Construction has a Project Failure Problem, and the Solution is . . .
November 12, 2018
Project failures, inefficiency, cost and time overruns and litigation problems plague the construction industry. Despite long-term investments and efforts to "cure" its project failure rates (defined as failing to deliver in-budget and on-time), its stagnant productivity and wasteful cost overruns--failure remains the most likely outcome. These are critical industry problems that persist virtually unaffected by improvements in project management training, software, technology, cloud-based management tools, mobile apps and improved communication options. The reason is not because these innovations are not beneficial. The reason is because they miss the mark. They fail to address the driving force and actual causes. The industry needs a makeover! It needs anew understanding and business model. It needs a fundamental paradigm shift in how it operates.
This article proposes (1) that the improvements made so far have failed to "turnaround" the majority project failure rate because they fail to address the primary causes of project failure, stagnant productivity, persistent cost overruns, and costly disputes and litigation plaguing the industry; (2) that an alternative approach directed at the primary causes underlying these critical industry problems is needed. (3) that the solution requires a fundamental change in risk management and the treatment of subcontractors.
I: The Status-quo is Broken
Industry study after study and survey after survey come to the same conclusion: Project failures are a majority outcome. Various solutions have been implemented, but the result remains the same: Projects continue to under-perform and fail; productivity remains stagnant.
The construction industry is stuck in a quagmire of inefficiency and over-budget, past-due project delivery. It delivers only about a third of its products (i.e., its projects) within budget and on time with some sectors even worse. Despite concerted efforts over the years to improve performance, construction continues to struggle, to cost more than it should, with little change in the outcome.
According to a major industry sturdy, under-performing projects and project failure are the majority result. This survey of Owners revealed that:
53% suffered one or more under-performing projects in the previous year.
For energy / natural resources and public sector respondents the figures were 71% and 90% respectively.
Only 31% of all respondents’ projects came within 10% of budget in the past 3 years.
Just 25% of projects came within 10% of their original deadlines in the past 3 years.
With respect to overall investments made to address and resolve these problems, KPMG states:
"The significant investment in project controls – and the high levels of confidence that many owners have in these controls – have not halted the run of underperforming projects. Over half of all the respondents state that they suffered one or more underperforming projects in the previous financial year. For larger organizations, this rose to 61 percent, while executives from the energy and natural resources and public sectors experienced even higher levels of project failure, at 71 percent and 90 percent respectively. [Source: KPMG]
Construction projects vary substantially in value, scale and complexity, and the larger the project, the more challenging it becomes, and the more likely it is to fail. Megaprojects, those costing over $1 billion, are in a class of failure all their own. At the megaproject scale and complexity of construction: “Nine out of ten megaprojects have cost overruns. Overruns up to 50% in real terms are common, and over 50% overruns are not uncommon." [Source: What You Should Know about Megaprojects and Why: An Overview Bent Flyvbjerg, Oxford University, UK].
Nonetheless, failure is an equal opportunity result and can happen to any construction project, and it happens far more often than not. It is a given that all projects are "planned" and have set budgets and time parameters, with the clear intent of meeting those objectives. It is therefore reasonable to measure project success and failure as to whether the cost and time metrics "as-planned" versus the project "as-built" survive to completion or not.
Project success = to deliver the project within budget and on time. This is what contractors are contracted to do. That is what they promise. That is the optimistic expectation upon the initiation of every project.
Unfortunately, successful projects are the minority. Undoubtedly, construction is highly competitive, unique and complex enterprise, as its cost / time predictions and conducting of business is in the "messy" uncertainty of the natural environment. This natural environment does not afford the same level of control and predictability that other industries enjoy. Yet, no other industry sector could continue to sustain anywhere near construction’s rate of failure without being forced to improve, re-tool and re-invent itself.
Nonetheless, for building, renovations, capital improvements, the construction industry is the only option available--success or failure, cost overruns, delayed delivery and in some cases, business value, be damned. With rising construction demand World-wide, especially in infrastructure, improving performance and project delivery are essential to meeting rising demand. However, the status-quo dynamics of the industry must change to make it happen. Demand is outstripping the ability of the industry to meet that demand.
