Warren Buffett once famously said: "I buy expensive suits...They just look cheap on me."
In this disrupted, unpredictable market of 2022, project selection may be the most important decision construction senior management will make. Last week we discussed what we called specialization, "sticking to your knitting" by only taking on work that is your established specialty. To avoid taking on "expensive" jobs that will eventually look "cheap" on your company financials, you must consider size and duration when selecting projects for 2022 and beyond.
Risk
Warren Buffett again:"I've often felt there might be more to be gained by studying business failures than business successes."
For many years I operated an international consultancy firm serving the contract surety industry and studied the causes of construction business failures up close and personal. Although the details of each company’s failure varied slightly one to another, their inability to manage risk was the common cause.
Warren Buffett, again: "Risk can be greatly reduced by concentrating on only a few holdings." and "Never risk what you have and need for what you don't have and don't need."
Size
For the rest of this year and into 2023 and perhaps 2024, inflation and labor shortages will most probably persist. Whether the current supply chain problems can be ironed out remains to be seen, but 2022 will certainly suffer from all three disruptions.
My research into the causes of construction business failures identified the relative size of projects to be the single most important risk factor. By "relative size" I mean that a construction company used to completing $1 to 5 million projects who suddenly leaps to a $10 million, or worse a $20 million project, has increased their risk of failure exponentially.
During this disrupted unpredictable market of 2022 and beyond, the example construction company above might better manage risk by taking on three $3 million jobs rather than one $10 million project. Three smaller projects can be completed in a more manageable time period and run less risk of prolonged and persistent cost inflation eroding profitability. Projects of familiar size also fit better into a company's organization structure where the staff is experienced at managing similar projects.
Duration
Duration has always been a risk factor in construction. Mega projects that take many years to complete are rarely concluded by the original team and almost never on time and on budget. They are often mired in litigation and losses soar into the millions.
If a contract is limited by a fixed bid price during hyper-cost inflation (which is where we are now), extended duration erodes profits and causes contractor failures. Limiting exposure by doing jobs that can be completed in one year or slightly longer is good risk management in this unpredictable market.
Growth
Too many contractors are concerned primarily with top-line growth. This emphasis is natural since all industrial companies see growth as a sign of success. If growth is managed carefully in construction, it is a good thing during healthy growth markets. However, in unpredictable markets when construction firms push for top-line growth to cover bottom-line problems, losses are always the result. Trying to grow your way out of past profit problems in an unstable marketplace like we are now experiencing can be a fatal error. Unfamiliar work on large projects that last an extended period of time can sink even established firms. In unstable markets, profit growth not top-line growth is the road to success. The strategic plan for 2022 that I recommend is stated clearly by none other than, guess who?...
Warren Buffett, again: "Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1"
Strategic Planning Steps for 2022
- Evaluate carefully if the 2022 "post-pandemic" market is the growth opportunity that will get your company out of the pandemic doldrums. Factor in unexpected hyper cost inflation, persistent shortages of labor, and material supply interruptions.
- Redefine growth as growth in profit, not top-line revenue.
- "Stick to your knitting" by doing what you do best.
- Only take on projects of the size your existing organization can manage easily.
- "Short" this 2022 hyper cost inflation environment by taking on projects you can complete relatively quickly.
- In an unstable market, learn to say NO.
- Finally, if you won't listen to me, listen to Warren Buffet:
"The difference between successful people and really successful people is that really successful people say no to almost everything."