Chapter 1
The Construction Industry

Construction may be the oldest industry in the world, but it was not until 1990 that it was discovered to have the second-highest failure rate of any industry in the United States. This finding was the result of 12 years of research that also documented the specific causes of construction business failure. And perhaps more significantly, the causes of failure were determined to be preventable. The research process included a detailed analysis of hundreds of annual financial statements prepared by independent accounting firms. A "statistically significant number" of all types and sizes of failed construction companies were analyzed in detail. The results were compared and contrasted with an equal number of similar non-failed companies over the same time period. It took years of research to identify the primary causes and in some cases the secondary causes of the failures. Most accounting experts were shocked to discover that the underperformance and losses discovered were occurring two to three years prior to losses being reported on the construction companies' certified financial statements.

After the publication of this research, a lot of construction companies altered their behavior and prospered. However, a large number of contractors stated that while the findings were correct, the lessons did not apply to themselves but pertained to less informed and less skilled companies that failed. The rationale, of course, was: "We have not failed so the findings don't pertain to us." Unfortunately, hundreds who held on to that belief subsequently did fail. Many of those who failed said to us or wrote to us with comments like: "I heard you but didn't believe it" or "I told others to change their behavior but didn't change my own" or "I didn't want people to think I didn't know what I was doing."

Few dispute that construction is a high-risk endeavor, and our research demonstrates that being in the construction business for a long period of time offers little protection. It may sound counterintuitive, but one of the difficulties in convincing construction professionals that these common elements of business failure are accurate and high risk is that the elements don't always cause business failure. For example, there is a huge risk in taking a project that is much larger than the organization has ever built or taking a project in an unfamiliar geographic area. However, when a firm takes either of these risks and it works out successfully, they believe they have disproven the research, and that the size of the project and change in geographic area is not a common element of construction business failure. These firms then, of course, continue to embrace the risk in the future because they did not believe the risk exists.

The reality is that while the scientifically proven common elements of construction business failure do not always cause failure they are, nevertheless, hugely risky because they often cause failure, just not 100% of the time. Many make the mistake of trying to measure the risk by measuring the odds. They think something like 6 to 1 odds are better than 2 to 1. The fallacy of measuring the odds this way is the true measurement is not simply the odds that an occurrence might happen. The real measurement must include the odds of an occurrence AND the magnitude of the occurrence in question. For example, most reasonable people would readily accept a bet of $1 at 6 to 1 odds. The question is would they still be interested at 6 to 1 odds if the bet was a million dollars?

Six to one odds with a bet of $1 is inviting for two reasons; one it would be great to win $6 and two the loss of $1 is worth it because it doesn't really hurt. The loss of a million dollars makes the bet seem almost ridiculous at any odds. An analogy I sometimes use is Russian roulette. If you take a six-shot revolver and place only one bullet in it, spin the cylinder, point it at your head, and pull the trigger; is it a small risk or huge risk? You might like 6 to 1 odds at a bet of $1, but few would bet their life at 6 to 1 odds.

If a larger project or a project out of your normal geographic area has the potential to weaken your financial position to the point of eventual failure, is it a reasonable business risk or a huge (almost ridiculous) risk? Indisputable scientific research data demonstrate that these activities have put a "statistically significant" number of other contractors out of business. Even if you are convinced you can beat the odds because you have been in business a long time, do you really want to "bet the farm"? If you were an investment advisor, would you be recommending these risks to your clients? You may also find it of interest to know how many of the failed construction firms in the database were second- and third-generation companies demonstrating that length of time in business does not protect against business failure.

The information about construction business failures we have to draw on today was expanded with the addition of 30 more years of research data. While the causes of business failure have modified some over time and the industry has grown tremendously in size, construction still remains the second-highest failure rate in the nation (second only to restaurants). Many of the construction professionals that were exposed to the original data have retired by now, and most of the new generation of industry leadership were never exposed to these essential documented research findings. The authors believe it is important to update and restate this material for the new generation of construction leadership. Fortunately, the industry has progressed, and leadership has benefited from specialized engineering and construction education programs developed over the last several decades, advancing the construction process considerably.

On the downside, very few of these education programs address the business side of the business of construction. Therefore, we are able to build better, but we are still having the second-highest failure rate. The industry failure rate continues, including spectacular failures like the 2022 multinational Carillion organization, the largest construction enterprise in the world. In light of the current US construction boom and global economic uncertainties, the failure rate will undoubtedly continue and has the potential to substantially increase. This information is most critical to a more receptive industry than ever.

The industry's growth combined with the persistent nationwide labor shortage has increased contractor risk and will, in all likelihood, increase the industry failure rate. Similar historic conditions in the past resulted in construction business failures, which makes the solutions in this text that much more significant. We need to understand how constructors can succeed during various and changing market conditions. This is particularly significant because most construction professionals and managers are graduates of engineering or construction schools or came up through the ranks as tradespeople. Engineering or construction education curriculum teaches how to capture and produce construction work, but typically includes little or no business, accounting, economics, finance, statistics, marketing, or personnel management courses.

This text provides a shortcut into how to structure and manage the business side of the business of construction with guidance on:

• Proven construction business strategies
• The advantages of and how to develop short- and long-term business plans
• The concepts of flexible overhead
• Corporate, and financial self-analysis
• The element of construction contractor failure
• An understanding of construction market cycles
• Cash flow thresholds
• The threat of industry accounting weaknesses
• The true cost of equipment ownership
• Modern leadership techniques
• The latest industry technologies and client maintenance
• Global construction industry trends
• And more

This book includes links to proprietary software programs, including:

• Company self-analysis tool
• Project selection tool
• Corporate self-analysis tool
• The R-score calculator
• Schleifer's manual of construction practice

Construction businesses underperform or fail not because they cannot produce the work, but primarily because they are not managed as a profitable "business" concern.

1.1 A Brief History

The modern construction industry in the United States as we know it today commenced at the end of World War II (WWII) when soldiers returned from the war and received benefits from the Servicemen's Readjustment Act of 1944, also known as the GI Bill, providing accessible and affordable mortgages. A building boom began fueled by housing demands that created unprecedented employment opportunities (Figure 1.1). Since then, in spite of temporary recessions, the construction industry has continued to grow through today. The industry prospered through the 70s paying wages well above typical factory work and generating double-digit profits. Not long after that and almost unnoticeable the construction wage advantages over other industries began to slip, and profits slowly drifted along with them. About the same time (in reaction to this or by coincidence, it is difficult to tell), new contracting methods began to be introduced, altering the "competitive balance" of the...