Creating a Valuable Modern Construction Enterprise

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Tuesday, April 5th, 2016
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There has been plenty of interest in my recent article suggesting the sorts of questions that budding construction enterprises might get ready to answer as their businesses look the next phase of growth.

The conversation around “Is this a business?” is set to continue.  There seems to be strong interest in taking the subject further. I believe start up-construction enterprises will be the engine room of the transformations that will reshape the modern construction industry. There is strong evidence to suggest this will be the case.

I hope to energise a conversation that points to what a successful construction enterprise may look like by beyond 2025 and how it might be valued. No one has clear intel here, but it’s time to put some opening metrics on the table. I have been working in this area with Dr Mary Hardie, the director of undergraduate construction management programs at Western Sydney University. We believe our work will help in this endeavour.

Most readers will be becoming weary of the constant shadow of creative disruption hanging over their businesses and jobs. For those interested in an origin of this theme, the term “creative disruption” seems to have been coined by Joseph Schumpeter in 1942. He denoted it as a “process of industrial mutation that incessantly revolutionises the economic structure from within, incessantly destroying the old one and incessantly creating the new one.” International competition is an important source of creative disruption. And so it seems for construction.

The evidence points to the reality of change. In a recent report, the American Enterprise Institute (AEI) offered some compelling insights into all of this. The institute reported that only 12.2 per  cent of Fortune 500 companies existing in the US in 1955 survived intact by 2015. That meant that over 87 per cent of the Fortune 500 had either gone bankrupt, merged with another firm, or had fallen from the 500 over the 60-year measurement period. The Institute reported that by 1980, the average tenure in the top 500 was 25 years and by 2012 it had fallen to 18 years. At that churn rate, 75 per cent of today’s fortune 500 companies will be replaced by 2027. Start to correlate this data with construction over the last 10 years or so.

Facebook, eBay, Home Depot, Microsoft, Google, Netflix, Office Depot and Target are new Fortune 500 entrants, while Boeing, Campbell Soup, General Motors, Kellogg, Proctor and Gamble, Deere, IBM and Whirlpool were amongst the 61 firms which had gone the distance.

Australian construction has its own story to tell. The AEI reported that the economic lesson from all of this was that survival will be dependent upon “serving customers with low prices, high quality products and services, and great customer service.” It concluded that customers are the ultimate beneficiaries of creative disruption. Just ask Australia’s banks, insurance companies, retailers, airlines, hotels and the taxi industry. Construction will surely follow.

Outgoing Cisco CEO John Chambers told a customer conference of 25,000 delegates in San Diego last year that he predicted that 40 per cent of the businesses represented in the room would not exist in a meaningful way in 10 years. He estimated that 70 per cent of these companies will attempt to go digital, but only 30 per cent will be successful.  He warned companies that they could not “miss market transition or underestimate your competitor of the future – not your competitor of the past.” New construction start-ups will fall into this group in my view, so beware if you’re a Tier 1 or Tier 2 resisting change.

To build a successful construction enterprise, start-up constructors will need to be very clear about what problem they are solving and what their customer value proposition will be. They will need to be very clear about the simplicity and integrity of their story. It must resonate not just with customers, but also with potential investors, employees and – most critically – their supply chain. Being different and understanding how modern construction enterprises will exist in a digital, industrialised and globalised construction future cannot be about more of the same.

Cisco’s CEO said “either we disrupt or we get disrupted, start-ups want to upturn every existing business, from taxis (Uber), and hotels (Airbnb) to banking.” He did not specifically mention construction or why these organizations are disrupting. However, Rachel Botsman’s insights into why collaborative start-ups are challenging failed institutions and business models given at a Grattan Institute lecture in Sydney last year was instructive. Budding construction disruptors should read the transcript.

The construction industry’s customers and the public are losing confidence in the institutions of construction – simply because:

  • Private certification has not led to better quality
  • Cutting red tape has meant less accountability
  • The ever rising costs of construction just get passed on
  • Government policy is dominated by self-interest advocacy

And construction’s supply chain is sick of the status quo, ineffectual government and industry leadership – full stop. They have had enough of bid shopping and being screwed. They cannot afford to have their legitimate payments for ‘work done’ held-up by others, and be at risk of not getting paid at all. They have had enough of unquantifiable risk transfer, and they have had enough of unfair contract terms.

And, these are just a sample of the systemic issues which reflect traditional construction.