“McKinsey estimates that the world needs to spend about $57 trillion on infrastructure by 2030 to enable the anticipated levels of GDP growth globally. Of that, about two-thirds will be required in developing markets, where there are rising middle classes, population growth, urbanization, and increased economic growth. These countries need infrastructure, but all too often many years will pass and the promised road, bridge, and metro projects still will not have materialized.” [Source: McKinsey&Company, “Megaprojects: The good, the bad, and the better:]
As the KPMG, Global Construction Survey 2015 shows, less than one-third of projects came within 10% of their budget, and just one-quarter of projects came within 10% of their delivery deadline. And those results include a built-in 10% tolerance variance. Other industry surveys and studies show similar results.
Despite implementing various improvements over the years to facilitate in-budget and on-time project delivery, the majority of projects fail, cost overruns are common, and productivity has not increased in decades. The supposed improvements in technology and digitization, training and certifications, lessons-learned analysis, mobile apps, etc., although necessary, have not translated into measurable improvement to project delivery, productivity, and cost and time management.
According to a McKinsey Global Institute Report, Reinventing construction through a productivity revolution (February 2017):
"While many US sectors including agriculture and manufacturing have increased productivity ten to 15 times since the 1950s, the productivity of construction remains stuck at the same level as 80 years ago. Current measurements find that there has been a consistent decline in the industry’s productivity since the late 1960s."
McKinsey also offers a critical observation on the industries failure to "digitize", although no doubt a beneficial addition, it is highly unlikely to resolve the deep-seated, industry problems:
"In comparison, much of construction has evolved at a glacial pace. Take one example: construction is among the least digitized sectors in the world, according to MGI’s digitization index. In the United States, construction comes second to last, and in Europe it is in last position on the index."
II: Common-sense is Uncommon
Granted, it may not be fair to compare the construction industry to more controlled-environment industries, such as manufacturing. Still, on every metric, construction lags other industry sectors by far. The innovations and solutions implemented are not getting it done. That alone should be cause to reassess to determine the reasons why. To do so, the industry needs to come to terms with, and reassess, its standard operating procedures and practices. It needs a new vision and approach, logical allocations of risk, improved training, a properly allocated and shared accountability, and new business-model. It needs a paradigm shift and make-over. The reasons are self-evident:
When the industry product is to provide "timely, within budget project delivery", and its product failures significantly outnumber successes, that is a problem.
When an industry is so inefficient as to waste $122 million for every $1.0 billion spent due to poor performance, it is a problem (Source: PMI.org).
- When an industry has essentially flat-lined its productivity over the past 80 years, and is by far the least efficient of all business sectors, that is a problem. (Source: McKinsey.com)
When stakeholder disputes become so numerous, unresolved and intractable that ADR, claims and litigation become common place as a means to equitable relief, usually at the end of an often failed project, that is a costly problem. And these escalated and extended “dispute costs” are frequently ignored, and not included in tabulating the cost of project delivery.
When an industry cannot manage and control its work scope, it is destined to fail. Scheduling is initiated upon the unfounded optimism of the "plan", invariably lacking realistic assessments of the as-built reality to come. In practice, scheduling is mostly misunderstood, done poorly, mismanaged, insufficiently monitored and updated, and is mostly “time fiction”.
When an industry is organized to undermine and disadvantage the financially weakest yet most critical of its stakeholders, its performing subcontractors, who collectively perform 85% of all construction work, that is the nexus of the problem!
Stealing a memorable phrase from NASA seems apropos: “Mission Control, I think we have a problem!”
III. A Proposed Solution
Productivity and project success are obviously interrelated, and with respect to solutions implemented so far, have largely failed. The reason they have4 failed is because they missed the mark! They fail to address root causes. This is not due to lack of effort or investment, but merely because the “fixes” have not addressed the operative, underlying problem. If we assume that premise has merit, we must first identify the operative problem, and align the “system” to promote resolution. The solution will then unlock and resolve the interrelated obstacles to in-budget, on-time project delivery.
The solution offered here seems obvious and logical on its face, mainly because it focuses upon the means, methods, process and procedures of scope performance. After all, performing scope within budget and on time leads to project success, and that is of course, the entire industry objective (or at least what it should be).
A Solution Proposal: Since subcontractors perform ~85% of all construction work, then all subcontract agreements, contracting policies, project operations, risk allocations, Owner and General Contractor practices and efforts, must align with and promote subcontractor success. (This proposal is of course, almost the opposite of current industry practices, and is in fact, so contrary to those practices that it would require a complete "makeover:" and paradigm shift. That is the real obstacle. The vested interests like the "system" as it is.).
