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Subcontractors Struggle in Fight for Survival

Thu May 20, 2010 - National Edition
Giles Lambertson

In a stumbling economy that has construction companies struggling to keep crews in the field and estimators busy in the office, the fortunes of subcontractors are especially subpar. The numbers tell the story.

Gary Zimmerman, senior economist of the Federal Reserve Bank of San Francisco, spoke to American Subcontractors Association (ASA) members in March at ASA’s San Diego convention. According to Zimmerman, the construction industry lost almost 24 percent of its jobs in the two years leading up to November 2009, far more than any other employment sector. Construction workers losing jobs were among 8.4 million Americans let go during the period

While the 24 percent figure is horrific enough, job losses among specialized construction trade subcontractors were even worse. Consider some other negative employment data from the period noted by Zimmerman:

• Drywall labor: minus 32 percent

• Masonry labor: minus 36 percent

• Steel erection labor: minus 37 percent

• Framing labor: minus 48 percent.

“Some of the numbers were really alarming,” admitted David Mendes, ASA’s senior communications director. “It was very disconcerting to us.”

The job figures reflect the labor-intensive makeup of the subcontracting industry. As incoming ASA president Timmy McLaughlin of Austin Construction in South Carolina noted, the recession “is a general turndown for everybody. But sometimes it affects subcontractors more because we might have more employees to deal with than a general contractor has to deal with.”

The pecking order among builders is perfectly clear: Project owners have a funded job; general contractors have a contract for the job; subcontractors have expert labor to do the job. Obviously, subs and their labor force are dependent on things going well up top so that contractual dollars can trickle down to them. It is easy to see why subs are the most vulnerable to interruptions in work and pay; during downturns, this vulnerability often becomes reality.

On the other hand, stalled economies don’t always pick on the little guy situated nearest the bottom of the order. Sometimes a sub proves more adept than his big corporate brother in steering his company into the wind before it’s swamped by financial turmoil. Seasoned subcontractors know when to expose themselves to more risk and when to furl it.

“The best subs began to adjust well before this downturn actually arrived,” Mendes said, speaking from his observations at ASA. “They saw signs of what was coming and made strategic decisions to change their companies so they would survive. “

Conversely, subs that didn’t act preemptively when storm clouds first appeared either are suffering mightily today or are history.

Yet even the most prescient subcontractor has to operate in the world and the world of construction is a dicey place for a sub. Besides being dependent on the principal contract-partners at the top, subs must contend with forces that almost always are larger than they are. Banks, for instance.

Most money that powers building activity comes from lending institutions, of course. It flows principally to project owners who then disburse it to architects and to general contractors, who in turn pass along a portion of it to materials manufacturers or suppliers and to subcontracting companies. When the money supply dried up last year, some pending projects never started and some projects that started, stopped, with pain felt all up and down the line.

“The biggest effect of tight money is lack of funding for new projects,” said McLaughlin. “That hurts us in the long run, of course. We have to have an owner with viable funding. When it’s not there, contractors and subcontractors are hurt.”

McLaughlin can cite his own experience. Business volume for his Summerville, S.C., firm has dropped by about 40 percent since the recession took hold, with his workforce reduced about the same percentage.

When a downturn persists and lenders retreat from lending, the impact on subcontractors can be doubly hurtful. First, they lose work and income and then, when work returns, are saddled with credit ratings lower than banks will consider for a capital needs loan. It is, observed Mendes, a double-whammy.

But McLaughlin doesn’t fault the banking industry for subs’ woes. “I think the community banks are doing a good job,” he said, speaking of the smaller financial institutions of biggest help to small construction firms. “They are doing what they can to keep the economy going.”

Chronic Subcontractor Complaints

Some issues are chronic irritants and ASA officials are hoping for some legislative resolution. One is the matter of timely payment for work done. General contractors generally pay subs according to a schedule favorable to them. When that schedule doesn’t neatly fit a sub’s scheduled obligations for payroll or paying suppliers, cash flow slows to a trickle.

A related complaint concerns retainage, the contractual final payment held back by a general contractor until a project is totally complete, liens are lifted and terms of a contract are satisfied. It is not uncommon for a sub’s final payment to be hung up for months after a project has ended.

These problems are nationwide, and ASA officials generally pan states for what the organization believes are unenlightened laws regulating such funding issues. The association’s 2009 report indicates some progress is being recorded among the states.

More recently, legislators in Oklahoma in early May passed and the governor signed into law a requirement that limits retainage on public projects to 5 percent. While that is not the lowest funds retention rate in the country, it does halve Oklahoma’s former rate.

