Some general contractors across the United States are facing a strategic dilemma: Slim down in the face of a potentially deep recession, or beef up and bid on big public works projects. The very survival of their companies could depend on the decisions they make.
Four industry consultants with expertise in construction management and strategic planning agree that the start of 2009 sees the construction industry at another crossroads. For companies entering the intersection, they offer forceful advice. It might be summarized as “Look both ways,” because the experts agree that lessons of the past decade are relevant to the next one.
In the end, a good many small contractors are not expected to prevail against the new array of economic forces. In the view of Roger W. Liska, this culling of the industry is a good thing.
“The majority of the construction industry is comprised of very small companies,” observed Liska, chairman of the Department of Construction Science and Management at Clemson University in South Carolina and a past president of the American Institute of Contractors. Indeed, no single company has as much as one percent of the construction market in the United States.
“These small companies are doing a lot of work when taken all together but individually they are not doing much. Among them are some companies that cause a lot of problems in the industry, such as litigation. I think you are going to see a lot of those go away.
“That will be a good thing to come out of this economy,” Liska said. “Like a heavy wind blowing into trees, it will be a neat way to prune the industry.”
For contractors likely to survive the downturn, Liska has three suggestions on how to steel themselves for the rough beginning of a new year. His first and “most important” recommendation for decision-makers is to train their workforce.
“We don’t train enough of our craft workers in this country. It is a huge problem,” Liska said, citing the construction industry’s standard one to two percent budgetary investment in training programs. He compared that with five percent investment common in other industries.
“Contractors need to retain their employees first of all and to train them so that they are ready for what could be a heavy influx of work. And I mean training at all levels, from craft workers all the way up to management.”
The professor who worked in construction for 10 years before moving into the academic realm believes some other developed economies, notably in the United Kingdom and in several countries in Western Europe, do a better job of certifying the skills of construction personnel.
“Over there,” Liska said, “they devote more time to professional development. Their measure of success is certification and being competent. People and companies that reach certain competencies are the only ones used. Over here the measure of success as a company seems to be profits. While profits are important there as well, there is just as high an importance put on competencies.”
Liska said the second recommendation he has for companies bracing themselves is to revise their strategic plans. This is especially important for builders whose primary work to this point has been in commercial properties.
“The stimulus carrot that is dangling out there mainly focuses on infrastructure kinds of construction,” he said. “So while that is going to have a major impact on heavy highway contractors, it doesn’t appear that contractors who do institutional kinds of work will benefit much.”
Larger contractors with institutional portfolios “still have a large backlog of work, but eventually that is going to go away and if there is not money out there for commercial work, the companies will have to adapt.”
As he looks into the new year, Liska calls new commercial development “the last horizon. The commercial money will not come until companies are building again because they are making money.”
While medium-sized companies probably don’t have enough contracts to carry them deep into the new year, Liska believes many of the organizations “have in place effective management techniques and will be ready to move when the stimulus money is released. They have a process in place that will keep them going. They will come out the other end of this thing even better than when they entered it.”
These contractors, he said, “are more flexible and can change their strategic plans to fit other markets. After all, managing processes is managing processes. It is just the trades that differ.”
Liska’s third recommendation for contractors looking for long-term growth is to recognize that management of the construction work force must change.
“There are more women in the industry, and more immigrants, and they bring different languages, values and perceptions to the workplace,” he said. “Retired people are coming out of retirement to go to work and they bring an entirely different set of values than someone in high school or college. It is not just an older person managing a younger person any more.
“The question is, are companies going to know how to manage that? It is different. The one-size-fits-all style of management doesn’t work any more.”
Liska isn’t as concerned as some observers about the new workforce being productive, especially at this moment.
“With people out of work, there is an intrinsic motivation to find a job. When people want to keep a job, they tend to be a little more productive.”
The Collaborative Approach
The onus to shape up doesn’t rest entirely on contractors. That’s the opinion of Ted Garrison, an author and radio show program host for a Florida think tank called New Construction Strategies. Garrison left the industry eight years ago to form Garrison Associates, which focuses on encouraging contractors and builders to work together to build greater value into projects.