The construction industry could revitalize and reinvent itself. It could become far more productive, efficient and successful. It could save billions of dollars currently wasted. The keys to making this happen are actually self-evident and simple common-sense:
Owner and General Contractor policies, practices and efforts should be directed towards:
Facilitating subcontractor productivity and ability to sustain that productivity, which will require they act with continued due-diligence to support subcontractors and lessen their usual focus on their own risk aversion and protection efforts.
At keeping subcontractors timely and proportionally paid at all times. The average progress payment today takes over 70 days for subcontractors to receive. That is a huge problem. There is no valid reason why subcontractors cannot be paid within 30 days. The funding is already in place, or the Project would not have been started. Right?
Of ensuring the sequence of project work is always logical and optimized as possible, unimpacted, coordinated, monitored and facilitated. Better training and competence by GC's in scheduling, sequencing, monitoring and control is a must. Subcontractor work performance must be the priority effort and protected, despite the "changes" that arise, the unforeseen conditions and competing agendas of the parties involved.
Prompt capture and mitigation of every performance impact, cost and time burden of every obstacle, change, disruption, delay and unexpected impact as invariably arise.
Use “equitable” Subcontract Agreements: Remove the illogical and broad-form risk transference, undermining terms and conditions, counter-productive financial and legal overreach burdens from subcontract agreements. Subcontractors are over-burdened with risks over which they have no control and no ability to mitigate.
Screen, hire and promote high-performance subcontracting. Stop hiring subcontractors on the basis of price alone. High performance is not a futures traded commodity, and it may cost a little more up front, but will save far more later on. Risk need to be allocated proportionally and solely upon the role and responsibility of each party. Unmitigated flow-down and transference of risk sabotages Project success.
Proper allocation of risk: Risk needs to be allocated proportionally and upon the party’s ability to control and mitigate the risk. Currently, the business model supports the constant, arbitrary flow-down of risk by Owners and GC's simply to avoid their own accountability, in an overly protective concern for their own interests--despite the ultimate cost of the Project, its success or failure.
Change impacts: Deviations from, and changes to the “plan” as arise, will always be disruptive and costly obstacles to productivity and project success. All variances to the "plan" must be resolved quickly and equitably. Resolutions that rest upon the legal contrivances of contracts are not actual solutions promoting productivity and success outcomes, but legal maneuverings and pass-the-buck tactics. If and only if the subcontractor is clearly responsible for a deviation or change from the plan, should they be held responsible, and this assessment must be prompt and fair. The Owner, A/E,GC and affected subcontractors must work fairly together, and promptly collaborate to resolve these impacts, and refrain from force-feeding and dumping on subcontractors when in doubt about the liability and cause of any deviation, ambiguity or change.
No doubt, such an implementation would require the industry re-engineer a long-established, albeit myopic, contracting model and broad risk transfer practices imposed on its weaker subcontractor base, who seem to be ignored as the ones actually building projects.. Would it not make better sense to promote project success, increase productivity and timely performance by helping subcontractor's succeed? Why not implement practices that promote subcontractor performance and timely payment, remove risks over which they have little or no control, and focus on paving their way to high performance? Clearly, this is a paradigm-shift proposition from the current business-as-usual model in place, and it is doubtful the industry at large would ever consider implementing. Instead, the industry thinks adding new technologies and better training is the solution to its inherent problems of stagnant productivity; of the over 70% failure rate to complete projects on time and within budget; of its high rates of litigation and subcontractor business failures. Clearly, that view is as misguided as it continues to be proven wrong.
However, since project success requires effective scope performance, and subcontractors perform most of the work scope, it is not just a logical approach—it is a necessity. The premise asserts that promoting and supporting subcontractor success, instead of burdening and damaging subcontractors, will ultimately resolve most of the intractable performance, cost, time and project delivery problems plaguing the industry. It is time the construction industry acknowledge that subcontractor success equals project success!
The industry should rethink and reverse engineer itself to break out from its long-established, project failure business model. Other changes and implementations to fix these intractable problems have failed. It should stop dumping on its subcontractors, because in fact, that approach actually subverts the project. Stop the undermining contracts, counter-productive policies and procedures, slow payments and tripwires at every turn. The industries ongoing attitude and contracting approach with subcontractors are counter-productive to project success.
The industry should focus on what it is in business to provide--scope performance and “projects” completed within budget and on time. Whatever facilitates timely scope delivery means those performing that scope must be supported throughout, and their path paved to successful performance and thus, project success.
To accomplish this requires multiple changes to the current "system" and its "standard contracting and operating procedures". There needs to be Owner / GC buy-in for change:
To a priority focus on better, more realistic CPM scheduling, sequencing and monitoring of work scope, by those trained in CPM scheduling, and the typical “time-fiction” that dominates scheduling needs to be eliminated.
