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Construction: A Risky Business
There’s no denying it – Construction is a risky business. And contracting in the construction industry might just be as risky as it gets. But don’t panic, you can identify and navigate the risks, and get into a better position for reaping the rewards of your hard work.
In my previous article, I had a look at the fact that some things – like supply and demand – work a bit differently in the construction industry. And today, we’re looking at another anomaly – risk versus reward for contractors. So let’s dive in!
The Construction Gods are at it Again
Our customers and competitors alike are more informed than ever before, largely thanks to the internet and accessible information. For us contractors, this means there is less mystery around contracting and therefore less opportunity where profits are concerned.
So we’ve got our work cut out for us when it comes to making a profit. And then, just to spice things up a bit, the construction gods decided to challenge us with:
- Customers expect shorter deadlines and build time
- More red tape than ever before
- Increased risk
- Increased competition
You need to be disciplined and vigilant about the way you work, the work you bid for and accept, and your fees. Keeping your systems working for you, working smarter not harder with the right team around you… it all sounds a bit cliché, but in today’s age the contractors who let the wheels fall off with this kind of stuff will soon fall off the wagon themselves – only to be replaced by a faster, smarter, and more efficient competitor.
Risk Versus Reward - but Not as You Know It
But let’s back up for a minute here and go back to one of the points we just touched on – risk. A bit like the atypical supply/demand scenario unique to the construction industry, ‘risk versus reward’ is a bit left field here also – and this is something every aspiring construction professional must come to understand. Let me explain:
In many businesses, the risk versus reward idea means that for each risk there is a reward – and for a lot of businesses, taking increased risks can really pay off with proportionally increased rewards. But as seasoned construction professionals alike will tell you – the construction industry is, yet again, different. That’s right, in many construction contracting scenarios – higher risk is associated with lower rewards and it’s usually the low-risk projects that come with greater payoffs.
This is because ‘risk’ in the construction industry comes in many tangible forms, and most of them are not worth a nice pay-off when – or if – we make it to the other side. In fact, many risks have the potential to be a contractor’s undoing. But even if we put aside the big, scary risk factors such as liability and litigation, health and safety, etc. and just focus on the more commonplace potential risks to our profit margin and cash flow – the risk/reward relationship doesn’t get much better.
You see, with smaller or lower-risk jobs and fewer variables, there’s a much higher chance you will be paid the fee you’ve quoted in full and on time. When it comes to bidding for the bigger builds, there are a lot more variables and a higher chance of variations in cost when it comes to the final figure.
And don’t forget, when it comes to bidding for bigger jobs, we are often tempted to decrease our profit margin to get the job. So if that’s how you’ve started off, you’re already a bit behind the eight ball. Remember, we’re running businesses that need to make a pretty exact percentage of profit on each project to keep the wheels turning – there’s very little room for movement on that figure – despite what many aspiring contractors may believe.
Let’s look at just a few of these variables that have the potential to increase risk:
Cashflow
When we contractors commit to a larger or lengthier project, our working capital is tied up in that project for the duration of the job. We are in effect both renting out and also risking our working capital to that project, and effectively charging interest on the rent and risk in the form of profit. This is a great way of looking at risk versus profit. The reliance on that capital coming back to us with interest – or rather, with a profit – and allowing us to move on to the next project, is a risk factor in itself.
New Territory
There are many ways in which risk increases – particularly on a bigger job – when elements of that project are new to the contractor or the owner. We’re talking about things like when you’re working for a new owner or customer, when the build type is new to you, with new variations in design when you’re dealing with a new department or regulator or there’s some other aspect of the build that sees you feeling your way through new legislative territory and processes, and also keep in mind that no two builds are exactly the same.
