“These don’t apply to my business.” We had just presented a client with a proven list of 75 risk factors that can impact a construction company’s ability to make a profit. He circled 20 and said the rest were of no consequence. If we hadn’t previously run a number of construction companies and closely observed hundreds more, his words may have cast doubt. But we knew better. Some risk factors are certainly less important than others, but they all can play a roll in causing business failure; even seemingly unimportant risk factors can interact with one another to have a large impact. With respect to business, a risk factor is defined as an action, condition or event that can cause loss or harm performance and profitability objectives. Risk factors vary by industry. For example, smoking is a risk factor in the medical world, specifically related to the health of an individual. It does not apply to a construction business. Likewise, failing to have a job cost system in place is a risk factor related to a construction business, but certainly is not a risk to an individual. Risk factors are also different across businesses. A risk factor related to overstocking perishables in a restaurant due to poor inventory control does not apply to construction. Poor humidity control is a risk factor in a flower shop but not in a restaurant. As you can imagine, there are many different types of risk factors and for the most part they are specific to an industry. Some are really important because the harm they can cause is great. Others are of lesser importance because the harm they can cause is not so great, thus having a smaller impact. To actually determine the impact a risk factor can have (its importance), takes years of case study. But suffice it to say, importance varies. What also varies is a contractor’s perception of the importance of various risk factors. Interestingly, the risk factors that a contractor usually thinks are important are the ones which it has experienced. While those the contractor thinks are unimportant are the ones it has yet to experience, and some of those can actually be very important. Focus on Expertise Now a case in point: The particular contractor mentioned at the beginning of this article was a General Contractor (the word “was” is telling). One of the risk factors he determined was of no consequence was taking on new types of work without prior experience. Another was estimating without historical data. In the months to come, this contractor decided that it could make more money by doing the rough carpentry work (framing) of buildings by itself rather than using subcontractors. In California, there are separate companies that do framing and that is all they do. It is very competitive and the cost is simply driven by how fast carpenters can put lumber in place. This GC proceeded to bid three large school projects. Now it had done schools before, but never the framing. We personally advised against the approach indicating that the estimating staff did not have experience bidding framing work, that the estimating staff did not have any historical information on hand to rely upon, that the personnel were not in place to do the framing, and that the company had no prior experience doing the work. Well, this particular contractor looked at themselves as a risk taker. Indeed they were. The net result was as follows: This particular GC was in business for over seven years and had been quite successful. However, GCs work on very tight margins. The contractor could ill afford to lose large money on the framing, but they did, and it cost them their business. That was all based upon risk factors that the contractor did not consider of importance. Contract Review Let’s look at another case in point: A contractor performed steady work in a niche market and historically made good money, however it didn’t have a contract review procedure in place. In fact, this contractor had signed a contract without having reviewed it completely and was unaware of the insurance requirements. One of the requirements was for $5MM of pollution coverage, but the contractor only had $1MM in place. The contract was for repair of 450 balconies on a 40-story apartment complex. It had done this type of work on large structures before, but never for a building that did not have air conditioning. During the summer months it became unusually hot while work was underway and many of the 450 residents had to keep their windows open because of the stifling heat, even while the contractor was chipping and grinding out the old concrete that needed repair. Concrete dust invariably drifted into some of the apartments. Simultaneously, the owner had given notice of eviction to a lawyer. To get back at the owner, he banded a bunch of the residents of the apartments together convincing them of great rewards, and proceeded to file a lawsuit against the owner for allowing cancer causing silica dust to harm the health of all of the residents. Since a lot of the residents were old, having little funds, and had little to do with their time, they had nothing to do but listen to an evicted attorney. Once the thought of cancer causing dust was put in their minds, even the invisible bothered them. During that time, one of the residents who had chronic respiratory problems was hospitalized even though work was not being performed at the time near her apartment. This just fueled the claim that all the residents were being exposed to a major health hazard, even though open windows were being covered with a filter cloth. Unfortunately, the court approved the suit as a class action with all 450 residents represented. The owner in turn tendered the suit to the contractor only to find out that the contractor did not have $5MM of pollution coverage in place as called for in the contract.... Read More
