Construction Contractors Evaluate Methods in Challenging Times
The market demand for general contracting and construction management services has changed significantly with the compounding effects of the events of Sept. 11, 2001, and the already slowing economy. Of course, this trend has been exacerbated by the sting of recent accounting scandals, the lack of investor confidence, and the continuing spiral of the stock market. But how are these broad market factors affecting contractors, and what actions are they taking to respond to the challenges?
As contractors continue to see their backlogs dwindle, many are taking time to evaluate and scrutinize their business. Contractors in weak markets are looking to reposition themselves in stronger markets, such as education, where capital spending will be available. This refocusing of strategic plans and entrance into hot markets is increasing competition in those markets and, in some cases, driving fees down. Balances sheets and other financial statements are being carefully reviewed. Contractors are taking cautious measures, such as securing long-term debt for future use.
Renovation and Retrofit
Once thought to be a niche market, the renovation and retrofit market is gaining strength. Many owners that had been planning new greenfield projects are not cutting capital expansion budgets and renovating existing faculties to stay satisfy short-term needs. Although these major projects may be revitalized in the future, interiors and tenant-upfit contractors are reaping the benefits from this shift in resources.
While this expanded market opportunity has fueled growth for existing interiors contractors, it has encouraged traditional firms to add new services for their clients. Creative firms are helping owners find solutions to a wide range of problems beyond the short-term need of locating their people and operations. This shift in focus requires a sophisticated approach to providing project management services for customers that are demanding more. Although some firms will make the transition easily, many contractors accustomed to operating in the adversarial hard-bid environment will find it difficult to reprogram their operations team to be more responsive to clients’ needs. Long-established interiors contractors are concerned that the increased attention to this market by the large general contractor/construction manager contingent is rapidly commodifying the fees and prices.
Leading-edge contractors recognize the importance of having a project culture that’s not contentious. They are developing and implementing training programs to sensitize their project managers and superintendents to be more empathetic to the needs of the customer. In fact, they see this as an opportunity to enhance margins by anticipating and responding to customer needs.
However, this approach requires a discipline to correctly identify, document, and price customer-driven change orders with the appropriate overhead, burden, and margin included in the price of the additional project scope. Too many times, field managers are focused on the project schedule and are reluctant to ask their client for additional fees, even when they are entitled to them. This loss of potential revenue and profit can be overcome with the installation of appropriate systems. With the controls in place, contractors can provide training to build the confidence and ability of their project management teams to educate customers on the economic benefits that outweigh the costs of their requests. Contractors should never be afraid to ask for and receive extra compensation for additional work.
With the decline of certain sectors such as office, institutional, and hospitality, contractors must find new opportunities to replace lost backlog. Many firms are shifting resources to selected public sectors such as education and infrastructure work. In response to the demographic demand, several states are launching massive capital expansion programs at all levels of education, including K-12, community colleges, and higher education.
Many firms that avoided public sector work in favor of private negotiated projects are now chasing school work. The K-12 market has traditionally been a hard-bid market with lower margins and lower fee opportunities. Many states are responding with more progressive and flexible procurement processes in an effort to attract the best firms. The result is a better value for state taxpayers, improved schools for future students, and more work for responsive contractors. In other states, hidebound procurement results in quite the opposite, making this a market with spending but significant margin challenges.
Community colleges accustomed to "starvation" budgets will have significant funding for construction as they prepare for the next big population wave now moving through K-12. Without systems in place to administer construction programs, these schools will likely look to contractors for help. Opportunities for alternative delivery methods will be available.
Higher education has historically taken a classical approach to construction, and significant funding is presenting new opportunities for traditional contractors. For example, the University of North Carolina system successfully campaigned for the passage of a $2.5 billion bond referendum to fund expansion on all 16 of its campuses across the state. When coupled with funding from ongoing resources, this funding results in a $6.7 billion program over the next seven years.
Building Project Management Competence
As more general contractors move away from self-performing any field work and the proliferation of construction management firms continues, project managers are increasingly becoming "business managers" instead of "builders." Although their formal education and training may not have prepared them for this transition, it’s the role they must play on a regular basis. Many companies are frustrated with the lack of business acumen that today’s young project managers exhibit. Obviously, this lack is partly due to the typical education that accompanies these people-either engineering or construction management. However, some universities are moving toward a more well-rounded approach to educating their future constructors by offering or even requiring some business courses before granting a degree-particularly in the construction management curriculum.
Construction companies must understand that their main purpose, and therefore their opportunity for differentiation, is to find solutions for their customers. This applies not just in the building sense, but even more so in choosing the correct delivery mechanism for a particular customer’s need-for example, in a design/build environment, finding a creative financial solution to a budget issue that pleases the customer, architect, and the contractor.
