If you're blaming all the contractor and subcontractor defaults lately on the recession and how thin times lead to management mistakes, such as chasing unprofitable work, here's yet another concern: Business in some sectors is picking up enough to create perils from recovery risk.
Contractors face recovery risk on the back end of a recession when they take on too much work after they've depleted their staff and cash and other assets during hard times and don't have enough resources to finish projects.
It's a little bit like a starving man suddenly finding too much food and eating himself sick.
"We've seen it in other cycles," says Mike Hill, senior vice president of Baldwin Cox Agency, a surety and insurance broker based in Dallas. "When work does come back, we're expecting more problems because so many companies were weakened in the last four years and don't have cash reserves."
Some defaults by fabricator-erectors in the first half of 2012 gave the impression that capital-intensive subcontractors with manufacturing operations were most vulnerable as the construction recession dragged on.
Trainor Glass, based in Farmers Branch, Texas, shuttered its nine locations on Feb. 22 and has made no public statements since then. Trainor was one of two major cladding fabricators and contractors to get into financial trouble this winter.The other was the default and temporary shutdown just before New Year's Day of Whitestown, Ind.-based ASI Ltd., a principal subcontractor on the $825-million Barclays Center in Brooklyn, N.Y. "It's hard to get riskier than the exterior cladding on a structure," says one contractor risk manager. Because of the high amounts of labor and capital needed to run a cladding operation, "those are the ones struggling the most."
Emerging from a recession can leave a contractor short not only of cash but also of qualified craft workers, managers and production equipment, says Matt Stevens, a management consultant in Winter Park, Fla., and faculty member at the University of Melbourne. If a contractor can't find veteran 10- to 15-year project managers or field superintendents to run its new projects, the inexperienced staff can get the contractor into trouble, Stevens says. Equipment mismatched to a project or task is another problem. "If you have too large or too small a bulldozer, it hurts the productivity rate," and project profits suffer, says Stevens.
Doug Irvin, vice president and unit manager for insurance broker Lockton Cos., has no dealings with either ASI or Trainor or their projects. But he says that less capital-intensive, asset-based companies tend to fold earlier in a recession than ones with more borrowed money, equipment and assets. "What we've seen up to this point is a lot of (smaller) subs starting to fail, ones that just ran out of cash," Irvin says. Keeping 30 days of cash on hand has been a rule of thumb, but these days many contractors aren't paid for 90 days. Total liquidity and debt-to-equity also may be important.
In "The Construction MBA" (McGraw-Hill, 2012), Stevens argues for a more quantitative approach to contracting (he is especially keen on gross profit per labor hour or week). And he's finishing a research project correlating management practices and overhead to direct cost efficiency. Poor financial measures and failure to follow some best practices, Stevens says, raise the risk of low profits and financial disaster. And an economic upswing is no guarantee that, post-recession, everything will be OK.
• Right-size equipment and fleets to match coming projects
• Chase only projects with acceptable profit
• Use most experienced field people on new projects
• If possible, keep more than 30 days of cash on hand