Construction Failure: Why Contractors Fail

The construction industry is full of unending challenges, requiring high energy and constant problem solving.  The company owner is like a juggler with 50 balls up in the air (potential problems); if any drop (actual problem) it could cause all the rest to drop as well (total problem i.e. business failure).

The large amount of potential problems, combined with low industry margins, is undoubtedly a major reason the construction industry has one of the highest failure rates (right up there with restaurants). Unlike companies in most industries, though, contractors usually don’t fail because of poor products or service.

Why Contractors Fail

Sure there are some cases, but in general, contractors don’t fail because of poor construction. Most contractors build a decent building. After all, they have to follow rigid design specifications and plans and have to undergo inspections. So if they don’t fail because of poor building practices, then why do contractors fail?

In simple terms, it is because of poor business practices. Many construction companies are started by project managers without specific schooling in running a business. They know how to run a job, but haven’t been taught to run a construction company. To compound matters, there isn’t really much formal education offered in running a construction company. Frankly, there should be a college major for it.

Finding the Root Causes of Failure

Every company has a bunch of business practices, and if those business practices are properly in place, the company will maximize its ability to make a profit. All those business practices (or things you need in place) are called risk factors.

That is the heart of Enterprise Risk Management: Every process, practice, system, procedure, or activity that takes place in a company must be working perfectly to maximize profitability. Obviously, this sort of perfection is impossible, but it is (or should be) a goal for every company.

So, we started on a quest to uncover the root causes of business failure. We began by identifying all of the major contributing causes for loss based upon our years of experience and sought out publications and other professionals who could serve as resources for further adding to the list.

We knew that all causes of loss could be fixed by putting a business practice or control in place and that if those controls or practices weren’t in place, it could cause a business to fail. Conversely, having all the necessary controls and practices in place would provide a business with the greatest ability to generate profits (to maximize profitability).

With a greater understanding of how controls impacted profitability, it became clear that the effectiveness of existing controls at a company had to be assessed to determine the degree the company was at risk of failure. This is, in fact, what the Enterprise Risk Management process does and what risk management was intended to be long ago.

Reactive Management

Just like financial advice is sought after a portfolio has shrunk or a financial dilemma has occurred, and business analysts are brought in after a company has lost money, we spent our early days as consultants patching up systems or procedures in construction firms that were disheveled. In fact, a large amount of our time was spent on complete turn-arounds.

It made us feel like lawyers, always looking in the past at what went wrong rather than looking toward the future and preventing problems from occurring. That really isn’t the best business philosophy… that is, to bring in an expert after something is messed up. A much better business philosophy is one that prevents “mess-ups” from occurring in the first place, which is why Enterprise Risk Management is so well suited to construction.

Proactive Management

Enterprise Risk Management identifies potential causes for loss well in advance so they can be addressed before harm occurs. This is a large shift from the thinking of fixing problems once they occur. That is the beauty of ERM. It prevents problems by recognizing weaknesses while they can still be corrected. That said, most contractors continue to unknowingly risk profits by failing to inspect systems and controls that could cause future problems.

Let’s get back to our project manager turned business owner. Without the proper educational tools or experience actually running a company, his chances of survival are low, which is exactly what the statistics show. To increase his odds, he should study the business practices (risk factors) necessary to run a construction company effectively; there are at least 79 which are important to a company’s success.

We encourage any contractor interested in preventing problems rather than patching them to consider adopting an ERM process and the philosophy of enterprise-wide risk management. It’s a sure way to strengthen business fundamentals and maximize potential profit.