The ability to persuade others and negotiate a plausible solution that makes everyone feel food about the outcome is a critical skill that too few project management personnel possesses. These "softer skills," such as building customer relations, negotiating contracts or change orders, project financial and cash management, and their own individual project leadership skills are often derided by "true builders" as irrelevant. In fact, these skills can have the largest influence on customer satisfaction and the final profitability of the job. If project managers were savvier about how to manage their costs on projects, they would have less "profit fade" and increase the final profit margin an their respective projects.
Certainly, project managers must have the technical and construction knowledge required to build a project. However, the field superintendent can be the primary technical resource while the project manager is busy managing the project from an administration and customer perspective. In owner surveys that have been conducted by FMI over the past five years, a trend that continues to grow is that owners look to the project manager or project executive as their single source of accountability for all things that happen on their project. Therefore, the project manager must be a multi-faceted individual who can deal with the people, financial, and customer-related issues that arise on a project as easily as he or she deals with the construction issues that regularly present themselves.
General Contractors and Self-Performed Work
General contractors may decide to self-perform a larger portion of the contracts they acquire to gain more control over the critical path, to secure additional margin, or to compensate for a lack of capacity in the subcontractor market. Contractors typically self-perform concrete forming, pouring and finishing, carpentry and interiors, and even landscaping to finish the project. In fact, one contractor, Kinsely Construction in York, Pa., has four separate divisions in additional to its general contracting company that provide everything from architectural design services and site work to mechanical systems and electrical installations. These divisions allow Kinsley to control the coordination among these critical trades and provide significant value for its clients.
Some firms have made a conscious decision to add to these services in order to be more responsive to the needs of their clients. These firms are usually dominant players in the local or regional market. For example, Pepper Construction Group, a Chicago-based general contractor, has an active concrete division that’s a strong contributor to overall corporate performance. This profit center gives Pepper more control over the early phases of the project schedule.
However, the majority of contractors continue to avoid labor risk. The advent and growth of white-collar management has been a direct result of this risk-aversion. Program managers, construction managers, and general contractors gain value-added fees from the owner-typically a combined 15 percent -with little assumed risk.
Which firms were making the most money during the recent 10-year boom? It wasn’t general contractors (GC) and construction managers (CM). While mid-sized to large GC’s averaged about 1.5 percent to 2.25 percent and CM’s limped along at less than 2 percent fees on major projects, specialty trade contractors generated 10 percent to 15 percent gross margins.
When asked how they get such relatively high margins, subcontractors respond with the fact that they manage all of the productive resources such as direct labor and materials, and thus deserve to reap the reward that’s commensurate with assuming that risk.
Issues for Specialty and Trade Contractors
Subcontractors as a group are diverse and unique. The market challenges, economic drivers, and strategies for the future differ based on specialty. But similarities are also shared. We see these main issues impacting specialty and trade contractors as a group.
Mechanical and electrical contractors are battling in the marketplace with manufacturers to determine who will "own" the building technology package. The combination of technology-security, controls, fire protection, etc.-bring an overlap of expertise with these three groups. Manufacturers see the building technology package as an opportunity to grow market share and expand service offerings. Mechanical contractors see it as an extension of their traditional work. And electrical contractors view it as a growing piece of low voltage work.
Field software utilization remains primarily focused on scheduling, e-mail, spreadsheets, and word processing. Substantial investments in systems and software in the field remain a tough sell. For many subcontractors, real-time filed information for costing and payroll remains a future promise.
Cell phones, pagers, e-mail, personal digital assistants (PDAs) and digital cameras lead the list of field technology tools. E-mail remains mostly tied to desktop applications, but the introduction of PDAs is taking handheld devices from an electronic to-do list to a real-time productivity tool tracking materials, labor, and time.
Real-time information is more likely to be achieved as contractors replace legacy systems with enterprise-wide systems. The enterprise system combines customer relations management, accounting, order entry, and other functions into one computer system so real-time information is available. The old legacy systems, which often involve re-keying of information, have not been able to provide this integration. Contractors of all sizes will continue to acquire and implement these systems.
Global positioning systems (GPS) are being used on heavy equipment and ready-mix trucks to streamline trip times and expedite productivity. Watch for GPS applications to gain in popularity for building layouts.
Emerging technology includes barcodes for use on project sites and during service calls. Field service technicians use barcodes to access work order information, track tools and equipment, and expedite the billing process. Field applications include monitoring material usage and tool inventories. One contractor using barcode technology cut the time needed to inventory tools coming back from major projects from weeks to days.
Radio tags are likely to be widely used in the near future to know who and what has been brought onto the construction site. The tags track movement, increase security, and allow for simplified paperwork.
