Financial District

Better Roads Staff | September 6, 2012

Industry changes demand careful, strong responses.

 

By Brian Moore

 

 

Changes in the construction industry are resulting in a wider variety of delivery methods and changes in the qualifications of who can compete. Whether evolutionary or revolutionary in nature, these forces have the potential to drive some contractors out of business.

There is a growing trend towards fewer but larger projects. Some of these are simply reflective of their scale (for example, the eastern span replacement of the San Francisco-Oakland Bay Bridge). Others suggest the “bundling” of several smaller projects to award as a single contract. This has significant competitive implications.

The information revolution has given purchasers more information than ever. Large owners are more sophisticated, with a ton of technology at their fingertips. This is fueling a growing pressure to look at construction as a commodity purchased on the open market for the lowest bid. There is even some pressure for the procurement of construction services to resemble online purchasing, something like Amazon, Groupon, eBay or even the Chicago Mercantile Exchange.

There are already reverse auction sites for construction. To say the least, this practice has not been endorsed by major contractor organizations. Along with a host of problems associated with the open-bid approach, the savings to owners have not been demonstrated. The reality is construction is different from products and services sold online. Construction is a professional service where each project requires a unique mix of skills, capabilities and technical specialties.

 

Margin Compression – the Master Builder Returns

Interestingly, there is another trend of involving construction managers (CM) and contractors in the project in the design or even pre-design phase, especially for midsize and smaller contractors.

This concept also includes employment of qualified owner project managers (OPM) to serve as clerk of the works. Some have likened this to a modern version of the ancient “master builder” concept.

Although an OPM increases the upfront labor costs, the value promise is a reduction of final project cost, process inefficiencies and risk of going over budget or schedule. This is accomplished by the OPM challenging the contractor to validate all elements of a project, including budget, the contractor’s margin and the project cost structure. What makes this concerning is the margin compression applied by OPM. Without attractive margins and profits, the financial health of the contracting industry is in question. There will need to be limits on the margin compression applied by buyers of construction services for this method to become common practice.

 

Project Delivery Moves

As the desire to accelerate delivery schedules and guarantee costs intensify design-build (primarily) and availability concessions (secondarily) are becoming increasingly common. A leading legal and policy advisory firm estimates 50 percent of transportation construction projects are delivered as design-build on a value basis. Other government agencies are exploring options such as construction manager-at-risk (CM/GC) to create a “team” approach to the project, speed up the overall delivery and provide a better result.

Just like contractors, owners have reduced the number of people on staff, with the “FMI/CMAA Eleventh Annual Survey of Owners” noting that, “In the view of more than half of all owners, diminished staff resources are a permanent condition.” The result is that owners expect greater support from construction service providers, and they want the lowest price possible. This often means changing construction delivery methods. The options have increased considerably over the last two decades to include design-bid-build (D/B/B), design-build (D/B), construction manager (CM), construction manager-at-risk (CM/GC) with a guaranteed maximum price, and the more recent addition, integrated project delivery (IPD).

 

Pre-Qualifying

The definition of a heavy civil firm will evolve and morph over time as the distinction of roles and responsibilities is blurred between design and construction. Preference, intentional or not, is being given to the largest firms and joint ventures due to resource constraints. Contractors are reporting that, in addition to their traditional competition, they are also experiencing competitive pressure from national firms, large joint ventures and the occasional international firm.

Even if construction projects are not being treated as commodities, owners are still looking for the lowest bid. When times are tough, owners are more willing to take the chance that the contract will protect them from risk; and contractors, hungry for business, will cut prices even at a loss. Not all owners are moving to low-bid methods of procurement. Some are considering alternative materials and methods to save money, especially as material costs have continued to rise throughout the recession. Savvy owners are concerned about poor quality and missed schedules. The risks are too high for owners to take the chance that the lowest bid is not the best-qualified bid. If a contractor fails in the middle of a bridge or highway project, the cost for delays is extremely high. In addition, structural failure in any of these projects is potentially catastrophic. Therefore, many government agencies use a pre-qualified bidder process to ensure best value.

 

Looking to the Future

There are many trends and economic forces that are here to stay: sustainability and green construction, reduction of energy use, industrial technology use, consumer buying power and the Internet consumer market, scarcity of raw materials and growing populations.

The trend toward larger and bundled projects is bringing about changes in delivery method and financing. An advantage is that more design-build, CM/GC and IPD can reduce risk, as well as improve project success for all involved. In addition, the master builder concept can help protect owners from process inefficiencies and the risk of going over budget and schedule. Competition will continue to be fierce and owners will continue to be demanding. The push toward commoditizing construction may continue. However, the trend toward large and complex projects should bring back awarding projects based on the best value in relation to qualifications and experience, rather than just low, low prices.

With little prospect for consistent, long-term funding and increased competition, small to mid-sized contractors are feeling intense pressure. Many engineering and construction executives are being forced to decide whether to develop niche specialties, move up by diversifying or move out, selling or closing their business. The result is an accelerated contraction of the industry as smaller service providers are acquired or exit.

Regardless, this apparent future offers an effective way to control costs. The thriving contractor of the future will be a dynamic innovator in all aspects of their business, making them an attractive partner for the owners who need, want and value professional construction services.

 

Brian Moore is a principal with FMI Corporation, consulting with contractors and construction materials producers on strategic, organizational and operational issues. Contact at (919)785-9269 or bmoore@fminet.com.

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