Star architects, or "starchitects" as they are sometimes called, often garner headlines for the new buildings dotting our nation's skylines. Meanwhile, too little recognition goes to the contractors responsible for bringing these designs into reality. Instead, news stories mentioning contractors tend to be negative, typically trumpeting project cost overruns and delays. This disparity mars the relationships of all involved in the process.
Contractors are a hardworking, important sector of our nation's economy. They regularly solve problems that arise during construction projects, even those that begin with the best-prepared design documents. Yet, they work within an inefficient industry with low profitability, a combination with serious negative effects on our economy. Imagine the impact contractors could have—and the credit they would get for their efforts—if they weren't hampered by a system they've come to see as "normal."
The market for construction services is broken because of how the industry operates. It is extremely fragmented, with hundreds of thousands of small firms. Of the 7.6 million construction workers in the U.S., 92 percent are employed by firms of twenty employees or less. It is truly the last "mom and pop" shop industry in the U.S. Smaller companies lack the requisite capital to make investments that enhance productivity. They also are unable to afford to assume much risk. As a result, there is no incentive in the current system for contractors to improve their highly inefficient ways.
According to the Federal Bureau of Labor Statistics, since 1964 worker productivity in all other non-farm industries has seen average gains of 125 percent, while the construction industry has decreased in productivity—by over 20 percent! Construction also ranks at the bottom of all industries in terms of investment in technology, research and development, and continuing education of its workforce and management. With annual profits of only 3-4 percent, this performance is no surprise.
Because of the highly fragmented nature of the industry, contractor performance is often adversely impacted by the actions and delays of others. Contractors suffer when other contractors are poorly managed or spread thin, delaying the work for all. Contractors forced to submit bids at or below cost suffer because they know from the start that they are unlikely to earn a fair profit on the work they perform. Contractors suffer when owners make unrealistic scheduling demands, add scope late in the project, or fail to make timely decisions and payments. And contractors also are hurt by the fast-track process, which increases the risk of claims, disputes, and costly litigation. Fast-track is actually damaging the industry.
The fact that owners rarely understand how construction is performed also holds back the construction industry. The non-transparency of construction cost information creates confusion for all parties. When contractors control all of the information about project costs and owners lack true intermediaries to help them negotiate properly priced construction contracts, the imbalance creates many problems.
The structural problems that plague the construction industry are solvable and they will be solved in the very near future. The "big picture" answer is vertical integration and consolidation. This will enable contractors to absorb risk, harness the benefits of new technologies, and provide true fixed prices to owners that will increase construction industry profits.
Of course, contractors are not in business solely to serve the needs of owners. Like all who compete in our economy, contractors should make a fair profit—not merely the minimal returns on investment they currently receive for the large risks they undertake. But to achieve higher returns, they must realize financial benefits from long-overdue industry reform.
Here are three strategic recommendations that will lead to increased efficiency, fewer cost overruns, and a stronger and more profitable construction sector overall:
Solution 1: The industry should embrace true fixed-price agreements. Standard industry contracts fail to properly allocate risk among the parties and encourage poorly managed firms to continue operating with a low-bid mentality that is anathema to most well-managed construction firms.
The industry should rally behind construction contracts that:
Are based on 100 percent complete and coordinated architectural and engineering drawings and specifications that enable contractors to know precisely what they are bidding on;
Include a fixed price for everything designed and approved by the owner;
Apportion and price all risks that can be reasonably anticipated during construction; and
Incorporate a fair profit to encourage quality contractors to assume risk and complete the work specified within the time allotted and within a fixed-price framework.
Fast tracking should be used only where achievable and identifiable benefits for early completion can be established. In almost every other instance, engineers and architects must be given the time and fees to complete their documents in order to pave the way for a true fixed-price contract. Contractors and project owners should sit together and share a free and open exchange about every possible project-related problem they can reasonably anticipate. Then—within the framework of a contract—they should equitably allocate the risks associated with these potential problems and be paid for the risks they agree to assume.