Technology is also having an impact on the services specialty contractors are being asked to provide. Smart buildings will be able to sense who is on site and cater to owners’ unique workplace-environment issues. Security challenges of moving in and out of high-security areas will be easier. In the case of emergencies, the building’s system can track where people are and help determine the appropriate response level.
"Technologist" may well be the hot future construction position that changes the way buildings are built. A technologist will be the person-perhaps on the architectural team, the engineering team, or maybe even on the GC/CM/subcontractor team-who focuses not on running information technology, but on bringing the most up-to-date technology to the building even before construction begins.
Human assets are the key building block for all specialty contractors. Balancing the needs of generations, overcoming the labor shortage, and developing their people in today’s competitive market are key challenges.
However, specialty contractors’ approach to developing their human assets remains diffused and too often ineffective. Craft labor training grew in success and importance in the past decade of economic expansion. The same can be said for safety training. What continues to lag is the growth and development of management, leadership, and customer-relations skills for field and office personnel.
Corporate "universities" are becoming the battle call of subcontractors large and small. More than a training class, corporate universities are focused on creating an ongoing process to grow the skills of the organization. With the continuing flattening of corporate organizational structures, growing people’s abilities is a key to ensuring a competitive advantage in the market place and achieving high levels of retention.
The labor shortage has cooled with recent softening of the economy, but the underlying challenge of finding talented people for the construction industry remains. Demographics are going to continue to present a problem even though the current market might alleviate the situation for a few years. The small "Generation X" (born between 1965-1980) is unable to fill the ranks of the aging Baby Boomers (born between 1946-1964). The problem will likely persist until late in the decade when the larger "Generation Y" (born after 1980) will begin entering the labor market in force.
The industry’s poor image continues to remain a hindrance to attracting talent. The industry hasn’t been competitive in attracting new talent in management or labor, and as a result, the average age of the industry’s workforce continues to increase. Part of the problem is that in this information economy, the industrial work option of construction does not appeal to most young people.
Subcontractors are changing internal systems to meet the needs of the younger generations in the workforce. Reward systems, sharing of information and the creation of structured career paths are a few of the tools subcontractors are employing for recruiting and retention.
Two years ago, finding the time for training was difficult given the long hours worked in both the field and the office. Today, the concern is finding the money to spend on training. Though easy to continue to delay training due to short-term business issues, today’s top subcontractors are making training and development a top priority in all levels and areas of their companies.
The average age of the construction workforce continues to increase. Subcontractors are particularly vulnerable to this problem due to the labor intensity of their field forces. Expect more back, elbow, and knee injuries as the workforce continues to age.
Compensation pressure is off due to the softer labor market in mid-to late 2002. Companies are using this time to reassess their compensation packages and bring into alignment their recent hiring practices. Over the past few years, it wasn’t uncommon to have to offer compensation rates to new hires similar the rates for existing staff.
Human resources departments are evolving from compliance and tracking functions to operating as a strategic partner to senior managers. The focus is shifting from managing one piece, such as compensation, to a holistic process in which management looks at everything affecting the performance of the organization’s people. Subcontractors are quickly learning how to embrace this new expertise in their planning and decision-making processes. The additional focus on risk management by human resources has turned into a key profit booster and retention tool.
Labor-intensive subcontractors are leveraging small percentage improvements in labor savings to yield significant improvements in bottom-line results. Proper planning and elevated communications lead the list of techniques generating the greatest bottom-line impact.
Material-intensive specialty contractors gain productivity through proper planning to minimize the time crews spend waiting for materials. An example is an electrical contractor whose motto is "eight hours of materials within 10 feet of the workers that need them." Another contractor slogan is "Keep the welder welding."
Keeping field forces informed, trained, and motivated helps improve productivity. It’s now commonplace for field foreman to have access to full cost estimates and installed work to date. Subcontractors are thinking of ways to continuously keep the field informed on the progress being made on the job – both when ahead and when behind budget.
Post-job reviews are once again gaining in use. The focus of these reviews is to ensure that challenges, lessons learned, and best practices are captured and used on futures projects. Also, a routine part of the process is a review of what the customer wanted and their level of satisfaction at the end of the project.
Marketing and Business Development
Subcontractors who focus on public work have faced increasingly steep competition as the private construction market cooled in late 2001 and 2002, and margins were down for fiscal year 2002. Many projects earlier in the year were put on hold, and some were even cancelled. The result is that subcontractors are scrambling to find work, putting downward pressure on prices. Not finding the plentiful work of a few years ago, subcontractors chasing private work have stepped back into hard-bid, public construction in an attempt to keep their people busy and fill gaping holes in backlog. Six to 10 bidders typically bid on a public project, and that number is growing. This growing competition will affect profit margins. At the level of 10 bidders, the probability of achieving a margin is close to negligible.
