevails around the world, and construction tends to fluctuate much more than the economy as a whole.A study by the McKinsey Global Institute (MGI) suggests that if all goes well, construction activity could return to pre-crisis levels in early 2021, but a long-term constraint on economic activity could mean a delay until 2024 or later.While previous crises have accelerated trends, this one will also lead to lasting changes in the way existing environments are used, such as using online channels or working remotely.

The backward performance of the construction industry is the direct result of the basic rules and characteristics of the construction market and the competitive dynamics of the industry.Cyclical requirements lead to lower capital investment, and customization requirements limit standardization;Construction projects are complex and getting more complex, with logistics to handle heavy loads and different parts;A high proportion of manual Labour and, in some markets, a serious shortage of skilled Labour;Niches with low project complexity have low barriers to entry and a high proportion of the informal workforce, which allows smaller, inefficient firms to compete;The construction industry is heavily regulated, with everything from construction permits to safety certification and site management tightly regulated, and the lowest price rule in tenders complicates competition based on quality, reliability or alternative designs.

Under these market characteristics, today's construction industry has to overcome a number of forces that impede productivity and change: limited repeatability and standardization of unique custom projects;Fragmentation (both horizontal and vertical), mostly small companies with limited economies of scale (due to local market structure and low barriers to entry);The various project steps and decentralized responsibilities make the coordination more complex, and the contract mode and incentive mechanism are misplaced.Risk is often transferred within the value chain rather than eliminated, with participants profiting from claims rather than directly benefiting from quality delivery;High levels of unpredictability and cyclicity lead construction firms to rely on temporary staff and subcontractors, which affects efficiency, limits economies of scale and reduces output quality and customer satisfaction.

Changing market conditions, technological advances and disruptive new entrants will trigger major changes in the industry.

Before COVID-19, the speed of disruption in the construction industry was already unprecedented.Fundamental market characteristics are likely to change in the coming years, such as a shortage of skilled workers, continued cost pressures from infrastructure and affordable housing, stricter requirements for site sustainability and safety, and increasingly complex customer and owner needs.Looming disruptions include industrialization and the digitization of new materials, products, and processes and new entrants that will shape the industry dynamics of the future.

Source of Disruption: Increasingly complex customer and lifetime cycle cost (TCO) pressures.Clients and owners are becoming more sophisticated and more specialized funds are pouring into the construction industry.For example, from 2014 to 2019, private equity firms raised more than $388 billion for infrastructure projects, of which $100 billion was raised in 2019 alone, a 24 percent increase from 2018.Customer demands in terms of performance, full life cycle cost and sustainability are also evolving: building energy and operational efficiency, as well as flexibility and adaptability of the building structure, will be a priority.Customers seeking simple digital interaction and the ability to adapt new and stronger building structures are also raising their expectations.

The construction sector faces continued cost pressures due to tight public budgets and housing affordability issues.Global infrastructure investment of $69.4tn will be needed by 2035 to support expected GDP growth, and a third of the world's urban households cannot afford market-rate homes, McKinsey analysis has found.The economic impact of the COVID-19 exacerbates the problem - of cost and affordability.

Persistent shortages of skilled labor and changing logistics methods.A shortage of skilled workers has become a major problem in several markets, with retirements draining talent.For example, about 41 percent of current U.S. construction workers are expected to retire by 2031.At the time of writing, the impact of COVID-19 on this process is uncertain.

Standardization of safety and sustainability regulations and building codes.Sustainability and site safety are increasingly required.New health and safety processes are needed in the wake of COVID-19;The global debate on climate change has intensified the pressure on the industry to emit carbon.

At the same time, in some markets, the government recognizes the need to standardize building codes or provide type certificates and certification for factory built products, rather than review each site on a site basis, but the process is still slow.

Industrialization.Modularization, off-site manufacturing and automation of on-site assembly will enable an industrial and product-based off-site approach.As COVID-19 progresses further, the transition to a more controlled environment will be even more valuable.The next step in the transition to efficient off-site manufacturing involves integrating automated production systems, essentially making buildings more like automobile manufacturing.

The new material.Innovation in traditional base materials such as cement can reduce carbon emissions.Emerging lightweight materials, such as light steel frames and cross-laminated wood, could lead to simpler factory module production.They will also change logistics models to move materials over longer distances and achieve greater centralisation.

Digitization of products and processes.Digital technologies allow for better collaboration, better control of the value chain and a shift to more data-driven decisions.These innovations will change the way companies approach operations, design and construction, and interact with partners.Smart buildings and infrastructure integrated with the Internet of Things (IoT) will improve data availability and enable more efficient operations and new business models, such as performance-based contracting and collaborative contracting.Companies can use Building Information Modelling (BIM) to create full 3D models and add other layers of data such as schedule and cost to improve efficiency by integrating the design phase with the rest of the value chain early in the project, rather than completing the design while construction is under way.This will fundamentally change the order of risk and decision in construction projects, and make the traditional EPC model overturned.Automated parameter design and library will change the engineering design process.The use of digital tools can significantly improve on-site collaboration, and digital channels are expanding into the build process, with the potential to change the way goods are bought and sold across the value chain.Like other industries, COVID-19 is accelerating the integration of digital tools.

New entrants.Start-ups, increased investment by established players, and new money from venture capital and private equity are upending the current business model at an accelerating pace.We also expect corporate restructuring and merger and acquisition activity to increase as the economic crisis caused by COVID-19 unfolds.

 Nine changes are expected to fundamentally change the construction industry

According to our survey, more than 75 percent of respondents believe these changes are likely to occur, and more than 60 percent believe they are likely to occur within the next five years.The economic impact of COVID-19 seems set to accelerate their  development.