“What we have said is even more urgent now: The whole emphasis has to be on delivering value,” Garrison said. “The whole mentality of, ’I’ve got to do it cheaper…’ well, you really are lowering the value instead of lowering the price.”
His answer to contractors who are wondering where to turn is design-build. Garrison believes the integrated approach to projects is a win-win-win for contractors, for owners and, in this instance, for a nation that wants to speedily inject new money into overdue public works projects.
The popularity of design-build has steadily grown over the past 25 years. According to data from the Design Build Institute of America, since 1985 the percentage of bids awarded to consortiums or individual firms given total architecture, engineering and construction responsibility for a project has risen from five percent to nearly 45 percent. During the same period, design-bid-build contracts have slumped from 82 percent to the same 45 percent.
“With all the economic pressure we are under today, we don’t have funds to waste,” said Garrison. “So there is more and more need to emphasize value. Companies have to get ready for the change. They have to provide value.”
Studies have shown for years that while productivity in most major industries in the United States has grown, construction industry productivity has been stagnant at best. Garrison blames that on the unwillingness of too many contractors to move to a new model of doing business.
“Construction people tend to be left-brained,” he said. “They don’t like to try new things. Consequently, we have not been one of the more innovative industries. I think that is finally trying to change.
“Some contractors think I am nuts when I say this stuff. They want to hold on to ideas that they are comfortable with; bidding low and beating down subcontractor’s prices is how they make ends meet. That is the process they know.”
But contractors are not the only component of the construction marketplace that must be willing to scrap business as usual. Project owners — private and public — also resist moving to a value-based bidding system, Garrison said, because for them, doing so is a professional risk.
“If you are the bureaucrat looking for the lowest bid, you don’t have to make a decision. The process makes the decision. On the other hand, if the bureaucrat picks some bidder based on value and the contractor doesn’t perform, well, then the questions start coming. So awarding low bids is risk averse. It puts the project more at risk to go with the low bidder, but… it doesn’t put the bureaucrat at risk.”
Garrison would have project owners “break away from the conventional wisdom. The mentality of selecting the lowest price is a disaster.” Instead he said owners should move to cede more control of a project to design-build contractors so that projects can be more cost-effectively built and oftentimes more quickly.
He cited the example of the Interstate 35 bridge across the river in Minneapolis, which was replaced following the collapse of its predecessor in August of 2007. With public officials setting the economic cost of the bridge’s loss at $400,000 a day, Minnesota Department of Transportation officials scrambled to erect a successor span.
They took design-build bids from four teams of building and engineering companies — and in the end awarded the contract to the high bidder. DOT justified it as the “best-value” bid, which factored in bid price as well as a “technical proposal” score to produce an overall best bid.
The bridge project was the 7th “best-value” contract awarded by MDOT and, like the previous projects, proved a winner. The bridge opened 339 days after bid opening, a full three months early. The department’s design-build program manager, Jay Hietpas, has said that had DOT followed the usual design-bid-build process, it would have been awarding bids the day the new bridge opened.
With one piece of the marketplace — public works — promising sizeable contracts, Garrison believes the time is right for the industry to swing even further in the direction of value-based bids that will foster confidence down the road.
“I think the industry has to provide value for the client instead of the usual short-term mentality. We need to think long term. The only long-term strategy is to have collaboration in construction.”
Resizing to Fit the Recession
In 1991, Thomas Schleifer published the Construction Contractor’s Survival Guide and ever since has been in demand for industry seminars. Contractor attendance has been high in recent months, he said. “I think they know they are in a spot.”
An assistant professor of research at the Del W. Webb School of Construction at Arizona State University, Schleifer sees the current environment as threatening to contractors but also as opportune. Which it will be for an individual contractor will largely depend on how the contractor adjusts to the situation.
“It is absolutely true that the industry is resistant to change,” Schleifer said. “But a sophisticated contractor in the market today has to be flexible.”
The flexing will be to accommodate the twin situations now presenting themselves — slowed opportunity as a result of the recession, and new opportunity in what might be a foreign market to some of them — public works.
“I think a lot of the stress for contractors will be that it is going to be public work or nothing. Public work is a change in type of work if you are used to private clients. Public clients have an altogether different way of doing business.”
