Warning Signs that a Contractor May Be Overextended

If you are involved in the construction industry, like it or not risk management is part of your job. From home office executives to workers in the field, each person is expected to manage schedule, cost, and safety risks. While these risks are common, the recent prolonged period of economic growth has created new challenges. One of those challenges is managing the risk of taking on larger or more projects than you can handle. A related challenge is to recognize and avoid working with other firms who have bitten off more than they can chew.

According to Christopher Daum of FMI, a construction industry management consulting firm, “Contractors don’t starve to death; they die from gluttony. They get too much work, too fast, with inadequate resources, and then they get into financial trouble and run out of cash.” Mr. Daum’s quote describes the concept of overextension, which is when a firm takes on more work than it can handle. While there is often no foolproof way to detect when a firm is overextended (that is, until it’s too late), there are several warning signs:

• Firms that have experienced rapid, uncontrolled growth. Rapid growth that results from a successful strategic plan is not a red flag. However, if a firm has experienced rapid uncontrolled growth, there will be several additional signs, such as overworked employees, poorly performing projects, cash-flow problems, etc. The key is to understand whether the firm’s growth resulted from a solid business plan or is merely a haphazard response to a booming economy.
• Firms that have rapidly expanded into new markets. Similar to rapid uncontrolled growth, another warning sign is rapid expansion into new markets. Savvy firms avoid becoming overextended by expanding into new markets in a controlled manner. They realize it takes time to develop strategic relationships in, and gain a deeper understanding of, new markets.
• New firms that have inexperienced executive teams. The construction industry historically has had a significant number of firms entering and exiting the market coinciding with boom and bust cycles. Many of these new firms are formed by people with some construction knowledge but little or no management experience. Overextension results when a firm’s inexperienced executive team cannot accurately judge how much work their firm can handle.
• Firms that have recently experienced significant executive turnover. Because executives usually are among the first to know when a firm is becoming overextended and on the brink of failure, their sudden departure may be a warning sign.
• Firms with inexperienced project management teams. Economic growth and changing demographics have combined to create a shortage of qualified and experienced managers. Although the shortage of skilled labor has received significant attention in the news media, firms also struggle to hire and retain experienced project management personnel. Increasingly, to address this shortage, some firms are hiring and promoting managers who do not have enough experience to handle more complex projects. Instead of setting up these inexperienced managers for success, they are asked to step into more advanced positions without the requisite experience or support.
• Firms without robust management and accounting systems. A core component of any construction firm’s success is its ability to manage the massive stream of cost and other data created on a typical construction project. Sophisticated firms have robust management and accounting systems that allow them to manage this data and leverage it to quickly recognize and solve potential problems. Firms that lack these management and accounting systems are at a distinct disadvantage. Because they lack these critical tools, they struggle to timely identify and address poor performance and cost overruns that often result when a firm is overextended.
• Firms that have a poor safety record. A poor safety record is often an indication that a firm has other problems. Overextended firms typically do not have the personnel or resources to appropriately manage safety and this, unfortunately, is reflected in their safety record.

These are not hard and fast rules, and for each red flag, there may be legitimate explanations unrelated to a firm being overextended. However, as the industry continues to expand along with the economy, construction firms should be mindful of the possibility that they — and the firms that they do business with — may become overextended.

Originally published as “OP-ED: Warning signs that a contractor may be overextended” on February 20, 2020, by the Daily Journal of Commerce.