To improve manageability, timeliness and progress monitoring, Schedules need to be "modularized" (Fragnets) into manageable sub-assemblies, with direct input and "buy-in" from subcontractors.
The scope must be logically sequenced, the critical path highlighted and the scope optimized--and never disordered later on for the sake of making up for prior errors, mistakes and incompetence that compel out-of-sequenced work, the stacking trades, acceleration, etc..
When changes and time impacts arise, the schedule must be immediately updated to assess changes to the critical path, the absorption of float and time extensions as needed. Trying to hold a project to the baseline timeline too long is counter-productive, and results in negative, unintended consequences.
Timely, fair and effective dispute resolution processes must be a priority. The "we will work this out later" approach dominating the industry undermines project success and only results in costly litigation and damaged businesses.
The industry needs to stop dumping on its subcontractors. Stop imposing ridiculously skewed subcontracts, risk-transference, restricted payment processes, and the errors and incompetence of the Owner, A/E, and General Contractor onto the backs of subcontractors.
If it truly wants to improve its productivity, generate project success and reduce its cost of doing business, the entire industry needs to wake up, stop the shortsighted business model, and stop shooting itself in the proverbial foot through its onerous and counter-productive practices.
Translating a two-dimensional plan into a three-dimensional product, with all the disparate stakeholders involved and obstacles to overcome, is a wonderful thing, and deserving of praise. To succeed, all must work together and be mutually supportive. Dumping upon the scope performing subcontractor stakeholders in the process is however, a formula for project failure.
Focusing on improvements to project management is critically important to drive successful project outcomes. But that does not, and has not resulted in comparable improvement to project delivery. The reason it has only marginal benefit is because it does not address and ensure the success of the 85% sector of the project performance metric performed by subcontractors. Instead, the industry has pursued a short-sighted, counter-productive, undermining of its subcontractors at every turn process, and then wonders why productivity has flat-lined over the past 80 years, and project failure rates are consistently high.
The industry needs to stop abusing subcontractors. It needs to stop imposing contrived, risk-transfer contract agreements, harmful untimely payments, damaging policies and procedures, and scapegoating of subcontractors as a means of offsetting the consequences of the delusional optimism, mismanagement and reality chaos that shape project failure.
Instead of using subcontractors to counter balance against the unfounded optimism of the project plan, fictional CPM scheduling, defects, omissions, slow payments, scapegoating dynamics, CYA tactics, and general incompetence of those above them in the contracting hierarchy--change the "system" to foster subcontractor success. Stop the unfair and counter-productive practices. A more rational and sustainable approach is needed. Consider the following points and self-defeating policies currently in vogue:
The party in a position to best control and mitigate a situation, condition or risk, should be responsible and accountable to do so. Unfortunately, that simple logic and practice is rarely found in the battleground of construction project contracting. Risks are hot-potatoes that those a position to do so, throw into the pool of subcontractors.
It is not uncommon to find subcontract agreements requiring the subcontractor accept the same responsibility and obligations that the General Contractor has to the Owner under the Prime Contract. The purpose of this skewed "standing in our shoes" clause is to protect the General Contractor only, as clearly, no subcontractor, who by definition is doing only a part of the project work, exercises control over the responsibilities and obligations of the overall project at large.
The cash-flow and financial burdens subcontractors face can be substantial. Implementing a more timely and less obstructive payment system to help relieve those financial burdens and cash-flow squeeze that the industry imposes on its subcontractors, will also actually promote project success.
IV. Justifying Failure
I understand why the industry promotes this counter-productive, decades-long, standard operating procedure of unmitigated risk-transference and policies and procedures detrimental to its subcontractors. The industry is competitive and fragmented, the risks high, and the more dominant contractors and the higher-ups in the contracting chain rightly want to protect their own interests. Further, there are many subcontractors to choose from, and after all, "they signed our subcontract and knew what they were getting into" is the standard rationalization offered.
The industry rationalizes that subcontractors are eager to sign those contrived subcontracts, and that they know, or should have known, what they were getting into. Of course, it is a take it or leave choice, and subcontractors are free not to sign up, and general contractors are very good at applying a "divide and conquer" tactic to get them to sign. It is how the game is played. Who then really cares if in consequence, subcontractors are sometimes taken advantage of, or even forced out of business? Again, they knew what they were getting into!
