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(This
paper was presented to the Shanghai Association of International Economic
and Technological Cooperation in Shanghai on December 10, 2002, and to the
China International Contractors’ Association on December 12, 2002, in
Beijing. It was serialized in China’s Construction Times newspaper.)
By Stephen
V. O’Neal and Paul W. Berning
Thelen Reid Brown Raysman & Steiner LLP
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| I. |
Introduction
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The
U.S. construction industry is diverse and huge. It ranges from the
plumber or electrician who works alone on residential and small commercial
projects to engineering and construction companies that design and
build giant, complex projects.
This
paper will provide an overview of the U.S. construction industry, describe
how it works, and explain the legal and regulatory issues involved
with it. The paper will conclude with a discussion of ways to succeed
in the U.S. construction market. |
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| II. |
Overview |
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Spending on construction in the United States was $505.6 billion in 2003. This amounted to 4.6 percent of the United States' Gross Domestic Product, which is the total of all money spent in the United States in 2003. Those figures exclude architectural and engineering services, which are separately tracked. By way of comparison, spending in the entire U.S. manufacturing sector was $1,369 billion, which was 12 percent of GDP.
The U.S. construction industry employed 7.3 million people in 2005. Another 1.3 million people worked in architecture and engineering.
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For more U.S. construction statistics, click
here.
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| III. |
Types of Projects and Contractors |
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| U.S.
contractors usually specialize based on type and size of project and
their role in the project. Construction can be divided roughly into two
basic types of projects: |
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Buildings: Contractors
in this sector construct buildings such as homes, schools, hospitals,
skyscrapers and high-rise office buildings, low-rise office buildings,
apartment buildings and condominiums, facilities for light industry,
theaters and shopping centers.
Heavy
Construction: Contractors in this sector build factories,
process plants, refineries, power plants, highways, roads, bridges,
airports, ports, dams, railroads, pipelines, power and telecommunications
lines and facilities, sewage plants and systems, and water treatment
plants and distribution systems. |
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There are few contractors in the United
States that perform both building and heavy construction projects.
Rather, they specialize in one or the other and frequently specialize
in a particular sector (heavy contractor that builds highways but not
power plants; building contractor that builds single-family housing
but not high-rise office buildings.)
There also are two major roles played
by U.S. contractors:
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General
Contractors: These contractors contract directly with
the owner and are responsible for getting the entire project built – whether
with their own employees or with subcontractors. General contractors
manage, schedule and budget the entire project.
Subcontractors: Subcontractors
are responsible for building a particular part of a project or performing
a particular scope of work. Examples include electrical, plumbing
and painting work. Subcontractors are also known as subs, specialty
contractors or trade contractors. These names reflect the subcontractor’s
role. They are subordinate to general contractors. Electrical subcontractors,
for example, specialize in electrical work. Electrical subcontractors
employ electricians to perform work, and “electrician” is
a recognized trade or type of job in the United States. |
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General contractors go about their work differently depending on whether
they are building or heavy contractors. Heavy contractors self-perform
much of the work on their projects, using subcontractors only for specialized
tasks. Building contractors use subcontractors heavily and may subcontract
all actual construction work, retaining only project management and coordination
duties. Other building contractors may self-perform wood framing, concrete
foundations and concrete frames. On both building and heavy projects,
the contractor selects the subcontractor. In the rare instances when
the owner wishes to select a subcontractor, the owner assumes substantial
legal liability for the subcontractor.
In 2003, there were 732,175 construction companies in the United States, according to the U.S. Bureau of Labor Statistics. Some 50,905 were heavy contractors, 219,899 were building contractors and 451,371 were trade contractors.