Solution 2: The industry should invest in new technology. The construction industry invests far less on technology aimed at improving productivity than other major industries. Little has changed since a 1963 study by Arthur A Little, Inc., declared that "during the last thirty years there has been no major technological change of major economic significance for the building industry....Technological change has been primarily evolutionary in small increments...it can hardly be called 'innovation.'"
It is wrong for the industry to present such developments as design/build, construction management at risk, and value engineering as true technological innovations. Real technological change is needed, and soon. Investment in emerging technologies such as BIM and other collaborative project management software, coupled with advances in manufacturing and construction techniques, all promise to increase productivity, reduce change orders and claims, and increase contractor profitability.
The construction industry also could benefit by emulating successful business management strategies employed in other industries. For example, some 70-80 percent of buildings in a given sector (e.g., hospitals, schools, or office buildings) use essentially the same raw materials and products. This means that larger contractors will have the capacity to order these supplies in bulk, reaping substantial discounts on the purchase of materials and passing a portion of the savings on to clients, while keeping the balance in the form of enhanced profits.
Solution 3: Contractors and owners should retain better intermediaries. Ours is a consumer society long accustomed to fixed prices. Too many owners, private and governmental alike, are wary of the construction industry and its tight hold over the actual costs that constitute a project budget. True transparency would substantially improve competition; it would enable better managed contractors to have a material advantage over those compelled to bid low to secure a project to further their "claims-oriented" game plan. Too often, the construction companies that do best financially are not those that build the best. Too often, contractors bid below cost to win the job, and then have little choice but to boost costs during the project in an effort to make a profit.
Regrettably, the contactor's information advantage over the owner creates perverse incentives that systematically reward this inefficient behavior. Contractors often say that owners can get sufficient information to discern price differences during the course of the bidding process. But most owners know so little about the construction process that contractor errors in bidding or workmanship can often be shifted to them, for example, via the project contingency, often at prices unrelated to cost.
Both owners and contractors need better intermediaries (owner representatives, project managers, and the like) to ensure that transparent information and a true fixed-cost contract with built-in fair profit—and incentives where appropriate—are made part of all negotiations. With capable intermediaries to work with well-managed firms, owners will be able to compare costs of competing bids and eliminate those who bid below or at cost to secure work. In true business parlance, such tactics are "anticompetitive."
Some might argue that this would eventually put some contractors out of business and lead many workers onto unemployment lines. To the contrary, as any economist could predict, removing anticompetitive firms from an industry strengthens the market for all, while raising profits for well-managed firms and elevating incomes for all employees.
Changing the construction industry will be painful for some, but it is necessary and inevitable. Our nation spends $1.23 trillion annually on construction and will spend more than $25 trillion on new construction by 2030. Add an additional $1.6 trillion to repair America's crumbling infrastructure, and it is clear that there is more work out there with more potential profits than ever before.
But the industry climate is changing. The public is too aware of "The Big Dig" and other public boondoggles to permit industry inefficiencies to continue unabated without demanding that the construction sector—once and for all—take real steps to improve the way it does business.
With the eyes of America on the construction industry, now is an ideal time for contractors themselves to play an active role in shaping their own destiny. This article sets forth some specific strategies that would lead to long-term improvement.
Naturally, there is room for disagreement and dialogue. But with ever-growing public impatience over chronic cost overruns, it makes sense for industry leaders to jump into the national debate that is heating up more each day. Inevitably, workable solutions will arise from the clash of diverse viewpoints. And, in the end, contractors and owners will come out ahead.
Barry B. LePatner is the founding partner of New York City-based LePatner & Associates LLP and the author of Broken Buildings, Busted Budgets: How to Fix America's Trillion-Dollar Construction Industry (The University of Chicago Press, 2007). He can be reached at 212-935-4400 or blepatner@lepatner.com. For more information, please visit www.brokenbuildings.com.
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