Get out of the building business
US-based industry expert Ted Garrison says it’s time for contractors to give up the business of construction or get savvy, by competing on value rather than price
Telling contractors to get out of the building business may appear to be a brash statement, but on careful review, the idea is sound.
However, the statement isn’t about telling contractors to stop building. It’s about getting them to focus on a more important goal, namely solving client problems that involve construction services as part of the solution.
You may have heard the comment that when someone buys a drill, he is really buying a hole. For years many contractors purchased coreboring equipment, but they found that was a very costly and inefficient way to drill a hole in concrete as inexperienced workers often tore up the expensive bits because they did not know what they were doing.
In contrast, today, most contractors hire a specialist to core drill their holes because they have learned it’s more cost effective.
The low-bid process doesn’t even guarantee that construction costs will be lowest after change orders, delays and quality problems are resolved and litigation costs are applied”
This idea is not an American idea, nor is it a European-, Australian-, Asian-, or a Middle Eastern idea; but rather it is an idea that has worldwide application.
Khaled Musaed el-Seif, the chairman of El-Seif Construction and Engineering and one of the most highly-regarded individuals in the construction industry in the Middle East, reported on the changing construction industry in an interview as the chairman of the committee on business development for the Riyadh Chamber of Commerce.
“But it is not standard construction. These opportunities are not construction contracts. This is very sophisticated work that includes the construction and development of highly-complex projects. So construction companies will have to change for these opportunities. These projects require developers, contractors and financial institutions to get together to form project companies,” he said.
Price pressure
[facts]
Construction Costs
30%
Costs are thought to have fallen 30% in UAE during crisis
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All over the world, the pressure on contractors to reduce their prices is intense. This has reduced profit margins to levels that are insufficient for the risk involved. For example, in 2005 in the midst of the last construction boom, Forbes magazine reported that the ROI for the largest construction market, the US construction industry, was 9.6% as compared to 16.7% for all US industries. While it’s difficult to obtain exact Middle East figures, all indications point to similar figures. The industry is truly international, and contractors go where the greatest opportunities exist, so profit margins become level around the world.
Despite the fact numerous studies reveal that the low-bid process doesn’t create overall lower project costs, the myth persists.
US professor Edwards Deming began his campaign as early as the 1950s to eliminate the awarding of work based on price. He argued that suboptimisation, in our case awarding work to the lowest-priced contractor, while it may reduce costs on the suboptimised task, often leads to higher overall project costs.
Worse, the low-bid process doesn’t even guarantee that construction costs will be lowest after change orders, delays and quality problems are resolved and litigation costs are applied. Unfortunately, too many owners have the mistaken belief that all contractors are equal because they are required to follow the plans and specifications. All contractors are not equal, and the construction process is too complex to rely on any single entity to prepare and design the best solution.
However, the bigger challenge for higher-performing contractors is not the low performer, but the need to differentiate their performance from other high-performing contractors. Regardless of how great their performance, if they can’t differentiate their services; they will still be forced to compete based on price. The reality is that most high-performing contractors are using the latest techniques and technologies and offering a high-quality construction product with similar costs and schedules. The only variable is the profit margin, and if that’s the only variable, then the pressure to reduce it becomes intense.
Outthinking competition
The only sustainable answer is a new strategy, one where the contractor can outthink its competition instead of outmuscling it in a destructive price war. To achieve this, contractors must think of their businesses in broader terms than the lowest common denominator, namely the building process. Railroad construction declined in the 20th Century because railroad executives thought they were in the railroad business. When the railroad developers accepted the fact they were in the transportation business, their resurgence began.
Contractors must learn to think and operate as a problem solver where construction is an integral part of the solution. This approach allows the contractors to offer greater value to the client and avoid competing totally on price.
Contractors must stop attempting to compete by building the cheapest structure. Instead, deliver the structure with the greatest life-time value for the prospect”
To illustrate how this can work, let’s look at a new factory project. A manufacturer wanted to build a new 100,000ft2 factory to replace its existing one. Three contractors were invited to make proposals, but all the estimates came in over budget. Two of the contractors attacked the problem the conventional way; they began value engineering the factory’s construction design. Maybe they could find 5% in savings, and if they found more than their competitors, they might get the job.
The third contractor took a different approach and hired a lean-manufacturing expert. The contractor had the lean consultant go through the manufacturer’s existing facility. The lean expert reported that he could improve the manufacturer’s operations and reduce its operating costs, in essence, make it more competitive in its business and do this in only 90,000ft2. When the contractor went back to the manufacturer with that information, the selection process became obvious. Not only did the winning contractor substantially reduce the construction costs by reducing the size of the building, but it improved the manufacturer’s profitability going forward beyond the capital savings. Further, the winning contractor wasn’t forced to squeeze its profit margins because it provided sufficient value for the client. This is a perfect example of a win-win scenario.
Author Peter Drucker wrote that there are two skills that every company needs: marketing and innovation. He was not writing about your brochure or your advertising campaign, but your market research. The idea is the contractor that best understands the prospect’s true problem or needs through both research and communication with the prospect has a better opportunity to develop the most innovative solution for the project. This approach is about competing on value, not price. Contractors must stop attempting to compete by building the cheapest structure. Instead, deliver the structure with the greatest life-time value for the prospect.
Integrated project delivery methods produce superior results because they allow all the stakeholders to put their heads together to define the problem then create the best possible solution.
It allows for collaboration and innovation, two fundamental principles of superior performance. Many countries are moving toward public-private partnerships to build infrastructure projects because this collaborative approach produces superior results and is what el-Seif described. The construction industry must start asking a significant question before starting any project: Why are we doing this project? Obviously the owner’s answer offers the contractor the opportunity to differentiate itself in how it addresses that need. However, the contractor should also ask itself that question because unless it can offer a reason it is the logical choice for the project, it will be forced to compete on price.
PROFILE
Ted Garrison is a construction industry expert who writes, speaks and consults on the future of the construction industry. he is also the host of the internet radio programme New Construction Strategies. he can be reached at ted@tedgarrison.com.
