Why Building Companies Fall Over In A Building Boom

With Auckland’s housing shortage and home renovation activity, you would be excused for thinking building companies should be surfing a building boom and reaping the rewards.
However, many continue to fall over despite promising industry conditions, leaving customers, contractors, suppliers and even the taxman in the red.

Building is a complex task

Building involves multiple parties from designers and architects to surveyors and councils, to suppliers and to customers. There are few companies that have the ability to perform the entire build process.

There are external specialist suppliers. Whether it’s the architect or the excavator and/or foundation company or the window supplier or the plumbers/sparkies and tilers and painters these trades (and many more) are usually separate from the builder. There are a lot of relationships and expectations for a builder to manage and at each stage the plan can go wrong. As margins in the industry are slim, any error or delay is costly, time consuming and potentially business ending. Defective work has a double impact in delay and cost.

Delays mean you are exposed to price increases and often further delays as preferred suppliers have to juggle their production schedules to meet new expectations. The cost of standing still due to delays also mounts up. Staff and the fixed costs (premises, and the inevitable leased ute and the dog) continue even if the project is standing still.

Those slim margins are easily gone especially if your customer controls themselves and does not vary much as the build progresses. A lot of builders make their money from increased margins in the hope for customers variations. So the initial build price is priced at or just above cost to win the work.

What can go wrong? Examples based on real life

Architects and Designers

The architect/designer may have their own view as to what the customer wants. I have heard of one house renovation project where the architect has changed some basic room dimensions a dozen times. Specialist suppliers are sick of the changes. How the builder is supposed to cope with that while managing a project and a business is anyone’s guess.

Assuming that is all under control and agreed at the beginning, the customer is happy and everyone is friends. It’s all going to be great.

Customers

Once the build starts the customers expectations can change to expect the world’s best house at the very lowest price. The customers have become experts in building, (the customer may even have a helpful builder “mate” in the background stirring the pot). They can be unmoving on price increases even when they change things. Maybe there are delays with council issuing consents on the initial build or on the variations. Disputes arise with customers and payments are delayed. Banks, suppliers and staff start to become nervous. How do you manage? You have lots of customers, you are growing. It’s the third day of a new month and you don’t have any money in the bank but you will be alright.

You get grumpy, and decide the customer(s) needs to be ignored for a while. That will show them….WRONG.

The customer relationship is no longer constructive (sorry, another pun). Maybe the customer’s bank is also getting nervous and it is taking more and more of the builder’s time and resources at each project payment milestone for the bank to release funds to allow the customer to pay. Some customers will construct disputes to force the price down/or gain an advantage and a concession or discount.

In the end while this is false economy as it forces corners to be cut later or in the worst cases, the customer has to find a new builder with new delays and often a higher cost. But it happens.

And you still don’t have any money. The contract payment you have missed out on equates to the margins on maybe 4 or 5 normal builds. You are now way behind.

Some customers know that the costs of recovery through any disputes process may mean there is no cost benefit. As a small but growing builder you may not have the time or energy let alone the money to contest a non payment. Have the best contract terms you can get.

If you and/or the customer has any type of construction completion insurance make sure you understand what it means, what and how much it actually covers and on what basis the cover maybe withdrawn. Some associations operate under a relatively complex structure.

Pressure from prior project failures

Increased build activity increases the problems and the cash requirements. Companies thrive and others fail. Many of the failures we see arise from the pressure that has built up from years of below average trading activity because of persistent project failures. There are many that will have been slow payers for years, have maxed out or are well over their credit limits with suppliers, they have changed suppliers a few times, they are generally well behind with their commitments to IRD. Only the ute gets paid for on time every month. Like a gambler, they have no other avenue but to fail eventually. It only takes one creditor or dissatisfied customer to act decisively and the whole façade (sorry, pun) falls down. A bunch of waste and ruin is all that is left.

The people involved in these companies are in my opinion much better off financially and in all other aspects of life working for wages or salary. They may even have a company ute for you!

The impact of our completely risk adverse bureaucracy cannot be ignored. We have seen new parties entering the market with a viable business plan to operate on a larger scale where investors have lost millions of dollars in development and machine costs, but have run out of money (millions budgeted and spent) and folded without much being built due to council, compliance and government decision changes or delays. The bureaucrats keep their jobs, but it can hardly assist our productivity.