In this post, we’ll give some background on the growth of Enterprise Risk Management and how it relates to the construction industry, and explain why adopting an Enterprise Risk Management philosophy for running your construction business is a wise decision. We say philosophy, because at its core, ERM is a shift in thinking, a shift in managing your business. It applies best in high risk industries, like construction, which have high failure rates due to persistent failures to recognize and mitigate risk across the entire business. Enterprise Risk Management Growth In a 2001 survey, Enterprise Risk Management: Implementing New Solutions, it was noted that 41% of the public companies surveyed indicated that they were currently implementing some form of ERM program. As a result of Sarbanes-Oxley Act (aka SOX, the compliance requirements set forth after the Enron debacle), that number has been climbing ever since. Why? Quite simply, the rules of the game have changed for public companies. They must now prove they have strong internal controls, complete intregrity and systems to manage all risks they face. Unexpected “surprises” are no longer accepted; they now have swift consequences. Given this environment it’s no wonder that Enterprise Risk Management (ERM) is being adopted by public companies at an ever increasing pace. In the United States, the Securities and Exchange Commission, as well as the U.S. Federal Reserve and the American Institute of Certified Public Accountants, are demanding more accountability from corporate directors in terms of identifying risks and developing systems for managing them. The National Association of Corporate Directors is encouraging audit committees to expand their scope of risk management reviews. Dunn and Bradstreet has released software to provide ERM Solutions. Standard & Poors, one of the largest credit rating companies of businesses worldwide, has announced that it is now including questioning about a company’s ERM practices to determine ratings for credit. This rise in expectations requires a level of risk management knowledge and capability not found in many organizations, so companies are scrambling and reacting to institute risk-based controls. But how does all this apply to private companies that don’t have to worry about compliance issues brought forth by SOX? Plainly stated, ERM is not just for the “Big Guys” anymore. As Tim Ling, president and chief operating officer of Unocal, stated: “I think you will see almost all companies over the next few years moving in the same direction [as we are], really trying to integrate the notion of risk management with the notion of just business management. To me, running a business is all about managing risk.” Essentially, managing risk is really about properly managing a business, and therefore managing risk can create shareholder value if done correctly. Thus, ERM is now seen less as a reactionary requirement to regulations, and more as just plain old good business practice. In fact, according to the RIMS 2011 ERM Benchmark Survey, over 75% of the 14K public and private companies in the survey had active ERM programs or were investigating ERM adoption: Why Contractors make good Candidates for ERM Does ERM apply to contractors? Yes, more than ever. Since ERM best fits companies in high risk fast moving industries, contractors are prime candidates for adoption. Here are some reasons why: All of these characteristics make contractors great candidates for ERM. So let’s talk about the how ERM can actually overcome the challenges for implementing risk controls as stated above, namely: the abundance of construction risk, the time constraints upon management, the insufficient knowledge about ERM and unstable controls. How ERM overcomes the challenges for implementation of risk controls Takeaways In short, ERM addresses an abundance of risk by following a systematic process that educates the workforce on elements of risk within their area of responsibility, empowers them to individually install risk controls which are then monitored within the process to make sure the controls remain fully in place, thus creating a “no surprises” management environment. Without an ERM framework, the failure to recognize risks or to mitigate known risks can make it difficult to compete, financially weaken the company, and potentially jeopardize its future. So there you have it. ERM is being adopted worldwide and it is a perfect fit for construction. It will just be a matter of time before you will be expected to run your business with a risk-based approach. In fact, banks and sureties are already asking contractors, “Who handles enterprise risk management for your company?” Do you want to be the company that lags behind in understanding and taking action on business risks, or do you want to be a survivor in today’s fiercely changing and competitive environment? As to the ultimate question: “Should I personally get engaged in a risk-based mindset and adoption of ERM,” we leave you with some final questions: To learn more, contact Druml Group for construction enterprise risk management solutions.