How
large a construction company gets to be depends on several factors,
including:
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Desire
of the owner. He may want to stay small or he may want to grow. |
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Success – or
lack of it – in completing projects. Several bad projects can
keep a company from growing. A few more can put the company out of
business. |
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Access
to capital. The amount of capital available can control how many
projects a company can take on, how large the projects are and how
risky those projects can be. |
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| IV. |
Other Participants |
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are several other groups of major participants in U.S. construction projects: |
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Architects,
Engineers and Other Design Professionals: These people and their
firms design the building or system to be built. Architects generally
design buildings while engineers design systems for buildings (structural,
electrical, mechanical) and nearly all heavy construction. Other
design professionals include geologists (addressing, for example,
soil conditions affecting foundations), construction managers, land
surveyors, building code consultants, landscape architects, environmental
consultants, and lead abatement and asbestos abatement specialists.
Manufacturers
and Vendors: These companies provide the specialized equipment for
projects and typically sell it to the contractor, who installs it
and takes contractual responsibility for it. Vendors are like subcontractors
in that they are under contract to the general contractor. But, unlike
subcontractors, they supply only equipment and perform no labor on
the jobsite.
Suppliers
and Materialmen: These companies sell bulk materials, such as lumber,
concrete, paint and wire, to projects. Suppliers and materialmen
contract with the general contractor or a subcontractor. The buyer
is responsible for installing the material. |
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| V. |
Types of Owners |
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| There are two main types of project owners in
the United States: |
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Public
Owners: These include government agencies at any level
of government in the United States: the federal or United States government;
any of the 50 states and their agencies; and local governments such as
cities, counties (states are divided into counties) or special districts
(such as for schools, water treatment or transportation systems).
Private
Owners: These include individual persons, families, any kind
of business and non-profit organizations (entities set up not to make
a profit but to do good works, such as operate a hospital or college).
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| Public and private owners have building and heavy construction projects of all sizes. About 22 percent of U.S. construction spending in 2006 was on public projects; the balance, 78 percent, was on private projects. |
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| VI. |
How Projects Are Obtained and the Commercial Organization
of Projects |
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| Whether
a project is public or private determines how it is obtained and organized
commercially. I will first discuss public construction because a good
way to understand private construction is to contrast it with public
construction. |
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prevent corruption and cronyism in government contracting, by the early
1900s all levels of U.S. government – federal, state, local – had
adopted a system of public bidding on all government procurement, from
pencils to construction.
In construction, the public bidding
process works in this way: The government agency obtains a detailed
set of plans and specifications for what it wants built. The
agency warrants that the plans and specifications are complete
and ready to build.
The government agency must publicly
announce that bidding is open on the project and allow potential
bidders to view plan sets or buy their own sets of plans. The
announcement sets a deadline – usually a month or two away – for
submitting sealed, written bids to build the project.
The bids are lump sum or hard
money bids. That is, the bidder agrees to build exactly what
is in the plans and specifications for its quoted price.
When the deadline for submitting bids
arrives, the government agency opens the sealed bids. The project
is awarded to the bidder that quotes the lowest price.
The process is a straightforward
way to obtain the lowest price for a particular project. How
government agencies protect themselves from shoddy work by a
low bidder is somewhat more complex. First, the architects or
engineers who design the project either are employees of the
government agency or their architecture or engineering firm is
hired by the agency to prepare the design and specifications.
That way the government agency controls the quality of what it
is buying and what will be included in the project. Second, agencies
employ or hire inspectors to ensure that the contractor complies
with quality standards in the design and specifications. Third,
progress and final payments are made only for work that is completed
and completed to the owner’s satisfaction. Fourth, contractors
must post a payment and performance bond from another company,
called a surety, equal to the entire contract amount. By way
of the bond, the surety guarantees that the contractor will pay
all of its bills arising from the project, including wages to
workers, for materials used and for subcontractors. The surety
also guarantees – again by way of the bond – that
the project will be satisfactorily completed. If the contractor
proves not to have the technical skill, management skill or finances
to complete the project, the surety must pay for another contractor
to satisfactorily complete the project.
On government projects, sureties
typically are large insurance companies. The federal government
and private credit-rating agencies rate the credit-worthiness
of sureties. Government agencies typically require that bonds
be issued by sureties with good credit ratings.