The consultant said the other stress factor is the probable size of the public work contracts to be awarded.
“I think there will be a huge bias for larger jobs because there is such demand right now. The stimulus is supposed to create jobs and so what the states and municipalities will do is put forth big projects. The contractor who is not used to big jobs and has no other work will attempt to bid, which will be stepping out of his area of experience. It is very risky.”
Schleifer said the effect of the recession on the industry will mirror that of previous recessions: More bidding for fewer projects with prices dropping and profit margins shrinking. With contractors bidding lower and lower just to have work and maintain a market share, even companies that are working will not be padding their bottom lines.
Schleifer said the better recourse is to shrink a company to match the shrinking economy.
“We cannot control the market, but we can control our response to it.”
He said a well-managed company in the beginning of a recession quickly reduces its overhead including the number of employees on the payroll. Trying to muddle through with token cuts in non-essential costs is not cutting deep enough if the goal is to remain healthy and responsive to business opportunities.
“I regularly hear from contractors: ’I can’t operate with 10 percent or 20 percent less work. I have a drop-dead volume I have to maintain to be viable,’” Schleifer wrote in a summary paper about prospering in a cyclical market. “My typical response is: ’As you grew your business from five and $10 million on your way to $15 million were you profitable at five and $10 million?’ Most contractors celebrated success at those volumes. The point is, if you have to go back to one of those reduced volumes, you need to size and configure the organization to exactly what it looked like when it was profitable at that size.”
Schleifer acknowledged that such decisions range from “difficult to distasteful.” Letting workers go when dependable construction help is hard to find and retain is a painful administrative decision, but Schleifer said any other response is not viable.
“Capturing, training and retaining good people has been a major issue for many contractors during the recent good years and serious resistance to these suggestions is understandable. However, timing is critical because there are real and significant costs to reacting late.”
Flexing a company’s size and business volume to reflect economic reality might be a headache, but it allows a company to remain financially resilient enough to rebound when the market does.
“They need to size themselves to the marketplace and certainly not try to grow at this time,” the consultant advised. “Even if there is a lot of public work, there is no indication it is going to continue. Another balloon [of construction activity] is not going to help them. They simply need to size themselves to the market place and manage their growth.”
Dennis Feidner was a 20-year veteran of the heavy construction industry as a chief financial officer for various companies before founding his own company called “CFO on the go.” The consulting company concentrates on providing to contractors the processes and technical support that will streamline their accounting.
“It used to be a guy, a dog and a pickup truck could make money. Now you really have to know what you’re doing. The margins are so small,” said Feidner, contacted at his Temecula, Calif., corporate office. “There are a lot of contractors making under $5 million a year and some between $5 million and $50 million. The middle and upper tiers of guys are doing well. The small guy is just trying to figure out how to meet payroll.”
Feidner said that reacting properly to good fortune and bad fortune in the industry is critical with long-term consequences always telling the story of decision-making.
“The small guys who were smart when they were making some money bought some real estate or something and now they have a revenue stream.”
The consultant lists a variety of accounting and bottom-line decisions that CFOs can recommend. In the short term the actions will buttress the bottom line; down the road, they will add to a company’s profits. The actions range from basic to high-tech. Such as:
• Feidner said the inviolable rule for staying in business is, “Don’t run out of money.” To help avoid that eventuality in 2009, he recommends an immediate review of all recurring and non-essential expenses. They add up.
• Improve collections by dedicating one employee to the task and having contractual incentives for prompt or early payment. Consider payment by credit card, because some owners will do it just to get bonus points from their credit card companies.
• Upgrade software solutions if current ones are as much as five years old. Connecting field employees with the office in real time can produce a quick return in investment. He can prove it.
• Market the company aggressively. Send photos of previous work to past project owners and new ones; inquire about work or get a referral or testimonial from them. Get back to monthly trade association events and network.
• Boost your employee training. “Most people have a tendency to take short cuts or get sloppy in the good times. Now is the time for good core business practices.” Feidner specifically suggested boning up anew on project management, estimating, construction accounting and marketing.
“Some contractors read something I have written and say to me, ’I knew that,’” Feidner said. “Yow,’ I tell them, ’but did you do it?’ Doing it is what’s needed now.”