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Why Construction Companies Are Destined to Fail

The construction industry faces many challenges. High failure rates of construction companies are notable compared to other industries. Understanding why so many construction firms fail can help new businesses avoid common pitfalls.

Statistics reveal a grim picture for construction firms. Almost half of the 69,296 private construction firms that started in 2001 failed within three years. Only 17.2% of those firms were still operating 20 years later, according to the Bureau of Labor Statistics.

Moreover, only 35.9% of the 43,277 construction businesses that began since March 2011 remained in operation by March 2022. Comparing these failure rates with other industries shows a higher risk of failure in construction.

Project Value Engineers list the top four contributors as Poor Requirements Definition (50%), Inadequate Risk Management (17%), Poor Scope Definition (15%), Communication Problems (14%), and Lack of Qualified Resources (3%).

maxresdefault.jpg Graph by Project Value Engineers

In this article, construction firms will learn about the following top reasons for failure and how to avoid them.

Top Reasons for Failure

  1. Business Knowledge Deficiency
  2. Staffing Issues
  3. Financial Mismanagement
  4. Project Management Failures
  5. Business Strategy and Market Position
  6. Operational and Structural Issues
  7. Financial Oversight
  8. Creating Partnerships with High Quality Builders & Suppliers

UPDATED AT: July 2, 2024

Business Knowledge Deficiency

Many construction company owners lack formal education or apprenticeships in business management. This means they may not understand fundamental business concepts such as financial management, marketing, or strategic planning.

They often also lack the hands-on experience and technical knowledge needed in the construction field. Without this experience, they may not fully understand the complexities of construction projects, such as project management, quality control, or compliance with regulations.

This knowledge gap can lead to poor decision-making and business practices.

Staffing Issues

Staffing issues are another significant challenge for construction companies. These issues often stem from insufficient administrative and support staff, as well as unskilled tradespeople.

Insufficient administrative and support staff can lead to inefficiencies in managing projects, finances, and client communications.

For example, if a construction company does not have enough project managers, existing managers may become overwhelmed, resulting in delays, poor project oversight, and decreased client satisfaction.

Unskilled tradespeople also pose a significant problem. Skilled labor is essential for maintaining high-quality standards and ensuring that projects are completed on time and within budget.

The construction industry has experienced a labor shortage for several years, but in 2022, it reached a "crisis level," according to the CEO of the Home Builders Institute.

construction-labor-market-min.webp

From 2020 to 2021, the industry’s job openings rate climbed while the hiring rate decreased. Graph by National Association Of Home Builders.

Financial Mismanagement and Oversight

Financial mismanagement is a common problem. Only 43.2% of construction companies have a dedicated research and development budget, and 46% spend less than 1% of their annual sales volume on IT, according to the ConTech Report from JBKnowledge, Inc.

Other common financial problems include:

Scope Creep: Scope creep happens when project requirements increase without corresponding budget, timeline, or resource adjustments. For example, adding an extra room to a house during construction without increasing the budget can strain finances.

Project Bleed: Project bleed occurs when funds from one project cover expenses for another, often due to poor financial controls. For instance, using a shopping mall budget to pay for residential project costs can lead to financial shortfalls and delays in both projects.

Improper Job Estimating: Improper job estimating involves inaccurately predicting project costs, time, and resources. For example, underestimating materials and labor for a bridge project can result in running out of funds before completion, causing significant financial strain.

Rapid Expansion Without Proper Planning: Rapid expansion without proper planning happens when a company grows too quickly without adequate preparation. For example, taking on too many new projects simultaneously without additional staff or equipment can lead to inefficiencies and financial difficulties.

Not Preparing for Economic Downturns: Not preparing for economic downturns means failing to save financial reserves for slow business periods. For instance, a construction company without savings may struggle during a recession, leading to financial instability.

Poor Cash Flow Management: Poor cash flow management involves ineffective tracking and managing of money inflow and outflow. For example, not monitoring cash flow closely and facing delays in receiving client payments can result in running out of funds to pay subcontractors, causing project delays and financial stress.

Financial oversight is crucial for the stability and success of construction firms. Many companies fall short in this area, leading to financial instability and potential failure. The practices below are essential to avoid these pitfalls and ensure long-term success.

Separating Personal and Business Finances: Keeping personal and business finances separate is fundamental for clear financial oversight. Mixing these finances can lead to confusion and potential legal issues.

For instance, if a business owner uses personal funds to cover business expenses without proper documentation, it can complicate tax reporting and financial tracking. Clear separation ensures transparency and makes it easier to manage and audit financial records.

Relying Too Heavily on a Single Client: Relying too heavily on a single client for large projects is risky because it creates dependency. If that client reduces their business or faces financial issues, the construction firm’s revenue could suffer significantly. This can lead to layoffs, halted projects, and financial distress.

Diversifying Revenue Sources: Diversifying revenue sources helps mitigate the risk associated with dependency on a single client. By securing multiple clients and projects across different sectors, a construction company can ensure a more stable income stream.