Sureties make money by charging
the contractor a fee for issuance of each bond. The fee – typically
a percent of the contract amount – is based on the contractor’s
financial resources, past track record and market conditions
(whether sureties currently are seeking business or being selective).
In order to be able to bid, contractors
arrange in advance for a bond to be issued if they are the low
bidder. To do so, the contractor must provide a surety with detailed
financial information so the surety is satisfied that the contractor
has the financial resources to complete even losing projects.
Thus, the more financial resources a contractor has, the larger
the projects it can bid on. Sureties may insist on collateral,
parent company guarantees or even personal guarantees from investors
in the contractor to ensure that they, and not the surety, pay
for any losses sustained by the contractor. The surety also will
consider the contractor’s track record. The surety will
write more bonds and for lower rates if the contractor has been
in business for years and has successfully completed all of its
projects than if the contractor is newly in business or has defaulted
on prior projects.
The total dollar amount of bonds
that a surety will issue at any one time for a contractor is
called bonding capacity. Thus, for example, if a contractor bids
on and wins five contracts and their total value equals the contractor’s
bonding capacity, the contractor cannot bid on more work until
it completes at least one of the projects or convinces its surety
to raise its bonding capacity.
Another bond is required to ensure
the integrity of the bidding process: the bid bond. This bond
is a guarantee that the bidder either will agree to build the
project (and provide a performance bond) for its low bid price
or will pay the difference between its bid and the next low bid.
Thus, bidders must put their financial resources behind their
bids. Bid bonds typically are issued by the same surety that
will issue the payment and performance bond if the contractor
wins the project with a low bid.
Construction of government projects
can be summarized this way:
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Selection
of the contractor is strictly controlled by public bidding laws. |
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There
is a fixed, lump sum price for the construction. Unless the
government owner makes changes, the contractor must build the
project for the quoted price – no matter how large its
losses may be. That is why such contracts are called hard money. |
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The
process is called design-bid-build. That is because plans and
specifications ready to build from are prepared first. Then,
there is bidding. Then, the project is built. |
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| Owners
of private projects are free to select their contractors in any way they
wish. They can select based on price, on quality or on some combination
of the two. They can have open bidding and invite several contractors
to bid. Or, they can work in private with only one contractor. Even if
they have competitive bidding, private owners can reserve the right to
select any bidder they want (high, middle or low price) for any reason
they want (price, quality, long-term maintenance costs, aesthetics).
Nearly all private construction
work in the United States is awarded on the basis of negotiation.
The negotiation
can begin from a variety of points:
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The
project owner can select one contractor and begin negotiations
with it. |
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The
project owner can work with several contractors and get at
least preliminary pricing from all of them before choosing
one for final negotiations. |
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The
project owner seek bids from several contractors and then choose
one based on price, quality or other factors. Or, having obtained
bids, the owner may enter into negotiations with one or more
of the contractors. |
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| In
evaluating contractors, private owners may look at a number of
factors, including: |
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Price. It
is a factor for private owners as well as public owners. The
private owner may be limited by how much money it has to spend
on a project. Or, it may be driven by the return on investment
that must be earned by the project. For example, on a process
plant or paper mill project, the owner is likely to have calculated
how much money it can earn from the output – be it paper
or chemicals – from the project. But, if the project costs
too much, the rate of return will be too low. This means
the project owner will be better off investing its money
in something else. |
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Quality. This
could be a particular factor in buildings, such as homes, hotels,
offices and resorts, where quality and craftsmanship are important. |
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Ability
to meet the project schedule. This can be crucial
if the work involves additions to or renovations of manufacturing
or process plants that will require a shutdown for all or
some of the work to be completed. There are a number of contractors
in the United States that have a large volume of repeat business
because of their proven ability to complete shutdown work
on schedule. This ability is valued because the plant is
making no money while it is shut down. |
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Ability
to complete huge, unique or difficult projects. Many
contractors make lots of money and are much-appreciated by
their clients for performing the same kinds of work on project
after project. Far fewer contractors have the ability – and
are trusted by clients to perform – projects that are
unusual because of their size, complexity or novelty. For
owners of such projects, price may not be as important as
the assurance that it has the best contractor for a difficult
project. |
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C. |
| Structure
of Private Projects |
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owners are free to employ the same design-bid-build system used
on public projects. But, they may use others as well.