The answer of course, is the entire industry should care! The short-term advantage that owners and general contractors leverage against subcontractors on every project to protect themselves, in reality has a long-term corrosive and costly impact resulting in high rates of project failure, flat-lined productivity, and of course, costly litigation. It is a dumb and dumber, short-sighted, self-defeating business model, that only serves the vested interests of the larger stakeholders, but at the cost of the majority smaller subcontractors and ultimately, at the expense of the projects performed and of the industry itself. Putting subcontractors into a such a contrived straitjacket and then expecting peak performance is simply stupid!
The reason why the "system" is as it is, is because the industry "big guns" like it that way. They like the fact that subcontractors are their "pressure-relief" valves on projects; often compelled into absorbing the unfunded cost overruns, incompetence and failures of those above them in the contracting chain. Subcontractors are easy targets, and because they are easily advantaged, the industry at large tends to do so when conditions merit. And since most projects falter and fail, the prevailing outcome is across-the-board abuse of subcontractors, and the continued promotion of project failure.
Subcontractors are also easily victimized because most are small businesses, sharing the same challenges of all small businesses, eager to get the job despite the contrive subcontract they must sign to do so, and lacking the knowledge and resources to defend themselves when needed. Owners and large GC's often have in-house legal counsel, whereas few subcontractors are large enough to afford it. It is an uneven playing field from the start. Reliance upon this might makes right legal inequity further promotes the avoidance of acknowledging and dealing with the real causes of project failure.
The construction industry will never improve itself as long as it can off-load the consequences of its overall inadequacies and incompetence onto its subcontractors. The industry has little incentive to do so as long as its base of subcontractors continue to "sign up" to agreements that allow General Contractors to later compel subcontractors to pay the price of failure.
As the weakest industry stakeholders financially and contractually, subcontractors are counterweights to the cost and time impacts the Owner does not accept and which the GC invariably passes through, irrespective of actual fault or negligence.
Subcontractors are the waste-basket where change and risk impacts arising on projects that the Owner and GC do not accept, are placed. These include design defects and omissions, differing conditions, constructive changes, untimely payments, bad scheduling and work sequencing, and where the escalated costs of that impacted performance flow into.
Why does this matter? Aside from the ethical and legal implications, it matters because ~85% of construction work is performed by subcontractors, and at some point, subcontractor success or failure determines project success or failure. It is an inseparable equation. The mindset, policies and procedures promoting abuse of subcontractors, underlies the entire self-defeating process that culminates in the majority project failures of the industry.
As a project begins to go over budget and duration, one would think Owners and GC's would engage to make subcontractor failure hard and success easy, because ultimately, that is the best way to promote scope performance and project success. They should, but in the risk-adverse, short-term thinking and hard reality of the "as-built" world of projects--CYA dynamics make subcontractors easy and expendable targets. When projects falter, Owners and GC's focus first on protecting themselves from liability and financial harm, positioning themselves as need be to off-load upon the subcontractors. Sacrifices must be made for the good of the Project! It's good to be King!
Good subcontractors are absolutely essential to the industry. Construction projects would not happen or complete without them. So why all the undermining policies and procedures?
V. How to Damage Subcontractors. Let us Count the Ways!
Competition is good! However, survival of the fittest should prevail on its own merits, but subcontractors themselves should be the determining factor--not the skewed, unmitigated risk-transfer built into all subcontract agreements, and often abusive policies and procedures that arise, especially once the project wheels wobble and fly off. Under payments; delayed payments; 10% retention; financing the first few months of the project. Imposing risks and obligations, escalated and extended costs upon subcontractors who otherwise have no power to exercise control; have no responsibility, obligation, fault or negligence, is not simply unethical--it's business malpractice, and undermines project success and the entire industry.
Cash flow squeeze play #1. Typically, subcontractors are forced to fund the first 45 to 90 days of every construction project before they receive their first payment, and are last in line to get paid. That subcontractors, who are the weakest financial links in the contract chain, are forced to front the construction costs of the Owner's project, is a dumb and dumber practice.
Cash flow squeeze play #2. On most projects subcontractors are denied 5 -10% of their money earned, as retention withheld until the end of the project. Of course, they cannot flow this 10% reduction in their own receivables by withholding the same in kind from their vendors, their employees and other payables. Subcontractors may even have been required to provide a bond to the GC. No matter, they still get stuck with getting essentially $0.90 for every $1.00 spent. The rationale? Owner's and GC's need to be protected. From what?