Involvement of Other Trades or Project Managers
Bigger jobs usually mean more trades or subcontractors sharing the same space and schedule – more cooks in the kitchen. This is nothing new to contractors, however, when your work is tied up with – or somehow dependent on – the work of other trades or subcontractors, the kitchen can get messy and even risky. Particularly when you haven’t worked with them before. Add to the mix various levels of construction managers, administrators and other back-office stakeholders with varying degrees of experience, and you can see where there’s potential for disruptions to your usually straightforward business process.
Poor Estimating and Unexpected Costs
Poor estimating is something a contractor cannot afford. Why? Because having unexpected costs popping up on a smaller job may be frustrating but on a much bigger job, it can mean the end of the contractor’s business. Now, you can do everything in your power to make sure your estimating and quoting is on point (and you should), but this isn’t always the only source of unexpected costs. Sometimes you estimate correctly but material costs change. On the other hand, if those unexpected costs arise as a result of a customer’s refusal to pay or a disputed claim, you’ll need more than solid estimating processes to get you out of that pickle. There are lots of ways that extra costs can catch you off guard – so having a backup plan here is essential.
I’m not suggesting you throw all these elements of risk into the mix and you won’t see a cent on completion of the job. But – given that you’re already likely to have cut down your profit margin to be awarded that bigger project in the first place – how much of that remaining profit is going to be eroded by being slowed down, tripped up or entangled by red tape, miscommunication, unrealistic or demanding customers, complex contracts, or some other aspect of business not usually encountered on smaller or less risky jobs?
Lower Risk = Greater Reward
In comparison, smaller or simpler jobs generally tend to have less risk – they’re often less complex and you can get them done sooner. They may be more familiar to you in terms of the build type and who your customer is. You’ll most likely get the job done on time and within budget, with a smaller team and fewer headaches. Now, if your profit margin looks healthier when it comes to smaller jobs, and you can turnover more of them in the time you get through one bigger, more complex project with less profit to be made…. Well, there’s more reward to be made on the lower-risk jobs.
Don’t get me wrong, I’m not saying you need to think small and stick to your ‘lane’. What I’m saying is that you need to find the right level of risk for your business. Moving from building up your construction business means working out what your ideal risk/reward scenario is at a particular point in time. You need to identify what works best for you, your team and resources, your capital, and your business goals.
At the end of the day, your long-term goal is to stay in business, so if you’re a small to medium-sized contracting business but you’re only quoting for jobs that are better suited to a sole trader or a handyman, there’s no sense in that. And yet, you don’t want to be bidding for jobs that are too far outside your capabilities because then the risks really will start to stack up and – as we’ve just discussed – the amount of ‘reward’ is nearly always disproportionate.
Find the Sweet Spot
Spend some time working out what that ideal risk/reward relationship looks like for you. In an ideal world, a low-risk project would tick the boxes for:
- smaller job size – but not too small that it’s not worth your time – we’re talking more ‘Goldilocks small’ – it’s good when it’s just right.
- shorter job duration
- a build type with which you’re mostly familiar and comfortable
- project type that play to your team’s strengths
- well-designed with little room for ambiguity or confusion
- straightforward contract – again, with minimal ambiguity
- a reasonable customer that communicates well and pays on time
Now, of course, we can’t sit back on our high horses and just wait for a job to come along that ticks each and every box. I don’t know about you, but I don’t even have a horse. But what we can control is how much risk we are willing to take on. We can control:
- Keeping our systems and processes strong and working for us
- Building and investing in a strong, skilled team
- Working within a particular sub-category or niche area of construction – instead of subjecting ourselves to too many ‘new’ or riskier variables
- The type of work we bid for or accept – including contracts that are straightforward or otherwise
- The location, size, and duration of the jobs we accept
- The type of customers we work for
Once you become aware of these choices and you start to work out your positions on risk-taking, you can then work on implementing some things to make sure you minimise risk at every turn. We’re talking about getting smart about the financial side of things and really tightening up your actual construction processes and procedures. That way, mitigating risks become a manageable reality, and you have a plan to fall back on and will be set up to properly manage the successful long-term growth of your construction endeavour.
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