Backlog is holding within 20 percent of the record high year’s volume. The challenge is that profit margins for backlog work are down. Subcontractors are looking for opportunities to grow profit margins through up-selling options on projects, pursuing change order, and continuing to elevate field productivity. The market pinch for subcontractors will ease in 2003. In most parts of the country, subcontractors will enjoy a recovery in late 2003 and early 2004.
Some customers, also impacted by the soft economy, are asking subcontractors with which they’ve had long-term negotiated relationships to bid jobs. Budget crunches have encouraged some customers to ask general contractors to bid on projects that would have been negotiated in the past. Motivated by the bid competition, general contractors and construction managers are putting additional pressure on the subcontractors to cut profit margins and shorten the construction timeframe.
The softened economy has reduced revenues for most subcontractors. However, although it’s easy to slip into concern over the financial health of a company due to the revenue lost, most subcontractors were projected to enjoy their second-best year on record in 2002. For other subcontractors, their 2002 revenue more closely reflects 1998 and 1999-the 2002 market is down from the prior year but still remains strong. The current challenges of getting work will be short-lived and provide subcontractors an opportunity to refine their effectiveness at getting work. The business development sophistication of specialty contractors has grown tremendously over the past several years. Today subcontractors create proposals and presentations that "sell" their proposed solution to the customer and general contractor. Proposals have grown beyond simple response to RFPs to become a robust sales tool positioning the value-added services being provided.
The increasing cost of insurance and bonding is limiting the profits on projects. Used to the ease of getting bonds on projects, many successful subcontractors are facing a challenge not experienced in the past decade – lack of bonding capacity. Those with sufficient capacity find themselves with a short-term market advantage over competitors because bonding is an entry barrier to many big projects.
Subcontractors need to be proactively working to build strong relationships with their bonding, insurance, and banking representatives. Now is the time to expand these relationships outside traditional providers so there are backup plans in the event the primary relationships quickly change.
Technology Comes to Business Development
The same technology that allows an avid sports fan to "see" the view from their seat before the stadium is completed allows customers to take a visual walk-through of a project prior to construction. Changes can be quickly made before substantial costs are incurred to tear out and replace installed construction. This three-dimensional visual capability will be a growing tool in subcontractors’ marketing arsenal.
Subcontractors are fighting against the compartmentalization of their work. Traditional packages are being broken down and bid separately. The intent is to provide a cost advantage to the project. However, the increase n the number of specialty contractors on site complicates coordination.
Specialty trade associations, which are struggling to retain and grow membership, are looking for value-added services for members outside the traditional political and labor negotiation. Union trade associations in many cases have higher revenue and member retention than open-shop associations. Associations are challenging members to volunteer for committees and be active in the association. The older generation was brought up to "give something back," but it’s unclear if younger generations are willing to give up personal time to serve in associations. Many people who aren’t active cite "life balance" as a primary reason.
Design/build continues to be a good opportunity, and subcontractors have enjoyed the opportunity to compete on a basis other than price. However, this delivery method has its warts. Design/build changes the economic model of a contractor that has previously relied on hard-bid work. Design/build projects have longer lead times and greater up-front costs without a guarantee of securing the work. It’s essential for subcontractors to balance the benefits of design/build with the required investment of time and resource.
Subcontractors are experimenting with the design/build market in a cost-effective way by forming alliances with architecture/engineering firms. The trend of A/E firms entering the market as design/build contractors is cooling rapidly.
Architects and engineers, pressured to get their fees lower and speed design, are turning out construction documents with less detail than in the past. Subcontractors are having to detail higher amounts of their work and resolve unexpected conflicts in the field. The impact on field and office productivity is substantial. Subcontractors are responding by adding detailers and expanding their pre-job planning efforts. In some cases, subcontractors are finding that by redrawing mechanical, electrical, and other systems, they can give their field workers clearer direction and ultimately raise productivity levels.
Giving customers an excuse to buy on something other than the lowest initial cost continues to challenge many subcontractors. The inability to differentiate their service offering keeps thousands of subcontractors competing in hard bids. The answer is for a cross section of managers to come together in a planning venue to consciously create a competitive difference in pursuing jobs. If that difference resonates with targeted customers, the subcontractor wins. If he doesn’t, the differentiation effort increases the cost of doing business without providing a bid-day advantage.
Adapted from the 2002-2003 U.S. Markets Construction Overview. Reprinted with permission from FMI Corp., (919) 787-8400. For more information, visit www.fminet.com or call Angela Blackburn at (919) 785-9220.