"Danger! Release / Waiver Forms Ahead!. To get paid, subcontractors may be unaware, or even wrongfully intimidated, into signing away their rights through the release and waiver forms for each payment and release terms of change modifications they sign, and unfortunately, mistakenly believe they have no other choice. Release / waivers actually modify the subcontract and subvert the already limited rights those contrived agreements provided in the first place. Subcontractors must always reserve their rights, and right to claim until they no longer need to do so, and final payment is accepted. Unfortunately, in my experience most subcontractors fail to do this.
Cash-flow squeeze play #3. Subcontractors typically must pay their supply vendors within 30-days net for material and equipment purchases, or have their accounts frozen, and a bond claim filed against the project. They are forced to float those payments as it is highly unlikely they get paid net 30-days from the GC. When a vendor remains unpaid, they will not hesitate to cut off a subcontractor, and even file a lien against the project and payment bond. And when that happens, the Owner and GC tend to get quite cranky, and quick to blame the hapless subcontractor.
The Golden Rule of Contracting. Subcontractors are at the mercy of the General Contractor. They either agree to the GC's onerous, risk-transfer subcontract; comply with the GC's often inefficient, un-optimized, sometimes arbitrary and incompetent work sequencing and scheduling process; be compelled to continue work and carry the cost of unresolved change impacts; deal with late and/or under-valued payments; suffer the disruptions, delays and cost escalation that the GC and other subcontractors inflict upon them; live with a "no damages for delay" and other undermining clauses--or they don't get to play the Game at all. Sucks to be a sub!
The End of the Line. Subcontractors have no privity of contract with the Owner. Their contracts are with the GC. If the Owner agrees to a pay for a change under the Prime Contract, to the extent a given subcontractor is affected, they will also typically get their pro-rated share of that funding. Typically, but not always. In addition, if the Owner refuses to recognize and pay for whatever change condition is at issue, subcontractors cannot rely upon the GC to defend them. In fact, the GC's loyalties are to itself and then the Owner. Subcontractors are last in line, and must advocate for and protect themselves. They are on their own!
The Weakest Link. Subcontractors are the least capitalized and have the highest risk exposure and risk of business failure.
Only in the Orwellian world of the construction industry does it make any sense at all that subcontractors--those actually building projects--are undermined, constrained and imposed upon, and in consequence, become the most likely to fail. The only reason the industry accepts and even promotes this system is because it does not know, or want to know, any other way, and because in general, the system is designed to favor its bigger and more powerful stakeholders.
The industry understands that it has many subcontractors to choice from, and those subcontractors know that to play the Construction Game, they have to accept more risk than they know they can include in their bids, manage and control. They know they must accept the often contrived terms and conditions of subcontract agreements--or they don't get the job. Should the industry really care then if one or more of its subcontractors, here and there, fail? I suspect that answer depends upon ones perspective and context. However, in practice the business reality is: those with the gold get to make the rules. No doubt, the rules are heavily skewed against subcontractors. However, all of this has an untold cost to productivity and project success, and the premise asserted here is that this underlies the majority cause of the rampant rate of project failure.
Take it or leave it, contrived subcontract agreements; restricted, reduced and withheld payments; disordered work sequencing and incompetent scheduling; assumed guilty until proven otherwise, tactics--these are the standard conditions subcontractors face on projects. Once under contract, subcontractors are exposed to being bullied, threatened with default, intimidated, and denied. On a bad project, a struggling subcontractor must weather the storm as best it can, and be content simply to survive to fight another day. Such is the Russian roulette game subcontractors must play.
Once on the project, they may be cajoled or directed to do change condition work, only to be left holding the bag when the Owner refuses to pay for it. In addition, they are invariably forced into receiving less progress payment than it cost them to perform--at least until the end of the project when that long-withheld retention is released (and then, less whatever back-charges the GC may withhold for whatever).
In reality, as previously stated, one rational for this underlying systematic undermining of subcontractors is that General Contractors need them to survive the risks and cost overruns Owners refuse to accept. Subcontractors are the project's cost / time, pressure-relief valves: for defects, omissions, disruptions, delays, designer and GC incompetence and mistakes, cost and time overruns the Owner denies. Subcontractors are the sacrificial lambs if you will, and necessary to help protect the higher ups in the contracting chain.
Sure, contracts define the terms and conditions of the business relationship from top to bottom, and parties are free to execute those contracts, or not--but that is also the problem. Subcontracts have become a dumping ground for every risk and obligation the Owner and Prime can pass through and jam in. Over the years, attorneys have been quite clever in crafting subcontracts that pass-through as much risk as the prior "lessons-learned" have shown and as they can otherwise conjure.
