Why construction companies fail: Strategy

It’s hard for us to avoid the news of (once) successful, and more increasingly, National sized construction companies, going bust in the current “boom” building sector. You've probably been keeping up with the news that the court ruled that Mainzeal traded while insolvent for an astonishing nine years and is currently liable for $36 million for letting it happen. Already this year, we’ve witnessed the likes of Ebert & Corbel Construction and most recently, Arrow International, become the latest liquidation causalities. Civil Contractors New Zealand said the strife at Arrow showed the industry had become too unstable, given it was one of the country's best builders of high-rises- It’s like Uncle Ben has let his renowned rice spoil after years of making hay. So what’s going on?

Journalists like Anne Gibson of The New Zealand Herald write that the building sector is broken. There's reasoning construction companies can fail, and in the first of a three-part series, we look at the factors that can lead to construction companies failing – The obvious cost of materials and a shortage of skilled workers are just the tip of the problem.

Let's examine the effect of strategic failings which are made up front before a project has begun.

  • Companies tender fixed prices on open-ended projects, leading to an inability to fulfill their services

This has become a major problem in the New Zealand construction sector in the last decade. We see it all the time: a head contractor or developer will bid for a contract via tender with the lowest possible price to ensure the client gives them the job. As the process gets underway and the project changes – as all projects do – the building company is forced to stick to their original bid. That means they are inclined to cut corners and screw their sub-contractors down to compensate for the overrun.

  • The “hard bid” process

In the same vein as fixed price tendering, the “hard bid” process is where a developer or building company shaves off money arbitrarily from a budget, in order to secure the job. For example, an original bid might be for $1.6 million, but then a competitor says they can do it for $1.5 million. The original bidder then decides to offer $1.4 million simply to get the job, and worries about saving that $200,000 later. You may know this practice as “Dutch auctioning”, which not only is frowned upon in the industry, it is also illegal.

  • Tenders being let with minimal documentation

Tenders are complicated processes which need expert professional valuations from quantity surveyors to ensure they can be delivered. When tenders are let to building companies for a fixed price, but based on incomplete documents– think of it as the Donald Trump style of “making a deal” – they may go through without the proper documents to outline the true costs. For example, the Leighs Cockram joint venture was abruptly ended over the allocation of risk and a $75 million budget blowout in November 2017. This was in part due to Tendering on only 70 per cent complete drawings and documents. Firms of these sizes are easily able to spend up to one million dollars just to submit a tender for an anchor project of this size – that’s a lot of capital just for a single bid – you want to ensure you get this accurate.

  • Contracts that push all risk from client to contractor

The companies that fail often believe they can control the risks of construction, of which there are many in terms of leverage, resourcing, materials, workforces, and timing. In the hyper-competitive industry some building companies or developers will take on all of that risk so the client has less financial stake in the building until it nears completion. This is yet another way to win tenders because it is seen as favourable terms for the client. When risks can't be controlled, however, all responsibility is on the contractor which can lead to quick failings.

  • There's an obsession with volume in New Zealand – companies try too much, too fast

New Zealand goes through big waves where construction is high, like during property booms and when an incumbent government decides to build more homes as part of their political strategy. This leads to smaller companies with minimal success taking on big design and build jobs with more properties than they may have ever worked on before. This volume obsession (and the desire for a small construction company to grow to a design and build juggernaut) is often short-sighted because it's too much, too fast. Additionally, companies forecast unrealistic growth and over-commit while they scramble for work, based on a buoyant market.

  • Project timing and resource/materials/sub-contractor management

Despite taking on a lot of the risk, projects are dictated by the owners' schedules. They start when the client wants them to start. Because a company will have multiple projects on the go at once, resources, materials, and sub-contractors may be over-committed to. When project dates slip, the management of those things are – sometimes quite literally – left out in the rain getting wet, often generating liquidated damages.

  • Budget blowouts

Fletcher Building's chairman Sir Ralph Norris quite famously (in the quantity surveying world) said, “Accurate construction contract pricing was almost an art”. Naturally we agree – contingencies of sorts should always be allowed for in a construction project's budget. For example, when building companies bid for work without allowing for price fluctuations, they are left to absorb any increased market related costs –whether a delay is of their control or not themselves – they already guaranteed they can deliver at a specific price. Using a professional quantity surveyor has one clear advantage in this “art form” – they are regularity tendering on a wide range of construction projects, for a wide range of clients- giving them on the sport, current market prices and rates across all elements of trades.