Contracting: It's All About Risk

LOOKING BACK OVER my many years in the mechanical construction business, Ive come to the conclusion that what were dealing with when we think were just calculating man hours or feet of pipe installed or crunching numbers to come up with a winning bid is really all an evaluation of risk. Every single activity we undertake rests on the validity of our risk assumptions. The fundamental challenge confronting

LOOKING BACK OVER my many years in the mechanical construction business, I’ve come to the conclusion that what we’re dealing with when we think we’re just calculating man hours or feet of pipe installed — or crunching numbers to come up with a winning bid — is really all an evaluation of risk. Every single activity we undertake rests on the validity of our risk assumptions. The fundamental challenge confronting all of us in this business is how to identify risks, and then how to assess and manage them.

What kind of risks are we talking about? I think we can put them in two categories: business risks and project risks.

Business risks

A partial list of common business risks would include bidding strategies, getting paid, cash flow, government regulations, indemnification and such fairly new elements as subrogation.

It’s pretty clear that the secret to identifying and dealing with some of these risks lies in educating ourselves. Bidding strategies, for instance, are different with a known owner or general contractor than they are with a company whose history and practices you don’t know. When we bid on a job that is owned or managed by a company with whom we’ve had positive dealings in the past, our situation — unless something fundamental has changed — appears to be less risky. If we’ve worked with a company before, we pretty much know how it pays, its standard contract provisions, how it deals with change orders and the quality of its safety record. When we’re dealing with an unknown company, all risks increase, including the risk of not getting paid completely. Even in cases where we have a history with the other company, however, we must always educate ourselves on just what we’re signing — or signing away.

A waiver of subrogation is a good example. Over the last several years, subcontractors began being asked to waive subrogation. When this topic is raised, most subcontractors’ first question is: “What the heck is subrogation?”

Subrogation is a term usually used to define responsibility between parties. For example, in the case of an incident, an insurance company can pay for damages knowing that, after payment, it can seek reimbursement from other responsible parties. A good example is a worker’s compensation claim where the subcontractor’s insurance company pays the claim, and then seeks partial reimbursement from other partially responsible contractors. The bottom line is that, if the subcontractor grants the waiver, the general contractor has no responsibility.

Most owners require a waiver of subrogation in their contracts. General contractors and construction managers with “risk professionals” on staff see this subcontractor waiver as a logical extension of the owner’s risk avoidance strategy. As many general contractors have stated, these waivers are a key component of their risk reduction strategy, so subcontractors should consider this requirement as just another “cost of doing business.”

The cost of doing business with an adversarial partner is much higher than the cost experienced with a mutually supportive partner. Those subcontractors who fail to learn this lesson will often find themselves in litigation and/or paying for the “privilege” of building someone’s project.

Project risks

There are also, of course, project or job risks. A partial list of common job risks would include labor productivity, scope definition, subcontractor performance, job schedule, weather, vendor performance and equipment delivery. As any experienced contractor knows, each one of these elements carries with it its own risks. And, as with the business risks described above, the more education you bring to any particular area, the more manageable the risk. Lots of this depends on experience, of course, but experience is sometimes a hard teacher and we all do well to get reliable information from as many sources as we can. Sometimes just standing back and trying to figure out just exactly what went right — or wrong — with a recently completed project can be an eye-opener.

Getting a handle on risk

One reason why I’ve been thinking about risk — about the tosses of the dice that we’ve chosen as our life’s work — is that, as a recently retired contractor, I now have the time to become more involved with the educational programming of the Mechanical Contractors Association of America. For the last few years, we’ve undertaken an experience-based educational program, the Project Performance Conference. Each year, we challenge participants to work as teams as they think their way through an actual project from multiple points of view. This year at our October conference in Chicago, we’re asking them to look at every point along the project path — from the decision to bid to project execution to project commissioning — all as an opportunity to assess and manage risk.

Formal educational opportunities like this are, of course, rare in our business, but incorporating risk awareness into your thinking from the very beginning — when you first start considering the possibility of bidding on a project — is a great way to bring rational decision-making into a process that sometimes seems to be a frenzied collection of activities that must all be managed at just about the same time if the project is going to work at all. And, if it all seems to be too much sometimes, it doesn’t hurt to remember that risk and opportunity are two sides of the same coin.

Until April, Tom Williams served as president of the Construction Division of McKenney’s Inc., a 52-year-old mechanical contracting and engineering company with offices in Atlanta; Chattanooga, Tenn.; and Charlotte, N.C. Elected to MCAA’s Board of Directors in 1996, he served as MCAA’s president in 2003. His future plans involve teaching seminars for MCAA’s National Education Initiative, as well as serving on the faculty of MCAA’s Institute for Project Management.