Summer is halfway over and so is the baseball season. At some point, you have probably heard someone say that baseball is a game of failure but it’s also a game of statistics, averages and probabilities. Knowing these probabilities can help managers and players make better decisions and improves their odds for success.
According to Baseball Reference, hitters in Major League Baseball have a batting average of .336 when stepping up to the plate. For any non-baseball fans, that means they are successful hitting the ball 33.6% of the time. However that average drops to .311 after one strike (7% decrease). Further, after another strike, the average drops all the way to .152 (55% decrease). Of course the hitter is out after the third strike. Clearly a batter’s probability of success after 2 mistakes is not promising.
So what does this have to do with construction? The answer is probabilities. Much like baseball, construction can be a business of failure. In fact, it has the second highest failure rate behind the restaurant industry. Like a hitter in baseball, a construction company can typically withstand one major risk. However, adding a second significantly reduces your odds of success and not many contractors survive a third. Below are a list of major risks that can plague a contractor during a thriving construction economy.
Too Much Work
It sounds contrary to say that too much work is a bad thing for a contractor. However, more contractors fail with too much backlog than without enough. More work means that a company needs more resources including cash and personnel. Problems arise when cash flow gets tight. Make sure your company has the resources it needs to pursue additional opportunities including adequate cash, manpower and available bank line.
Poor Internal and External Accounting
Speaking of cash flow, do you know where your company stands? Companies with poor accounting practices scare bond companies and other creditors. Mistakes, errors and the overall inability to know your company’s current financial condition typically leads to financial losses down the road. Yes, good construction accountants cost money. Bad ones may cost you your company.
Poor Estimating and Supervision
All the work in the world won’t be enough if your jobs are not bid correctly or profits keep fading. As contractors add more work, it is important to keep an eye on job costs. Fades in profit should be addressed immediately with management, estimators and project managers. Additionally, change orders should be aggressively managed so that they are approved before the work is completed.
Working in a New Geographic Area
Many contractors fail to adequately consider this risk. What is the labor pool like in the area? How will they treat an “out of town” contractor? Will they work overtime, weekends, ect.? Their labor market may have different standards than you are used to. What about the quality of the local subcontractors, the political climate and the weather? They are many challenges to an unknown region. Start small and slowly work your way into a new region so that you know what you are getting into.
Taking Work Outside Your Expertise
Most great construction companies are optimistic by nature which is terrific. However, that optimism can lead to a failure to fully analyze potential risks. Building a school is not the same as building a hospital. Before venturing into a new scope of work, it’s wise to hire those with significant experience in estimating, supervising and managing that type of project. Additionally, you may want to put additional funds into the project to cover the unexpected.
As already discussed, more work puts more pressure on contractors. Unfortunately, the stress is even greater on subs who have to finance the work for longer periods. Add to that the labor shortage, and it makes sense to protect yourself from subcontractors who may be overextended. Construction is a competitive business and many contractors do not want to incur the cost of subcontract bonds or subcontractor default insurance (SDI). However, that’s probably a mistake. Contractors with even the best practices for handling subs can get burned. In the best circumstance, it usually costs them their profit on the job. Sometimes it costs the company’s profit for the year…or worse. At the very least, have a strong prequalification process where you can analyze their financial situation and job qualifications. Have critical subs, large subs or those that are in question bond back. Contractors often say, “They can’t provide a bond.” This should be a major red flag. It’s a soft surety market and the changes in credit-based bonds along with the SBA guaranty program mean almost anybody can be bonded. If they can’t go through one of those avenues, there is a high chance of them costing you money down the road.
When the construction economy is thriving, it can lead to great profits and excess cash. Sometimes, contractors use this cash to purchase airplanes, yachts, developments, additional businesses and other assets for the company. The problem is that these items take cash out of the company and often create ongoing expenses. As many contractors found out during the recession, they can also be difficult or at least costly to sell in a tough economy. The best contractors hold onto their cash for rainy days and unforeseen circumstances. My experience is that even the best banks become less friendly when you really need money.
It’s been a great year for the overall construction economy and that is projected to continue through the remainder of the year. As more opportunities emerge, remember these batting probabilities as you evaluate new projects. You can probably handle one of these risks, but two could really hurt your chance of success. And we all know what happens on strike three.
By Ben Williams
Director of Surety Operations