Project Management Failures

Project management failures are prevalent in the construction industry. Over 50% of engineering and construction professionals report one or more underperforming projects each year, according to KPMG.

Delays-Survey-2022-Chart-5.jpg Graph by Cornerstone Projects Ltd

These failures can arise from several factors, including inadequate pre-construction planning, insufficient project management, and inability to handle unexpected changes and delays.

Thorough pre-construction planning is essential to handle changes and approvals. This phase involves detailed planning of all project aspects, such as timelines, budgets, resources, and risk assessments.

For example, failing to properly plan the sequence of construction activities can lead to work stoppages and resource shortages.

Competent project management is crucial for effectively handling project execution. A skilled project manager ensures that the project stays on track, coordinates between different teams, and handles changes efficiently.

Business Strategy and Market Position

Business strategy and market position are critical for the success of construction companies.

Without a clear business strategy, these companies risk inefficiencies, taking on unsuitable projects, and failing to remain competitive. A well-defined strategy helps guide decision-making and ensures the company remains focused on its strengths.

Here are some of the strategies to achieve a strong business strategy and market position:

Clear Vision and Direction: A clear vision and direction guide the company’s goals and strategic decisions. Without a clear direction, the company might take on disparate projects, leading to inefficiencies.

Taking on Inappropriate Projects: Taking on inappropriate projects can lead to failures. Choosing projects that match the company’s expertise and resources ensures better performance and client satisfaction.

Underestimating Competition: Underestimating competition can hinder a company’s success. If a construction firm does not stay informed about competitors’ strategies, it might lose bids or fail to offer competitive pricing.

Low Profit Margins: Low profit margins can make it difficult for a construction company to sustain operations and invest in growth. For instance, consistently underbidding to win projects might secure contracts but will not cover costs adequately, leading to financial instability. Ensuring sustainable profit margins through strategic pricing is essential.

Geographic Overreach: Geographic overreach occurs when a company takes on projects outside its usual operational area, leading to increased travel and logistics costs. Managing these costs effectively is crucial to maintain profitability.

Poor Marketing: Poor marketing can result in a lack of visibility and missed opportunities. Effective marketing helps create a unique value proposition, distinguishing the company from competitors and attracting more business.

Creating a Unique Value Proposition: Creating a unique value proposition involves offering something distinctive that sets the company apart from competitors. For example, a construction firm might focus on sustainable building practices or advanced technology integration to attract clients who value these aspects.

Operational and Structural Issues

Operational and structural issues further complicate the landscape for construction companies. These issues involve the need for standardized procedures, appropriate equipment, clear accountability, strong leadership, and managing workloads to prevent burnout.

Addressing these challenges is essential for maintaining smooth operations and achieving long-term success. Here are some key areas to focus on:

Standardized Procedures: Standardized procedures ensure consistency and efficiency in operations. For example, having a set protocol for safety inspections reduces the risk of accidents and ensures compliance with regulations. Without standardized procedures, different teams might follow varying practices, leading to confusion and mistakes.

Right Equipment: Having the right equipment is crucial for operational efficiency. A company that invests in modern, reliable equipment can complete projects faster and with better quality. Inadequate equipment might result in frequent breakdowns, project delays, and higher maintenance costs.

Clear Accountability: Clear accountability means assigning specific responsibilities to individuals or teams. This ensures that everyone knows their roles and what is expected of them. Without clear accountability, tasks may be overlooked or duplicated, leading to project delays.

Strong Leadership: Effective leaders motivate employees, resolve conflicts, and steer the company toward its goals. For instance, a construction company with strong leadership can navigate challenges such as project delays or budget constraints more effectively than one with weak or indecisive leadership. Poor leadership can lead to a lack of direction, low morale, and high turnover rates.

pexels-rezwan-1216589.jpg Photo by Anamul Rezwan

Managing Workload to Prevent Burnout: Construction work can be physically and mentally demanding, and overloading employees can lead to burnout. Managing workload to prevent burnout is vital for maintaining a productive workforce. Ignoring workload management might result in increased absenteeism, higher accident rates, and lower overall productivity.

Creating Partnerships with High Quality Builders & Suppliers

Weak partnerships with other builders and suppliers can cause delays, cost overruns, and quality issues. Establishing strong, high-quality partnerships is crucial for the success and stability of construction firms.

A robust network consists of a wide range of contacts within and related to the construction industry, including suppliers, subcontractors, industry experts, and clients.

High-Quality Partnerships: High-quality partnerships involve collaborating with other companies or professionals who bring complementary skills, resources, or knowledge. These partnerships can enhance a firm's capabilities and competitiveness.

Collaboration Opportunities: Collaboration opportunities arise from strong networks and partnerships, enabling firms to take on larger or more complex projects that they might not be able to handle alone. This type of collaboration can open new business avenues and lead to shared success.