Guaranteed Waste

We are all prisoners of our history. Our culture, built on unquestioned beliefs with which we define reality, shapes our behavior.

In the construction industry, the culture is deeply contentious. Owners try to extract the last nickel out of contractors, contractors try to squeeze the last nickel out of subs, the lawyers lard contracts with buried indemnification clauses because no one wants to accept any liability for anything and when something goes wrong, the accusations, claims and lawsuits fly thick and fast. Somehow in the midst of all this the ultimate aim of the whole construction process appears to be lost: to create a benefit to an owner, his or her customers, and the community.

This contention and resulting waste costs the citizens of our country billions of dollars per year. This waste is not anyone’s fault; it is a product of the industry’s history. It is built into our culture.

Let’s look at an example.

Anyone in hard bid construction knows that bidding is so cutthroat you can’t have any margin to speak of in your bid and still get the work. How do you make a profit? Any profit you make will be in change orders and claims. This means the contractor and the customer are starting out with a conflict of interest. It is in the contractor’s best interest to work strictly to plans whether they make sense or not. In fact, the contractor has a financial incentive to hope the plans make no sense. The resulting rework required is then a change order or a claim on which the contractor can make at least some profit.

But what about the owner? The owner’s budget and schedule is now blown, but that’s not the contractor’s problem. Is it any wonder the owner takes a contentious stance?

How could the interests of the owner and contractor be brought into alignment? The contractor wants to maximize profit. The owner wants to minimize cost. This appears to be an irreconcilable structural conflict. To find the resolution we have to look at our assumptions.

The owner assumes that cost will be minimized through the competitive bidding process. We know this assumption to be fallacious. How many contractors worry when they win a bid that they only won because they have left something major out of their estimate? How many contractors who may be financially marginal bid low on the project just to keep their people busy? How many contractors may not be the best qualified to do the job and bid low because they don’t really understand the job? All of these situations put the project at risk. We also know the less margin there is in the bid price, the more aggressive the contractor will have to be with change orders in order to prosper in the project.

What owners seem to lose sight of is the real cost of a construction project is related far more to throughput than cost. If a $20 million retail development project is scheduled to take a year to build and it takes 18 months, what is the real cost of the project? Change orders and claims aside, it is six months lost revenue on the project. When you look at lost revenue, factor in claims and change orders, and the cost of capital, the total cost can easily be 50 to 100 percent greater than the original contract price. The delay of benefit applies to a homeowner who loses months of the pleasure of living in his/her new home, the commercial developer who loses rents, the plant that can’t produce products, and even public works where the community loses the benefits of infrastructure that supports the economic life of the community.

The real focus of construction should be time. How do we minimize the time it takes to build something? Owners need to shift their focus away from dollar cost to time cost. Contractors should commit to time schedules with the expectation that they will make money if they complete on time and lose money if the project is delayed. The owner’s interest should be working with the best qualified contractor who makes the strongest case that he/she can deliver the job on time. Owners should be happy to let the contractors make a reasonable profit as long as they are not delayed in getting the return on their investment.