Lessons from Homebuilders
How to Fix Americas Construction Industry
by Barry LePatner
According to our ViewPoint guest writer?an author and attorney who represents developers and owners?an ailing construction industry can help resolve its woes by taking lessons from homebuilders.
America's $1.17 trillion construction industry constitutes nearly five percent of America's economic output. But it continually remains a bastion of waste and inefficiency.
Cost overruns and delays are so common that everyone expects projects to run over budget. No one involved can accurately declare in advance how much any particular project will ultimately cost. This inflates prices and feeds uncertainty among homeowners, renters, commercial tenants and end users of all types, not to mention investors and taxpayers.
Construction is a highly fragmented sector that stands alone as the economy's only remaining large "mom-and-pop" industry. Unlike every other major American industry, there are no truly national firms. Even the largest of the nation's homebuilders do not conduct business in more than 20 states.
On the commercial building side, today's largest construction companies are structured largely as management shells, retaining, overseeing and coordinating countless independent subcontractors. The numbers reveal a highly splintered industry: America's 7.6 million construction workers are employed by some 883,000 different companies. Over 90 percent work in firms of 20 or fewer employees.
Fragmentation takes a huge toll. Small, poorly capitalized firms cannot invest in new technology to improve efficiency but instead must work "from paycheck to paycheck." Living marginal and unpredictable existences, they often have to bid low to win business. This means they undercut prices so that better-managed firms submitting bids that factor in a fair profit are not awarded projects.
The sector also ranks last in terms of productivity. Again, the figures are shocking. According to federal figures, all other sectors of the economy have collectively been able to boost productivity per worker by approximately 250 percent since 1964. But in construction, over this same time span, productivity has dropped more than 20 percent over the same time span.
Among other factors, I believe that these unacceptable failures are largely attributable to the industry's fragmented composition and low-bid mentality.
How does the construction contracting process contribute to cost overruns?
The conventional contract bidding process is also a big culprit here, though the contract process itself?as suggested above?is partially a manifestation of industry fragmentation.
Too often, developers rely upon standard-form, boilerplate contracts that give license to a "lowball bid" syndrome whereby contractors are actually bidding for the right to secure a contract and not for a profit. Unlike every other industry, they bid low to win the contract and the subsequent right to submit change orders that they hope will lead to a profit.
Once a "standard" contract is signed, the owner or developer frequently becomes subject to a succession of change orders that can quickly boost project costs beyond expectations. Since work has already begun, the construction company cannot be easily dislodged from a job. Sundry difficulties can trigger a queue of change orders.
Traditional standard-form contracts are, in fact, mutable-cost contracts subject to constant adjustment throughout construction.
Contracts such as this would seem odd in another industry, but they are typical in construction. Individual contractors and subcontractors are simply too small and too far-flung to take on the risks and liabilities for going over budget on a huge project. The party left holding the bag is the developer, owner, government entity or institution.
How can the process of bidding for contracts be fixed?
The development community as a whole needs to reinvent its relationship with America's troubled construction industry so that projects can come in on time and on budget.
Step one? We need truly fixed-price construction contracts based upon design documents that are 100 percent complete and coordinated by the architect and engineers so they contain all necessary information that will enable contractors to provide a proposed price that is a fixed price.
Developers and construction companies vying for work need to have a frank and frontloaded discussion of risk before a contract is signed. Bidders and developers should roll up their sleeves, discuss every risk and contingency they can envision, and equitably allocate those risks within the text of the contract before it is executed. That will stabilize construction costs and reduce uncertainty.
What can the construction industry learn from the experiences of homebuilders?
When owners know precisely what they want and when well-managed contractors are brought to the bargaining table with full information on what is expected of them, the adversarial nature of today's construction world is removed. Once the low bidders?usually the culprits that create the modern claims environment and cannot afford to take the risk of a fixed-price contract? are removed from the scene, owners will get their projects built on time and contractors will finish on budget and make a fair profit.
In addition, this will lead to contractors having more money to invest in the latest technology to improve efficiency, which, in turn, will lead to greater consolidation in the construction industry.
Anyone with an interest in improving this industry need only focus on a great lesson the Levitts taught America in the years following World War II. Seeing a need for affordable housing for returning veterans, the Levitts came up with a design for a basic house, together with a way to reduce construction procedures to 26 steps. Building communities from Long island to Georgia to Puerto Rico, they showed how control over subcontractors and tighter management can deliver huge advantages in respect to productivity and cost control.
Levitt and Sons maintained tremendous control over costs. Its organizational structure prohibited the possibility of passing costs along to owners via change orders. Efficiency was imbedded within the Levitt business model and led the company to large profits.
The keys were organization, mass production and vertical integration. Its "subcontractors"?who were only called that for tax purposes?were essentially employees who worked solely for Levitt and were supervised by Levitt's own engineers and superintendents who maintained close control over all operations. The company owned a timber stand and a wood mill. It owned a wood shop and a nail factory. It owned a construction supply company. Levitt's size and vertical nature allowed it to be efficient and productive.
I think construction companies can also look to the example of Fox & Jacobs. Dave Fox has said he viewed his firm as a "housing manufacturer" engaged in "continuous production."
There are other worthy role models as well. Despite current economic problems and pressures, Toll Brothers, K. Hovnanian and Pulte Homes also demonstrate how residential construction has emerged as a sophisticated and relatively well-capitalized sector of the construction industry. These are efficient firms with the capital to invest in R&D and productivity.
Commercial, government and institutional builders should examine the factors that make these residential construction companies efficient and, wherever possible, adapt these factors to their own purposes.
What's the long-term solution to fixing the construction industry?
Because the sector is comprised of such small firms, construction companies lack the wherewithal to invest in technology, boost productivity and take advantage of the efficiencies of scale and vertical integration. Because of the industry's fragmentary nature, worksites are often poorly coordinated. Bulk purchases are prohibitively expensive. Fragmentation also gives rise to the dysfunctional contract bidding system.
We are not talking about a change that can happen overnight. But I attest that many of the construction sector's problems would be solved if there were greater consolidation within the industry. Bigger construction companies would purchase materials in bulk, would be able to pay higher wages to better-skilled workers who perform efficiently, and would manage their projects with the newest technologies that would achieve greater profitability, thus driving out less efficient firms. Greater concentration within the industry would boost efficiency and help put an end to chronic cost overruns. Even a modest ten percent improvement in cost-efficiency would add some $130 billion in new private and public investment each year.
But consolidation itself will require a lot of front-end investment. This sector is begging for capital infusions. The equity markets should take note of the untapped opportunities here. Whoever gets there first could turn out to be a big winner.
Barry LePatner, an attorney representing developers and owners, has been called America's "guru of construction industry reform" by Governing Magazine. His recent book, Broken Buildings, Busted Budgets: How to Fix America's Trillion-Dollar Construction Industry, analyzes reasons behind chronic cost overruns and productivity problems within the industry and outlines a strategy to manage and control costs.
Editor's note: Opinions expressed by ViewPoint guest writers are not necessarily those of Homebuilder editors or of LPI Multimedia. Have an opinion to share? Contact editor@lpimultimedia.com.
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