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

I 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, I spent my early days as a consultant patching up systems or procedures in construction firms that were disheveled. In fact, a large amount of my time was spent on complete turn-arounds.

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.

I 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.

1. A company has proper risk controls in place and is successful/profitable
2. A company does not have proper risk controls in place and is successful/profitable
3. A company has proper risk controls in place and is unsuccessful/unprofitable
4. A company does not have proper risk controls in place and is unsuccessful/unprofitable

The Success Paradox

The term “Success Paradox” has been used to refer, among other things, to individuals that are economically successful not being as happy as those less economically well-off, to the increased vulnerability of developed countries to diseases such as measles, and to the concept that an enterprise, such as a poverty NGO, can put itself out of business if it is successful.

All these references are useful, but our use of the term is specifically in reference to situations where a risk is present and successful mitigation of that risk, in hindsight, reduces the risk’s perceived importance. One great example is the Y2K problem. Since there were no major catastrophes related to Y2K, there is a tendency for people to assume it was not really a problem in the first place! However, the fact that no catastrophes occurred might also be attributable to the excellent risk mitigation efforts of thousands of companies and individuals working diligently to fix the exposure.  In essence, effective ERM can cause a business to run very smoothly, which actually lessens the perceived value of the ERM implementation.

The Four Quadrants

In the first quadrant, effective ERM leads to enterprise success.  This quadrant describes a company that is maximizing long-term profitability.  If management understands the role that effective risk controls played in the success, they will appreciate its importance.  However, it is often the case that the perceived importance of the risk controls will be diminished, just as Y2K controls were downplayed after a relatively uneventful Jan 1, 2000.  This is the Success Paradox.

The second quadrant, however, is slightly different in that it deals with chance/luck. It is analogous to Russian Roulette.  In this situation, a Russian Roulette play might assume there is no danger to the game because no damage occurred from his “turn”. In a sense, he is still successful/profitable, but that does not mean his actions were risk free, or that he made the right decision to play. He just got lucky, which is the operative word; he could very well have died.

The third quadrant, is one we rarely encounter.  With effective risk controls in place, companies rarely are unsuccessful.  They may go out of business, but this is usually due to, among other reasons, wanting to exit the industry or simply shutting down due to retirement.

The fourth quadrant is one in which poor risk management controls and operations lead to business failure.

Prevalence

Because effective risk controls do not exist in most businesses, quadrants one and three are the most rare.  Companies in quadrant one are usually at the top of their industry.  They have spent a good deal of time implementing effective risk controls and have excellent long-term strength and security to show for it.  They rarely experience business failure, more commonly just closing up shop in an orderly business when they decide to exit a business.

The second quadrant is the most prevalent in the business world, and especially in the construction industry.  Most companies skate by with ineffective risk controls in place; they may stay in business but do not maximize long-term profitability and remain susceptible to numerous risk exposures.  Unfortunately, many of them are not so lucky and find themselves in the fourth quadrant.  That is why tens of thousands of contractors go out of business each year; poor risk controls leading to undue exposure to risk.  Millions more simply get “lucky” and remain to battle the risk gods another year.

Our goal with MyRiskControl.com is to make quadrant one the most prevalent in the construction industry.  How do we do that?  By making ERM simple, affordable, accessible and easily manageable.  In essence, by bringing ERM to the masses and an extremely cost effective manner.  Speaking of costs, we’re often asked what the typical ROI is for implementing an ERM program.  Unfortunately, this isn’t an easy question so it will be the subject of a future post.