Chris Coleman is partner-in-charge of the Construction Services Group at accounting and consulting firm RubinBrown. Opinions are the author’s own.
The economic warning lights are blinking for the construction industry.
After nearly two decades of relatively stable growth, climbing interest rates and high inflation have project owners looking to pull back on spending. It’s time for construction leaders to firm up their financial practices and instill a culture that can survive any economic conditions before it’s too late.
Project costs are becoming more difficult to control. Even the data center boom, which promised huge returns for the industry, may now be under threat as governments enact moratoriums on new builds and communities begin to rebel against projects in their area.
Whether firms are feeling it yet or not, demand is slowing. But many companies will find themselves behind the eight ball when it comes to preparing for a downturn because they’re unaware of the danger indicators their own books are showing them.
Leadership that’s too focused on revenue growth may be blind to signs of slipping profitability and the indicators that their team’s own practices and culture are to blame.
Here’s how construction leaders can take stock of where they’re at, and build the practices that ensure resilience down the line.
Establish a strong monthly close-out process
A monthly close-out process should already be a part of a construction firm’s regular meeting cadence. If it’s not, the time to start is now.
Every project manager or project executive should be meeting monthly with their construction and finance leads about each significant project that’s already in motion and any delays they're facing. If job fade is happening, they need to look at what is causing that fade. They should also be sharing in as close to real time as possible the key activities of every project that’s underway.
For too many firms, this sort of meeting of the minds happens only quarterly. That means by the time profit leaks surface, the company is already two to three months behind in stopping the bleeding.
Strong internal reporting processes on active projects hold everyone accountable and ensure that leadership actually has their finger on the pulse of what’s happening. Once you have monthly visibility, the next step is understanding what the data is telling you.
Tracking job fade
Between labor shortages and turnover, and fluctuating tariffs and shipping costs, the expected costs of a project can shift dramatically, even week to week. Suddenly, a project that was bid at a 20% margin has dropped to 15%, or even 10%.
On one project, this sort of fade may be manageable and perhaps even projected.
But when a company sees this happen across multiple projects, it's an indicator that the bidding team needs retraining. Given the tenure of growth we’ve enjoyed in the construction industry in recent years, this may be the first time some construction professionals need to account for a truly resource-constrained environment.
Having that insight now, as opposed to a year from now, when every project is operating on the thinnest of profit margins, means a company can better protect its future growth.
Keep in mind, job fade isn’t the only signal to watch out for. You should also be looking at how often you’re relying on workarounds to cover up bidding mistakes and provide training to address them.
Track underbilling, change orders and cash flow problems
More indicators that bidding practices may have become sloppy are high rates of underbilling and change orders.
While in an ideal world, the initial bid for a project will track one-to-one with the actual cost it takes to execute, that’s not always the case.
What we’re seeing today is more and more contractors coming to rely on change orders to cover unexpected costs. It’s a strategy that works, until it doesn’t, and, once again, one that may be indicative of a culture of sloppy bidding.
Most clients may be fine to rely on change orders during times of relative success, but as interest rates go up, everyone becomes more strapped for cash. Clients are more likely to tighten up contracts to contain more fixed-fee and guaranteed maximum price provisions, fewer price escalation clauses and less cost-plus work. These internal metrics show where your current practices are breaking down.
Bidding outliers, on the other hand, reveal something else entirely: a shift in the market itself.
Monitor for bidding outliers
The bidding process is a window to the future for construction firms, but it can also be a thermometer for the industry as a whole.
If a company finds it has a higher win rate than usual, it’s likely because they’re not pricing correctly and may now be on the hook for a job at a significantly eroded margin.
Alternatively, if new competition is emerging in the bidding process — firms that would never have bid on a certain type of project before now entering the mix and competing — it may indicate that the number of new projects is contracting.
The good news is, these are indicators within a construction company’s own data ecosystem that leadership can use to understand the true financial health of the business, both now and down the road.
For construction companies, bringing together the right people to ensure everyone is being held accountable to the same profit discipline is how firms can ensure they’re prepared for any economic downturn.
Discipline matters, especially as the market softens. Companies that allow their financial ratios to weaken, borrow more and pay higher interest rates, will find themselves trapped in a downward spiral during market crashes.
The construction companies that manage the warning signs materializing now will be the ones that inevitably take off when everything rebounds. The key to realizing that future means starting today.