The point is, the industry has created a system that has gone too far in undermining its subcontractors. It has created a process that unnecessarily damages the very subcontractors who build its projects--and that shortsighted logic makes no sense at all. What goes around does eventually come around! As study after study demonstrates, the industry has a productivity and project failure problem. If project success equals "to deliver the project within budget and on time", then any policy and procedure that undermines that goal needs to be addressed and changed.
Does it matter that subcontractors have no control over all those risks and obligations jammed into their subcontracts? Does it matter that projects are not only built by subcontractors, but on the backs of subcontractors who are forced to finance the front end of project work; to sustain a 10% reduction of its progress payments? Does it matter that the industry "big guns" believe they know best; that this is how construction is supposed to work and has for decades? Does it matter to continue to ignore the fact that subcontracting practices as currently imposed may actually be the cause of project failure? You decide!
There is no doubt that without qualified, competent subcontractors, the entire industry would come to a squealing halt. With due respect to General Contractors today, they hardly have the wherewithal or inclination to get their own hands dirty, or the skill-set necessary to build the entire project. GC's rarely self-perform construction work any more, as they once did several decades ago. GC's today have become CM's@Risk, configured to financially qualify, oversee, manage, monitor and direct the build of projects. Without subcontractors they are effectively useless, with nothing to offer and no one to direct.
It is past due that the industry give its beleaguered subcontractors a break; show them some respect; give them some oxygen. It's time to change an industry-wide business model that continues to result in flat-lined productivity, a majority of its projects failing, and the costly litigation that often results. It is time the industry recognize its counter-productive paradigm that succeeds in systematically harming its absolutely necessary base of subcontractors, and in the process, shoots itself in the foot.
Whether you agree or disagree with that assessment, the forensic evidence does seem rather damning. It demonstrates some onerous ways the industry treats its subcontractors, and despite the fact that without its subcontractors it is not really a functioning industry. The high rate of under performing and failed projects, lack of productivity growth, claims, litigation and business failures are the smoking guns. Subcontractors are mostly small businesses, and often, simply struggling to avoid bad project outcomes and stay in business. Not all subcontractors are necessarily competent, but the dynamics of the contracting and construction process rarely differentiates. Failure is an equal opportunity event. Well-qualified subcontractors are harmed by these undermining processes, and some are forced out of business. Subcontractor success equals project success. Focusing on helping subcontractors succeed will result in a higher rate of successful projects.
GC's are responsible to pre-qualify their subcontractors--and not just take the lowest bid, or act in ways to compel even their good, pre-qualified subcontractors into damaging cost overruns to which those subcontractors have no fault of negligence in creating. GC's will always put their own interests and that of their Client first, but that does not mean they should abandon defense of any of their subcontractors when right is right.
VI. The Right Way Must First Eliminate the Wrong
There are a number of policy and procedural changes the industry could implement to alter its undermining practices against its subcontractors. The premise of this article is that by doing so, the industry would solve its lack of productivity and high rate of project failures.
I have already enumerated in this article some recommended policy and procedural changes the industry should implement to support subcontractors, and by doing so, solve its productivity and project delivery problems. The following is a recap of proposed changes and solutions:
Subcontractor Cash Flow, Part 1: Project Owner's should set up an escrow account at the beginning of their projects to fund the documented, early material / equipment costs incurred by Subcontractors. Subcontractors are compelled to pay these costs usually within 30 days. However, receipt of their first progress payment can take up to 90 days. Such early escrow-fund payments for delivered materials and equipment can then be deducted from the progress payments owing. To maintain contract privity, escrow payments can go through the GC, but the Owner must monitor the GC to ensure these precedent early payments are timely and in the correct amount.
Why is this an important? Obviously, the Owner must have the funds in place to build the project from the start, and clearly subcontractors must pay their vendors within 30-days. Therefore, it makes sense to ease the financial burdens on subcontractors, who must pay their vendors and equipment providers within 30-day, to expedite payment on those incurred costs once those materials and equipment items are confirmed delivered to the project. This will promote project success, and as importantly, reduce vendors filing lien claims against the Owner's project or the payment bond. It's a simple and sensible thing to do--so why is this not standard operating procedure?