Product based path.In the future, more and more structures and additional services will be as "product" of standardization to delivery and sales, including the development of personnel to promote brand products, has standardized but can be customized design (can be from a product generation upgrade to another) architecture, and the use of modular elements of different production and standardized components delivery.The modules and components will be shipped to the site and assembled.In a safe, non-hostile environment, production will be similar to the process of an assembly line, with a high degree of repeatability.

Specialization.In order to improve profit margins and the level of differentiation, the company will begin to focus on market segments (such as luxury single-family residences, multi-storey residences, hospitals or processing plants) in order to establish a competitive advantage in these sectors and markets.The company will specialize in the use of different materials, components or construction methods.The shift to specialization will also require companies to develop capabilities and knowledge accumulation to maintain their competitive edge.Clearly, participants will need to carefully balance effectiveness, efficiency and brand positioning -- greater scope of specialization to address potential risks and cyclical advantages from a more diverse mix.

Value chain control and integration with the core supply chain.Companies will shift to control important activities along the value chain, such as engineering design, selective component manufacturing, supply chain management, and on-site assembly.Companies will be able to achieve this through vertical integration or strategic alliances and partnerships through the use of collaborative contracts and more consistent incentives.Digital technologies will change interaction models: BIM models will make more decisions at the early stages of the process, distribution will move to online platforms and advanced logistics management, and end-to-end software platforms will enable companies to better control and integrate value and supply chains.Value chain control or integration will reduce interface friction and make innovation more flexible.

A merger.The growing need for specialization and investment in innovation (including the use of new materials, digitalization, technology and facilities, and human resources) requires much larger enterprise scale than is currently available.As product-based approaches become more standardized and repeatable, further increasing the importance of scaling up, the construction industry is likely to increasingly see mergers and acquisitions in specific segments of the value chain as well as throughout the chain.

Customer focus and branding.Through productization, the transformation of development, engineering, or construction services into an easy-to-market product or solution, brands with unique attributes and values become even more important.As in traditional consumer industries, a strong brand can tie customers more closely to the products of construction firms or suppliers, and help build and maintain relationships and attract new customers.Similar to brands used in other manufacturing industries, such building brands will include product and service quality, value, lead time, reliability, service offerings and warranties.

Technology and equipment investment.Transition means setting up off-site factories, which requires investment in factories, manufacturing machinery and equipment (such as robotics for automated manufacturing) and technology.Construction sites are also likely to become more capital intensive using advanced automation equipment and drones, among other technologies, without the use of modularity.R&D investments will become increasingly important for companies that are more specialized or productized, so companies are likely to increase spending and technology investments to develop innovative products.

Human resources investment.Innovation, digitalization, value chain control, technology use, and specialization in end application segments all increase the importance of research and development and internal specialization, which will drive companies to invest more in human resources.Risk management and other current functions will become less important, while other functions (such as supply chain management) will become more important.To build the necessary capabilities, companies will need to invest further in their workforce.Most of the participants are working hard to attract the digital talent they need and are excited about future business model shifts.

Internationalization.Higher standardisation will reduce barriers to cross-regional operations.As scale becomes increasingly important for achieving competitive advantage, participants will increase their global footprint, ranging from high-value, small-volume projects such as infrastructure to globally demanding, replicable products.But COVID-19 could slow that development.

Sustainable development.Although sustainability is already an important factor in decision-making, we are only now in the midst of rapid and rapid development.In addition to the discussion of reducing carbon emissions, natural climate risks are already growing and need to be addressed.Companies need to consider the environmental impact when purchasing materials so that manufacturing will become more sustainable (for example, using electric motors) and supply chains will be optimized in terms of sustainability and resilience.In addition, the working environment will need to be changed from hostile to non-hostile in order to make the construction safer, with water consumption, dust, noise and garbage also key factors.

Today, the project-based build process seems to be shifting to a fundamentally product-based approach (Figure B).Instead of building uniquely designed structures onsite, the company will manufacture them in off-site facilities.Standardized subelements and artifacts are likely to be designed internally as R&D.These elements will be manufactured separately and then combined with custom options to meet custom requirements.In order to produce and learn effectively through repetition, developers, manufacturers, and contractors will need to focus on segmenting end users.Data-driven business models will emerge.In general, the process may be similar to manufacturing in other industries, such as shipbuilding or car manufacturing.

It is reasonable to believe that a winner-dominated landscape will emerge, and that companies that cannot adjust quickly are likely to see their market share and margins eroding until they eventually fail.

Construction is not the first industry to experience lagging productivity and disruption throughout the value chain.Lessons can be learned from other industries that have similar characteristics and have faced the challenges that the construction industry now faces.We looked at changes in four of them: shipbuilding, commercial aircraft manufacturing, agriculture, and auto manufacturing.All of these changes are visible, and value is transferred to those who can best cope with them.Innovation in production technology and new working methods initiated a new process.Today, winners across industries continue to invest heavily in technology, many of which are focused on digital and data-driven products and services.

In the past, for example, commercial aircraft manufacturing was highly fragmented.Each aircraft is built from the ground up according to a custom and project-based manufacturing setup.Industrialization triggered a shift to assembly manufacturing, which later became highly automated.As a result of the subsequent standardisation, the commercial aircraft manufacturing industry entered a phase of consolidation that led to the rise of two major players: Airbus and Boeing.The transformation has resulted in a significant shift in the value of the industry chain to customers.The transition took about 30 years, as commercial aircraft manufacturing faced similar headwinds to the construction industry today.