Profitability Equals Viability

Profitability Equals Viability

 

Dateline:             Engineering News Record, August 26, 2020,

Debra K. Rubin and Peter Reina

“…As it moves away from lump-sum contracting, in the wake of project charges and recent quarter losses to focus on higher-margin engineering, Montreal-based SNC Lavalin Inc. has named Robert E. “Bob” Alger, former president, CEO and chairman of Lane Construction, as president of its infrastructure projects units…charged with overseeing the completion of the firm’s lump sum contracts… 

 

The contractor is about three years away from totally withdrawing from lump sum operations in EPC contracts, which accounted for about 25-30% of sales in recent years, says its president and CEO Ian L. Edwards…

 

The firm reported it lost $84.5 million in the quarter, noting impact from still remaining fixed-price work and restructuring charges in shrinking locations and staffing in its energy and resources businesses. 

 

SNC-Lavalin Group will no longer bid on lump sum turnkey construction projects and will restructure the company. Interim CEO Ian Edwards stated that fixed-price contracts are the “root cause … of performance issues,” adding further: “I think the current model within our industry is broken.” 

 

Time to Take A Closer Look

I have recently been warning the industry about the probable depth and length of this current and sudden market downturn and suggesting one remedy might be a renewed focus on profitability rather than a continued top-line emphasis. With ever shrinking margins plaguing the industry and some small and med-size firms already operating with insufficient capital, the example above of SNC-Lavalin’s shift in risk assessment is a wakeup call to all small and medium sized contractors. Trying to be the low bidder on lump sum turnkey construction projects is a strategy that didn’t work for an enormous firm like SNC-Lavalin and similar losses could easily sink undercapitalized smaller contractors.

Lessons from Large Firms

  • HNTB attorney states, “From my perspective in the legal department of a large national engineering and design firm, these pullbacks are not a surprise.  For too long, owners have been flowing down inequitable and unsustainable risk to the design-build teams while reaping most of the benefits of these delivery systems.” (Jamie Peterson, Senior Attorney & AVP, HNTB Corporation, Oakland, California)
  • Granite Construction announced a large Q2 loss in August last year resulting from legacy fixed-price projects in its heavy-civil group, and CEO James Roberts stated, “it is now clear that, especially in the context of these megaprojects, the fixed-price design-build contract delivery model and public-private partnership model resulted in an untenable imbalance in risk sharing.”
  • Fluor reported a large loss in Q2, last year and in September, 2019 announced the results of a strategic review that included plans to limit or end its pursuit of fixed-price projects across multiple market sectors.  In announcing its new project criteria, Fluor stated, “for lump-sum projects, the terms and conditions must have an appropriate allocation of risk between client and contractor….”

No More Low-Bid/Fixed-Price

This current market downturn is the perfect opportunity to rethink how you acquire business. If your marketing department and estimators are set up to aggressively bid lump sum contracts, now is the time to redesign their function to think about risk allocation and best value procurement.

Equitable risk allocation is by its nature subjective, but common factors cited for determining how to allocate risk include: (1) which party can best control the risk and its consequences, (2) which party can best foresee and bear the risk, and (3) which most benefits economically in controlling the specific risk.

Best-Value Procurement – Simplar characterizes the principles behind a best-value procurement approach like this:

“The ability of contractors to more clearly differentiate their expertise from competing firms is a critical skillset. Contractors who develop proficiency in this skillset will more consistently improve their competitiveness in best value procurement scenarios, thereby potentially increasing their hit rate and unlocking opportunities to grow both their business and profitability. Intuition holds that certain strategies, approaches, and types of qualifications-based content are more effective at communicating construction expertise to owners, and that these are learnable techniques contractors can employ to improve the corresponding owner evaluation scores they receive.” (What Wins Work? Developing More Competitive Proposals: Relationship between Contractor Qualifications and Owner Evaluation Scores, Simplar)

A New Profit Paradigm

“Getting down to business” in the aftermath of this COVID pandemic means only one thing; focusing on profitability and capital preservation rather than top line growth. Trying to be low bidder on fixed price contracts is an outdated business acquisition paradigm that even the largest contractors are forsaking. Best value procurement that focuses on being the most qualified contractor to do the job and properly assigns risk to the party that can best foresee and bear the risk, is the new acquisition paradigm that focuses on job profitability rather than revenue growth.