Subcontractor Cash Flow, Part 2: End the practice of withholding 10% retention from progress payments. This if often a flow-thru of the Owner's in-kind withholding upon the general contractor. In a competitive bid environment, 10% is more than the subcontractors' estimated profit. In practice, retention not only serves no productive purpose, but rather strains subcontractor finances and may undermine project success.
Why is this an important? How many risk protections do Owners and GC's need? The answer is of course, as many as they can get. But that is a detrimental practice. Most GC's require subcontractors secure a bond upon their work when over $100K in value. Owners always require 100% P/P bonds from the GC's. These bonds cover the risk of default and failures to pay subcontracting tiers and suppliers. In addition, all contracts contain numerous "protection" clauses, such as liquidated damages, termination for default and convenience, and others. Why then add the burden onto subcontractors of only paying them $0.90 out of every $1.00 earned by this unnecessary practice of retention? Contrary to the intended purpose, withholding retention until the end of the project undermines subcontractors financially and adds to the chance of project failure.
Follow the Money (or lack thereof): Cash flow is the lifeblood of any business, and a lack thereof, a primary cause of business failure. Cash flow problems are a double whammy for Subcontractors. They finance the first few months of every project, because that is usually how long it takes before they get their first progress payment. Yet, in the interim they must pay their labor weekly; they must service their overhead; they must forego 10% of their payments because the GC holds retention; and they must pay their material suppliers net 30 days, or risk getting cut off. This is a huge financial burden to place upon small-business subcontractors. They are damned if they do and damned if they don't! Faltering subcontractors, and GC's then replacing faltering subcontractors to complete the project, means the project has already failed.
The Subcontract Agreement (or how to play Russian roulette): The typical subcontract agreement is a virtual minefield of unmitigated risk transfer, much of which the Subcontractor exercises no control over whatsoever. In their efforts to protect themselves, GC's have actually undermined their own competence and accountability, and hence, project success, by transferring what is otherwise under their own control and responsibility onto the backs of their subcontractors, and forcing them to accept the full responsibilities and obligations of the GC, as if "They are standing in their shoes". Clearly they are not.
Work Sequencing & Project Schedules (or how to write time fiction): Baseline project schedules are 99% fiction, give or take. Monthly updates contain progressively less fiction, but overall, construction scheduling is typically done poorly; is misunderstood by many, and as often, virtually abandoned in the "as-built" world of projects as they unfold. Subcontractors invariably are required by their subcontracts to adjust and work according to GC schedule updates and directives. That is about as arbitrary as it can get. That is akin to trying to hit a moving target that constantly changes size and shape. Good luck with that! "Time is of the essence" applies to almost all construction projects, but the largely fictional scheduling is merely the smoke and mirrors attempt to hide the truth. Most projects do not finish on time in any case--schedules be damned! Projects will succeed only when the scope is sequenced, scheduled and optimized throughout by those who know what they are doing. Projects will succeed only when those performing the scope are supported to succeed, and not obstructed, burdened and damaged in the process.
No doubt, construction projects are risky ventures, and contracting, like any business enterprise, is ultimately a survival of the fittest process. Unfortunately, the rules of this game are as much an arbitrary creation as they are heavily skewed against subcontractors. The Construction Industry should not be pleased with its persistent failure to deliver projects on-time and in budget; its failure to increase productivity in over 80 years; its reliance on claims and litigation to solve its unresolved disputes, among many others problems it continues to sustain.
Instead of finding additional ways to risk burden subcontractors into failure, Owners and GC's should recognize that the standard operating paradigm is stupid and far too costly in the long run. The industry needs to recognize that the success or failure of its subcontractors performing 85% of all construction work, determines the success and failure of its projects.
The shortsighted protections Owners and GC's have wrought for themselves in their use of ridiculously contrived subcontracts; onerous payment procedures; tripwires and IED's at every turn; and in general, using subcontractors as "pressure relief valves" on projects, comes at a steep industry cost as well. It is all interconnected.
The construction industry needs to focus on supporting its subcontractors, the right way, and in doing so, will prove the best approach to solving its project failure problems. The industry needs a make-over. It is long past due!
Alan Paquette, B.Sc., PMP, Principal Consultant
Construction Analytix, LLC
Alan Paquette is the principal consultant at Construction Analytix, LLC. He has 40-years construction front-lines industry experience, schooling and acquired expertise. He is a former federal government construction manager; former general contractor and subcontractor, and currently is an independent industry consultant.
Disclaimer: The information contained in this article is for general informational purposes only and reflects the opinions of the author. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice, or as advice specific to your situation.