The bigger projects are so complex few can appreciate the risks that are being taken by all parties in those projects, and the foresight and work needed even before the build starts. Added to that the very small number of NZ (and possibly Australian) contractors with a balance sheet strong enough to undertake big projects comment those projects would be at best superficial and likely unfair. This article does not focus on those projects or contracting parties.

Why small to medium sized Building Companies Fail

I am pretty certain that very few builders assess what would happen if a project payment is delayed a month/or does not occur at all. Would they be able to survive financially? Some would be able to, no doubt.

Some small to medium building companies do well during a boom because they provide good quality product and attract good customers (realistic to price fluctuations and prepared to pay the price for a quality build). They have industry knowledge and know what is possible for the customer’s price expectations. They do not over commit, and they build some delay into project pricing. They may have relationships with the architect of designers. They know the world is not perfect.

Growth requires cash

You have to pay more people often weekly to operate and manage. Your customers don’t pay weekly, they may pay monthly or even every two months if there are delays. Some suppliers require deposits to be paid? The more work you take on, the harder it becomes to manage and meet those requirements.

Do you have enough to meet the wages bill when customer payments are delayed? Can you pay your suppliers? Can you pay yourself? If you put money into the business is there or has there been a return on that investment?

There are many that allow themselves to take on more business than their capital base can fund at all, or fail to manage expenses properly placing their cash flow under stress and so flirting with disaster.

Inexperienced New Entrants

Boom conditions in the building industry also encourage new operators to enter the market. To them, there is money to be made. Many previously worked as employees or sub-contractors and so lack many of the real life business skills or the resources to run a business.

Similarly, many, while fine tradesmen, struggle with business administration such as filing, PAYE and GST, let alone paying business commitments, invoices on time or managing their cash flow effectively. Often the private commitments are not met by the business income. The private commitments get priority and the business suffers.

These tradesmen often operate their business account as their own personal bank account inviting calamity. They finance their ute or 4WD through a personal loan and put their tools on their personal credit card. {not sure what is wrong with that]

Common reasons for these new entrants failing include:

• Poor contracts
• High fixed overheads and thin margins
• Pricing mistakes
• Under-capitalised balance sheets
• Missed deadlines
• Contract disputes
• Cost overruns
• Overly aggressive tendering trying to increase market share at the expense of profit margins
• Poor estimating and job pricing
• Poor variation analysis with variation sign-offs not completed formally leading to contractor wearing additional costs
• Perhap’s incomplete level of technical building education and overall knowledge in the industry
• Unfamiliar with legal and statutory regimes and compliance costs compounded by poor documentation and record keeping for PAYE, GST and creditors.

High Costs Increasingly Drive Failures

A common issue with building firms is being crunched by labour and materials cost fluctuations while working on fixed price contracts. Labour and materials costs frequently increase during a boom (demand exceeds supply) and only fall when a slowdown hits the industry.

Final Observation

Few new business owners fully appreciate it is every bit as difficult to manage a building business during a boom as it is during a slowdown or recession. High operating costs inflated by sustained demand places cost pressures on many businesses locked into what are effectively fixed-price contracts while capital constraints cause issues when companies look to take advantage of boom conditions by taking on too much work.

Have enough staff that you trust. If you don’t then don’t take on new work. You are likely to fail.

If you have a bad feeling about a customer or how hard they are pushing you on price, then walk away. There are some people who will never be satisfied and these are the ones who will find a reason not to pay you, and there is plenty of other quality work/jobs around.

Once a project has started it’s a complex and harsh environment when things go “wrong” and wrong can start very early on in a building project. There is plenty of pressure on the industry participants as a result of growth that means things go wrong. The typical reaction these days seems to be to ignore the issue or to blame someone else. Neither of those responses solves anything. You feel better for a while and create a delay but it is short lived.

At the first sign of wrong communication is key. The builder needs to have everyone from the designer to the customer and the suppliers understand what the issue is and to we hope arrive at a solution that works for all.

Everyone involved may need to give a bit otherwise the project will fail probably impacting on the builder and any unpaid suppliers the most. Professionals can assist if instructed to.

 

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