In the fast-paced construction industry, slowing down might just save you in the long run.
Taking the time to set up risk management systems and infrastructure is crucial to protecting the value – and helping the long-term profitability – of your construction company.
So, don’t let your unsuccessful projects erode the profit from your successful ones. By getting solid, repeatable systems in place early, construction companies can help minimise loss-making projects and maximise year on year growth.
But what systems can you use to achieve this?
A Portfolio Approach to Construction Risk
Many construction companies have a good idea of the profits and losses on individual jobs. However, it’s the company-wide picture that’s going to give you the best ability to assess risk and opportunity.
A portfolio approach to risk involves looking at multiple projects or company activities as a whole, rather than on a project-by-project basis.
If you treat the projects under your company as a portfolio, you start to see the bigger picture. Much like an investment portfolio, your construction projects are likely to involve a mix of risks and potential rewards. Balancing how much of each you have at any one time is the key to a manageable, sustainable portfolio.
The portfolio approach examines the risk-reward ratio of each project and ensures that you have the right mix of ‘risky’ and ‘safe’ projects.
Once you understand your appetite for, and the company’s ability to take on, risk you can start to examine potential new work from that perspective.
For example, if you believe that working in a particular area (say, large infrastructure work) is particularly risky for your company because of the required resources, you could sensibly limit the amount of that work you had at any given time, and ensure that you balanced it with less intensive projects that could provide stable cash flow. You might strategically decide to only have 1 such project going at any given time, on the understanding that if things went south on the job your company wouldn’t be on the line.
Systems to manage profitability
Detailed below are the key systems that have been proven to work, and actions you can take to implement/improve these systems.
Corporate governance framework
We each make thousands of decisions a day, some more important than others. As your level of responsibility increases so does the multitude of decisions that comes with it.
A functional corporate governance framework allows the right decisions to be made by the right people, rather than putting all of the final decision making for everything in the hands of just one (or a few) people. It works like a decision tree, branching out the processes of review and how far up the line you may require approval for those decisions to be made.
Frameworks provide a structure to drive the strategic plan. They ensure that timely and accurate information is disclosed on all material matters and expose gaps or weaknesses that may exist within the team.
In the absence of a corporate governance framework companies may lose board oversight of operational, reporting, and risk management processes. This can be detrimental to its long-term profitability and prosperity, as it’s inevitable that at some point the board will get blind-sided by some major problem that was preventable.
For example, a construction company may become so preoccupied with the engineering and technology of their projects that it fails to consider business and risk fundamentals.
So what actions can you take to improve your corporate governance?
- Participate in a corporate governance workshop.
- Agree the terms of a corporate governance framework (decision-making).
- Introduce the corporate governance framework to the business.
- Apply the corporate governance framework when making key decisions for the business or within projects, with periodic review.
Contract Administration
Contract administration involves establishing systems for management and oversight of a construction contract from start to finish.
Not knowing entitlements and obligations under a contract is one of the key reasons that projects end up unprofitable.
From sending compliant and timely notices to understanding how to ensure site directions are properly documented, compliance with the contract can make or break your project.
And when push comes to shove, should the date of practical completion be delayed for any reason, all eyes will shift to the clauses laid out in the contract and whether or not the contractor is entitled to more time.
While the contracting parties and contract terms may vary depending on the job, it is crucial to have a key checklist in terms of what clauses you will and won’t accept, and to consider how you will manage that risk moving forward.
Following a proven contract administration plan will help you reflect on the relationship between clauses, assess the overall contract risk, propose amendments as needed during negotiations, and make decisions throughout project delivery with your contract risks in mind.
How to manage your contract:
- Establish and apply a contract review management system.
- Brief the project delivery team on the key risks in the construction contract for the project and ensure they are trained on the key terms.
- Prepare a contract roadmap document summarising the key risks.
- Implement periodic contract/ project administration reviews.
Insurance coverage
Insurance coverage is confusing to everyone, so having a complete understanding of your insurance framework is critical to protect your company’s value.
If there is no cover when you need it, the hit your company might take could be fatal. It is common for companies to get caught short, believing they have coverage when in reality they do not. This isn’t helped by the fact that insurance contracts are notoriously complicated documents.
A significant risk is posed when entering Design & Construct projects without carrying your own or any professional indemnity policy. Having your own policy as a contractor, means your insurers will step in and compensate for any claim you may have to make (and hopefully cover your legal costs as well).
With the right insurance coverage, you can lower the risk of a given project and perhaps put it in a safer “category” for your project portfolio.
What does your insurance cover?
- Identify your umbrella policies and project specific policies.
- Keep a record on what the construction contract(s) requires you to get cover for.
- Obtain a summary of your coverage, and a brief on the gaps in your coverage.
- Understand the exclusions, exceptions, and coverage limitations in your policies.
Legislative compliance
Legislative compliance is about ensuring that an organisation is following the laws, regulations, and standards relevant to its operations.
This can include laws related to construction licensing, health and safety, environmental protection, employment practices, data protection, and many others.
The impact of non-compliance is significant. It is more important than ever for all relevant team members to understand the legal compliance framework in which you operate and ensure that your company complies accordingly.
It would be quite devastating to bring forward an adjudication application for your works, only for it to get thrown out the window because you are not properly licensed. Believe it or not, this happens more than you would think.
Knowing the compliance framework in which you operate is critical for the long-term profitability and success of your business.
So what can you do:
- Carry out a compliance audit (first identifying the scope of your business – work type, geography etc)
- Agree the terms of a compliance framework (legal compliance):
- What laws govern what you do?
- What licences or other registrations do you need?
- What steps must you take to preserve your legal entitlements?
- Implement / apply the compliance framework.
- Periodically review the compliance framework
Link between system failures and low value for construction companies
There is a direct relationship between profitability and your company’s value. A lower company value means damage to your exit strategy, impact on your finance terms, changes to investment opportunities for incoming business partners or joint ventures, and less stable footing on which to explore larger more risky projects.
Company value is the economic value of a company. While this seems like a pretty straightforward concept, there are many factors that determine your company’s value.
These factors include:
- Revenue and earnings (that long-term profitability we spoke about earlier);
- Debt;
- Growth potential;
- Assets and liabilities;
- Cash flow;
- Industry and market conditions; and
- Risk factors.
This valuation is particularly important when it comes to things such as mergers and acquisitions, raising capital, financial reporting, and investment analysis.
Failures of these systems (corporate governance; contract administration; insurance coverage; and compliance) are some of the many key causes of poor profitability.
By adhering to these frameworks, you will optimise your construction company’s value in the long run.
Are you Pulling the Right Value Levers?
Companies that employ and maintain rigorous standards in these areas build effective protections into their business’ core, which could just prevent them from going down if a project turns sour.
You might also just see that over time these systems can not just minimise financial risks, but ultimately have a positive impact on your overall profitability.
If you think you might be leaking profit through any of these areas and want to start exploring opportunities your business has, get in touch today.
