Weekly Thoughts


Weekly Thoughts: Overdue and Over Budget

Here is something that caught our eye this week:

Overdue and Over Budget

As our landscaping entities do some project work, we have become more familiar with the construction industry.  For us, one the biggest challenges working in this space is a lack of clarity surrounding when our phase of work will begin, which typically is the very last stage of a broad-scale construction project.  One can imagine how difficult it can be to plan and budget for a multi-million dollar landscape project that should start…sometime this summer.  Or maybe the fall.  Or maybe next year if construction is really delayed and the weather starts to turn.  If we can tell that our Uber will show up in exactly 11 minutes, why can’t we have a bit more visibility into when a gigantic construction project will be finished?

At least there is comfort in numbers, and we are not the only ones experiencing opacity in this area: KPMG reports that only 25% of construction projects finish close to their original deadlines and only 31% come close to budget.  Interestingly, the problem becomes more ubiquitous as the projects become larger, as McKinsey reports that 98% of “megaprojects” become delayed or are over budget.  Even Apple, a model of efficiency, saw its new headquarters cost $2 billion more than budget and open two years behind schedule. Whoopsie-daisy, indeed.

Surprisingly, cost overruns and delays have become worse over the past decades, as productivity in the American construction industry is actually lower today than in the 1960s.  This is in stark contrast to the extreme productivity gains seen in other industries, with enormous economic consequences: McKinsey reports that if productivity growth in construction matched that of manufacturing over the past 20 years, it would save the world $1.6 trillion each year.

So, what’s going on?  While there are some large players, the industry remains highly fragmented as projects are generally individually customized based on client needs, and building codes differ greatly based on geography (American counties and municipalities have upwards of 93,000 different building codes).  Furthermore, generally low margins and high cyclicality hinder investment.  The Economist explains further:

“One source of the industry’s productivity problem lies in its fragmented structure.  In America less than 5% of builders work for construction firms that employ over 10,000 workers, compared with 23% in business services and 25% in manufacturing.  Its profit margins are the lowest of any industry except for retailing. It is also highly cyclical. During the frequent downturns that afflict the industry, any firm that invests in capital, and thereby raises its fixed costs, is vulnerable.  By contrast, companies that employ lots of workers without investing much can simply cut their workforces.”

As a result, the industry has lagged in terms of tech adoption40% of construction companies still use paper plans on the joband almost 50% manually prepare and process daily reports.  Market Watch explains further:

“Underinvestment in technology is another root cause of low productivity. There is robust evidence of the link between the level of digitization in a sector and its productivity growth. The U.S. construction industry has invested 1.5% of value-added on technology, compared with 3.3% in manufacturing, and an overall average in the economy of 3.6%. In the United States, construction is the second-least digitized sector after agriculture.”

Somewhat counter-intuitively, it seems the technology that has been implemented has actually played a role in hindering productivity.  As new tools have been more readily adopted on the building design side, it has made projects exponentially more complex, which can result in thousands of pages of plans.  Without a bridge between increasingly detailed plans coming from designers and those doing work on the ground, more detail just means more room for misinterpretations.  When working with multiple vendors, one small mistake (i.e., putting a pipe one inch too far to the left) can cascade into huge delays and cost-overruns, which is why re-work typically accounts for up to 12% of a project’s expense.  Furthermore, while some firms have embraced technology to reduce complexity (i.e., component standardization, 3-D printing), the aforementioned structural constraints mean most are not eager to be the first mover, as one industry leader noted to KPMG:

“If we can see an immediate cost benefit to our clients, we’ll implement, and if not, it will remain on the shelf for someone else to experiment. We are all about proven solutions and quite frankly, don’t have the profit margins to experiment or be on the leading-edge.” 

Despite the focus on the benefits of widespread tech adoption in the construction sector, McKinsey had a somewhat more pragmatic (and surprising) takeaway from an analysis of more than $1 trillion of capital projects, noting that “improving ‘basic’ project-management skills offers the most potential to improving site performance.”  This hits close to home, as the allure of technology solutions, which all of our companies are in the process of implementing, does not replace the need for basic project management skills – proactive communication, expectations management, time management, attention to detail, micro-scheduling, etc. – to make (or break) budget versus actual results for our entities.  This week’s reading gives us a more contextual understanding of construction dynamics, but we still look forward to the day when “that project” which always seems to be “in the pipeline” will actually begin.

Have a great week,

Your Chenmark Capital Team

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