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, 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.

This weeks Case ‘n Point (and first ever) reveals the painful truth about being too relaxed with risk control. The lesson of our story illustrates how Enterprise Risk Management is shadowed by its own success. As always, the names of those involved have been changed.

The Risk Victim
Xcavator Inc has been in operation for just under a decade. Its strong reputation places it on top of local GCs’ calling lists when excavation and grading work is needed. Unfortunately, management is a bit closed-minded to installing risk control procedures.  Xcavator Inc has been lucky during its last few years of growth and has grown a little cavalier, mostly due to effects of the success paradox. But all games of Russian Roulette must come to an end.

The Risk Impact
While grading for a public works project, Xcavator Inc hired a third-party to off haul dirt from the construction site. The expense for off hauling dirt wasn’t part of the original contract, but Xcavator received a verbal change order from the public agency’s construction manager to incur the extra cost.

The bill for off hauling came to $20,000 and Xcavator Inc added the additional expense to its next invoice. But the public angency rejected the extra cost, stating that it hadn’t approved the change order. Xcavator Inc tried to produce a valid change request, but since the order was verbal, none could be produced. And to compound matters, the construction manager who had given that verbal order was no longer with the agency.

The Lesson
Faced to absorb the $20,000 expense, Xcavator Inc management set out to lay blame. Ultimately, the superintendent had blame for ordering the hauling company to begin work. With proper controls, there should have been at least two responsible parties: the superintendent making a request and the project manager approving the request.  Lack of a written change request should have been a red flag for one or the other responsible parties. This weakness would have been uncovered by the MyRiskControl system during a review of the Contract Non-compliance risk factor.

This story helps illustrate how Enterprise Risk Management shadows its own success. Xcavator Inc learned a hard lesson. Whether it begins to get serious about installing risk controls has yet to be seen. But even if it does, the reward for installing controls after a disaster is greatly reduced. However, if the controls were in place from day 1, we would never know the value Enterprise Risk Management can have.