We begin this week with the first “belief” on last week’s list – “Growth is always good “. The complex nature of the construction industry seems to lend credence to this belief. Since a construction business does not enjoy a “continuum” of business, contractors must hop from one job to the next to keep the company afloat. That’s simply the nature of “contracting” – signing new contracts one after the other. Growth, therefore, sneaks into the contractor’s belief system by masquerading as new business every time a contract is signed. “If getting one new job is good, getting three new jobs must be better.” Makes sense.
Until It Doesn’t Make Sense
Believing that “you must grow to survive” is a common misbelief among contractors. As far as that simple statement goes, it makes sense. However, research over decades while completing failed construction projects for sureties revealed that growth was only good when it was carefully managed. Most of the contractors who had abruptly failed and left projects unfinished had done so because they were not managing the growth their company was “enjoying” over the previous years.
The Research
Whenever my firm was sent in by a surety to take over and complete construction projects interrupted by the sudden financial failure of a contractor, we would also initiate research into why the contractor had failed. An initial step was to review the contractor’s last five years’ financial statements trying to discern what trends could account for a successful contractor suddenly failing.
The immediate cause was always that the contractor had suddenly run out of money and could no longer sustain normal business operations. The question we wanted to answer, however, was why did this contractor, successful for many years, suddenly run out of operating capital?
The research revealed that the cause was never some unexpected immediate circumstance. It was always a long series of questionable decisions based on erroneous beliefs that the contractor held – particularly about growth.
Bad Beliefs Lead to Bad Decisions
Most of the failed contractors:
- Took any job they could get. (Biding too low if necessary to get the work).
- Took jobs that they didn’t have the capital to finance. (They usually didn’t know this because they rarely did a forward working capital analysis.)
- Took jobs that they had little expertise in building. (Based on an erroneous belief that “We can build anything”.)
- Took jobs that were located outside of their normal operating geographic area. (Another erroneous belief that “We can build anywhere”.)
- Took jobs that were substantially larger than their normal size. (This seemed to be a common mistake since they all shared the belief that growth is always good and rapid growth is even better).
Artificial Intelligence
Analyzing five years of the failed contractors’ financial statements to uncover decision making trends that led to accumulating losses and capital erosion was an early do-it-yourself form of artificial intelligence.
- It enabled us to see the gradual negative impact on capital caused by aggressive low bidding resulting in too many marginal jobs slipping into the loss category.
- It revealed a downward trend in capital available that coincided with an upward trend in job size and complexity that required more capital to finance to completion, not less.
- It showed how the unexpected and unaccounted for expenses required to complete jobs that were out of the contractor’s normal operating geographic region had a devasting effect on expected profits. To make matters worse, every time contractors left their normal operating area, they would lose money and not know it because the unassigned losses were buried in the front-loaded cash flow of the next project.
- We discovered another unnoticed trend in capital erosion when contractors took jobs they had never attempted before. What they didn’t seem to realize was their estimators were working outside their area of expertise, and the contractors didn’t recognize the gap between their expected expenses and actual expenses until the jobs were well along. Often, they didn’t experience the losses until the jobs were completed, and all the final invoices were in and accounted for. Then it was too late to do anything about it. Especially if they were busy on the next job that may have been bid too low to keep cash flowing to cover the job losses accumulating from other jobs the estimators had mispriced.
When Is growth Good?
We discovered by using our early homemade artificial intelligence that growth is not always good. Only well managed growth is always good.
Next week we’ll talk about how to manage growth.
For more information bad beliefs, read more at: BAD BELIEFS
For a broader view of well managed growth, read more at: GROWTH
To receive the free weekly Construction Messages, ask questions, or make comments contact me at research@simplarfoundation.org.
Please circulate this widely. It will benefit your constituents. This research is continuous and includes new information weekly as it becomes available. Thank you.
