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Warning: over-confidence in recovery can lead to disaster – Construction Manager (CIOB’s Magazine)

Posted on: January 6th, 2014 by Staffan Engstrom

Two years ago the Italian cruise ship Costa Concordia sank in calm waters while sailing past the island of Giglio because the captain “knew those sea-beds well” and switched off the navigation alarm system. As UK construction markets begin to look calmer, the same root cause – a dangerous sense of over-confidence – could also spell danger ahead for the construction industry.

When a contractor has been through the storms of recession, felt the pain of “reefing back” resources to the minimum, and suffered the impact of wave after wave of suicidal competitive pricing, then the prospect of recovery is a cheerful one. Yet the biggest danger is complacency, because having downsized to survive, neither the contractor nor its suppliers are as able as they were before the storm struck. They are weakened and have both reduced resources and lowered flexibility.

As difficult as the issue of paper-thin margins has been, the real risk of shipwreck for a construction company is that in its newfound confidence it takes on work that it cannot deliver effectively – either because it has lost the requisite skills or never had them in the first place.

In my 20 years’ experience as a senior construction executive, I found that it is this issue that makes the difference between single digit and double-digit margin losses on bad construction contracts. Trying to do what you don’t have the skills for is normally much worse than under-pricing something that you understand well.

I have led the post-contract review of hundreds of completed contracts for large regional construction businesses through a systematic “deep” exploration of many different potential profit and loss drivers, thus exposing the root causes of loss-making contracts. One regional builder found that 30% by value of its contracts lost money or broke even, and that more than 90% of these losses were evident in factors that were clear before the contract was even signed. It saw how the discovery of these factors could increase future profitability substantially, and applied this learning to its forward bidding programme.

This regional builder was at its profitable best when it focused on simpler one or two-storey buildings and warehouses, sub-£10m projects, and when avoiding the complexities of basements, precast concrete frames, and fancy curtain walling or roof finishes. It made most profit when it knew the client and advisers, when it avoided complex contract forms (PFI was a disaster for it) and single-stage tenders, and when it stayed in mainland Britain. Moreover, its capabilities varied across the country, for example certain of its dozen or so area offices were able to deliver housing projects profitably, but most were not.

Each construction company has different skills, based on both the skills and capabilities of the individuals that work for it and on the composite skills and processes of the whole organisation – in other words, how people work together and support one another with specific expertise and resources. In contrast to the example above, a major contractor like Balfour Beatty or Laing O’Rourke will often focus on delivering more complex projects, because they have the skills for them and can normally charge a premium price as a result. Each contractor must find its own core competence area and stick to it.

But it’s harder to know what you should do or avoid than you think. Very often the key decision makers in a company have different perspectives on what constitutes a good future contract. There is a lot of debate and discussion about where to focus, but with many different stakeholders in a regional or divisional business the lack of an objective approach to assessing this can make risk management a real mess, with either the head office going overboard on controls or regional offices sailing out of control.

Best practice for regional construction businesses involves understanding core competencies through a deep contract profitability analysis of what makes money for that business and what doesn’t. This is the best risk management of all, enabling companies to ascertain their core skills, and to implement empowering governance approaches where regional businesses or divisional management know what they are allowed to bid on their own without central guidance, and where they need help.

The governance framework should focus on: types of construction; contract size; commercial terms and conditions; client, client advisor and partner relationships; geography; skills and resources; design risk; and sector. And the most important question at any internal tender or bid review is not “what is the mark-up?” but “who in our team has the skills to deliver this for us?”

This approach enables the whole organisation to get on board because the analysis is entirely transparent. Furthermore, it identifies the actual core competencies of the business to set the compass for the new growth markets where the business is best equipped to thrive.

Staffan Engstrom BSc CEng FICE is a strategic development consultant who runs an independent consultancy working with construction and support services businesses to help them to accelerate growth, increase profitability and manage risk. He was formerly group strategy director and divisional managing director at Carillion and Tarmac Construction. www.staffanengstrom.co.uk se@staffanengstrom.co.uk

This article was written by Staffan Engstrom and originally published on 6th January 2014 by Construction Manager.