In a separate law, Oklahoma lawmakers stipulated how long project owners can wait before paying prime contractors, and prime contractors, in turn, can delay paying subcontractors. Furthermore, if subs pull off a job for nonpayment and give written notice beforehand, they are entitled to additional payments to offset the cost of stopping and starting work when they subsequently return to finish a project.

These all are critical issues for subs. Because subcontractors’ credit lines and capital are limited, they are not just frustrated by chronically slow payments, they are genuinely threatened by them.

“Subcontractors always are working and counting on that future payment,” Mendes observed. “They are paying for the labor, equipment and material as a project moves along and expecting the upper tier people to pay them when the work is complete. When that payment is slow in coming, it really hurts.”

This deep recession may win new congressional support for a federal measure that subcontractors have lobbied Washington to pass for a decade. Essentially, the bill would stop “bid shopping” on federal projects of $1 million or more.

A Pennsylvania Democratic House member, Paul Kanjorski, first introduced the legislation in 2000. The bill’s intent is to stop general contractors from shopping for lower subcontract bids after an overall contract has been awarded and the bidding process theoretically is over. While considered unethical, there are no legal barriers to prime contractors continuing to work the process. (A corollary practice is “bid peddling,” which is when an offer to undercut an accepted bid is initiated by a subcontractor. The ASA opposes both practices.)

Bid shopping puts pressure on subs to lower their submitted and accepted bids. If they are unwilling to do so, a prime contractor who wants a new bid will approach other subs until someone agrees to a sought-after contractual amount. The savings produced by the lowered bid increases the general contractor’s profit margin.

Besides making something of a joke out of the public bidding process, the shopping and peddling also tends to lower the quality of a final product. That’s because the shopped or peddled bid often is lowest for a reason; that is, materials are of lesser quality and corners are cut where least noticed by a project owner. The Kanjorski bill would require all subcontract bids to be listed by a prime contractor in its general bid and would limit substitution of subs after a contract is awarded.

Ridding the bidding process of post-bid activity is generally supported in the industry, but that doesn’t mean everyone is behind the Kanjorski bill. Associated General Contractors, for example, comes out four-square against bid shopping, declaring on its Web site that the organization is “resolutely opposed to the practice of bid shopping … AGC believes that bid shopping and bid peddling cannot sustain long-term working relationships between prime and subcontractors.”

Yet AGC opposes the House bill in the belief that listing of bids unnecessarily slows down the procurement process. The better solution, the organization insists, is to continue to rely on “a strong commitment to ethical conduct by the professionals that work within the construction industry.”

Besides, the Association stated, there is “no evidence to support assertions that the practice is widespread. Legislation designed to constrain bid shopping on the federal level is unnecessary … The construction industry does not consider bid shopping a common practice in federal government contracting.”

The AGC perception that federal bid shopping is rare does not seem to be widely shared by subcontractors. The National Electrical Contractors Association, for example, calls the practice a “pervasive problem” that reformers for 80 years have tried to persuade Congress to bar, so far unsuccessfully.

Mendes is encouraged by votes on the Kajorski bill this year. “It actually came up as a possible amendment to a defense bill last week (late April), though it didn’t make it to a floor vote. But it has gotten a lot more attention recently than in the past few years.”

Immediate Goal: Survive

Regardless of how that congressional debate plays out on Capitol Hill, the immediate objective for many subcontractors is to survive the recession — and to do so with enough capital and momentum to carry them forward into a period of growth. McLaughlin said having members stay solvent and viable certainly is ASA’s objective.

“Our focus this year is to help our members be in a position to be around to do the work when it finally comes,” he said. “We are going to provide them with information to make good decisions. We’re going to encourage them to be responsible and not become desperate to take unreasonable contracts just to get work.”

Mendes said the pressure on subcontractors to win a contract — any contract — can be overwhelming when relatively few are being let for bidding. The flip side is that subs sometimes quit bidding altogether, which ends up hurting them as well as project owners.

“One of the special risks we’re hearing about is subcontractors simply not bidding on projects when the bidding gets too intense and contractors dip below costs in seeking subs,” the ASA communications director said. “Subs simply look at the cost of the work, calculate that it is not going to be profitable even in the short term and make a financial decision not to bid. That hurts everyone — the project owner, the general contractor and, of course, the subcontractor. That’s when you get sub-quality subcontractors and sub-quality work.

“I hear people say it is a great discount they are getting on construction these days,” Mendes added. “Well, that discount comes at a price.”

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