Other modernized industries cannot afford these value chain disruptions; they are gone. And construction is next. These disquiets offer modern construction enterprise start-ups limitless opportunity, but those start-ups will need to avoid regression if they are to break out.

The modern construction enterprise will need to recalibrate how the industry organizes and delivers a better deal to its customers. It will need to identify as a new breed of best practice enterprise that has left minimal levels of entity and project compliance behind. The next generation of construction enterprise will be collaborative, but this should not be taken as variations of soft practices such as ‘partnering’ and ‘alliance’ contracting. The key words to this transformation will be accountability and measurably better value for money.

Fundamental to setting out on a modern construction journey will be a clearer line of sight to the economics of a construction enterprises and what benchmarks could be used in calibrating growth and value. These are important considerations not just for the breakout enterprise. They will be just as important in identifying key supply chain collaborators to ensure their combined efforts will create mutual value. Waste and dysfunction will be common enemies. Collaborative development of enterprise IP will be central to new relationship platforms. Sharing the core economic metrics for success will be part of this.

value added enterpriseThe concept for a modern construction enterprise Dr Hardie and I are attracted to contemplates a resolution of the unresolved risks that are inherent in traditional construction procurement for clients. It is in this space that disruptive constructors will find new start-up opportunities. All projects require what we will call the ‘client’ and ‘constructor’ intermediaries of record. These may be the same entity, but the degree to which one may be the other could vary. The important difference will be the singularity and quality of the ‘client risk wrap’. A ‘value added enterprise’ could be part of either or it may also be separate.

Accepting the ‘value added enterprise’ proposition for now, this collaboration of participants should then turn their minds to the game changing characteristics that modern constructors will need to exhibit. These may include:

  • The transaction lite enterprise (at least 50 per cent fewer transactions)
  • The transaction lite project (at least 50 per cent fewer transactions)
  • Evolving traditional trade packages into elemental packages to reduce supervision, duplications and optimizing multi-skilling and innovation
  • Shared compliance certification and insurance bundling
  • Integrated direct payment systems
  • Embracing multi-jurisdictional and international trade protocols

Our next line of enterprise consideration then turns to how budding start-ups should define the simplest economic metrics around which they will build a business. This was the most common deficiency in the companies that gave rise to my article, ‘Is this a business?’

To this end, Dr Hardie and I have elected to coin a descriptor called a Construction Economic Unit (a CEU). Its purpose is to help enterprises think about where they sit in the construction arena. Often that arena is described by companies being Tier 1, Tier 2 and Tier 3. Often, it’s only years later that a start-up with a good idea stumbles to maintain growth or to attract investment capital to plough back into the enterprise or product developments.

A CEU can apply to measuring any key output of the enterprise. We are suggesting that it could be a basic building block for growth and enterprise value creation. For example, a start-up building block could be 100 square metres of build area costing $2,500. In this instance, the CEU would be valued at $250,000 per annum. This could equally be applied to 100 billable hours of BIM design, 1,000 square metres of road construction or one kilometre of installed cable. It’s normal that as businesses grow, their value becomes a function of the quality and volatility of their earnings. Keeping these factors in focus must be at the heart of the enterprise. Construction enterprises have traditionally submitted to the proposition that the industry’s cycles create circumstances beyond their control. This attitude has destroyed enterprise and supply chain value for too long. Modern construction enterprises must address this chronic weakness.

teir 1 construction

The Tier 1 – 4 Construction Enterprise Characteristics table shows where early construction enterprise learning could provide budding construction start-ups with a better understanding of the business landscape which lays ahead. Graduation from what we define as Tier 4 (start-ups) to Tier 3 will involve achieving a business volume base of say 100 CEUs. Here the quality and volatility of the enterprise earnings can be measured and considered. These become fundamental to providing potential investors with insight into the business and what they should reasonably pay to invest.

Understanding these characteristics will involve acceptance that adequate enterprise capitalization will enable better demonstration of the norms for return on investment and reducing enterprise trading risk. De-risking these elements across the construction value chain is a more proactive approach than difficult to enforce regulatory alternates. Shifting construction enterprise market perception from a one size approach which only sustains the lowest common denominator businesses to a new trajectory is how modern construction practice will displace its traditional counterpart. Creating valuable new construction enterprises is now more prospective than ever for those minded to apply the disciplines of rethinking their value proposition and business models.

It’s time to understand the competitors of the future, not your competitors of the past.

In collaboration with Dr Mary Hardie
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