October is here and that means it’s playoff season in baseball. Baseball is a game of failure statistics, averages and probabilities. Knowing these probabilities can help managers and players make better decisions and improve their odds of 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 successfully hit the ball 33.6 percent of the time. However, that average drops to .311 after one strike (7 percent decrease). After another strike, the average drops all the way to .152 (55 percent decrease). Of course, the hitter is out after the third strike. Clearly, a batter’s probability of success after two mistakes is not promising.
Much like baseball, construction can be a business of failure. According to Bizminer, 26 percent of construction businesses operating in 2011 were no longer in business by 2013. Like a hitter in baseball, a construction company can typically withstand one major risk. However, adding a second significantly reduces the odds of success and not many contractors survive a third. Following is 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. The company needs to have the right resources to pursue additional opportunities, including adequate cash, manpower and an available bank line.
Poor Internal and External Accounting
Companies with poor accounting practices scare bond companies and other creditors. Mistakes, errors and the overall inability to know the company’s current financial condition typically leads to financial losses down the road. Yes, good construction accountants cost money. Bad ones can take a company out of business.
Poor Estimating and Supervision
All the work in the world won’t be enough for a contractor if 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 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, etc.? The labor market may have a significantly different work ethic. What about the quality of the local subcontractors, the political climate and the weather? There are many challenges to an unknown region. Contractors should start small and slowly work into a new region.
Taking Work Outside of Expertise
Most great construction companies are optimistic by nature. 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, contractors should put additional funds into the project to cover the unexpected.
More work puts more pressure on contractors. Unfortunately, the stress is even greater on subcontractors that have to finance the work for longer periods of time. Add to that the labor shortage, and it makes sense to have protection from subcontractors that 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 could be a mistake. Contractors with even the best practices for handling subcontractors 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 to analyze their financial situation and job qualifications. Have critical path subcontractors, large subcontractors or those that are in question bond back. It should be a major red flag if they can’t provide a bond. The surety bond market is soft right now, meaning credit is easy to obtain. Changes in credit-based bonds, along with the SBA guaranty program, mean almost anybody can be bonded. If a subcontractor can’t go through one of those avenues, there is a high chance of problems or default down the road.
When the construction economy is thriving, it can lead to great profits and excess cash. Sometimes, this cash is used to purchase airplanes, yachts, real estate developments, additional businesses and other assets for the construction 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, these assets also can 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.
It’s been a great year overall for the construction economy and that is projected to continue through the remainder of the year. As more opportunities emerge, contractors should remember these batting probabilities as they evaluate new projects. Contractors can probably handle one of these risks, but two could really hurt the chances of success. Everyone knows what happens on strike three.