The
most common alternative is design-build (the term typically
used for constructing buildings) and engineer-procure-construct
or EPC (the term typically used for heavy construction projects).
Rather
than the steps 1.) design 2.) bid 3.) build, there are different
steps in a different order in design-build or EPC projects.
Typically, they include:
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Owner
determines the basic inputs and requirements of the project,
such as: Design, procure the equipment for and build a power
plant at a particular location, that will burn a particular coal,
that will produce a specified amount of electricity and that
will be a base load or peaking plant. Or, design and build a
warehouse at a particular location, of a particular size, with
a specified number of loading docks, concrete floors that will
withstand a specified forklift load, and with specified heating
and cooling capabilities. |
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Owner
seeks bids from or negotiates with contractors. |
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Owner
selects the contractor. |
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The
contractor designs or subcontracts for the design of the project
and builds it. (Industrial projects typically are called EPC
because procurement of major equipment, such as boilers for power
plants, paper machines for paper mills, crackers for refineries,
is so important to the design and to project costs. |
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The
start of construction is not delayed until design is complete.
Rather, construction can begin before the design is complete. |
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| Design-build
or EPC contracting lends itself to projects that are easily defined
by objective measures ("build me a power plant that generates
this much electricity"). It does not lend itself well to projects
with important subjective elements, such as fine finishes, important
architectural elements or very specific owner needs.
Some
of the advantages to owners of design-build include:
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Shortened
project duration because the design and construction phases overlap
rather than coming one after the other. This reduces financing
costs and makes plants, factories and buildings revenue generators
sooner. |
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Shifting
performance risk from the owner to the contractor. With EPC
contracting, if the power plant does not generate the specified
amount of electricity, the contractor is responsible. With
a design-bid-build project, the owner is contractually liable
for the design, having hired the architect or engineer. If
the contractor builds what the engineer designed and the plant
does not generate the planned amount of electricity, it is
the owner’s loss, not the contractor’s. |
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Shifting
construction risk from the owner to the contractor. Because the
owner is contractually responsible for the design on a design-bid-build
project, the contractor is entitled to extra compensation for
correcting any problems arising from the design. Examples include
conflicts between piping and structural members or specified
components that do not work properly. On a design-build or EPC
project, the contractor is responsible for the design and is
entitled to no compensation for fixing problems with its own
design. |
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D. |
EPC and Design-Build Contracting on Public Projects |
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| Government
agencies have noticed the success private owners have had with
design-build and EPC projects. In the last few years, special
laws have been enacted allowing some federal, state and local
government agencies to experiment with design-build and EPC contracting.
Special
laws were needed because design-build and EPC contracting
do not lend themselves to the public bidding process and
its focus on the low bidder. If the successful bidder will
both design the highway and build it and if the evaluation
is purely on the basis of price, then the bidders will have
an overwhelming incentive to design the cheapest possible
highway. On design-bid-build projects, government agencies
prevent this by controlling the design.
With
EPC and design-build contracting, evaluation no longer can
be purely objective (lowest price wins) but necessarily must
include subjective factors. These may include quality of
design, life cycle costs, past track record, perceived commitment
to the project, expertise and experience. Involving subjective
factors in selection of the contractor poses the risk of
re-introducing corruption and cronyism into the government
contracting process.
The
government experiments in design-build and EPC typically
include stringent procedures to keep the selection process
fair and honest. Whether the procedures are successful remains
to be seen, as the experiments are rather recent.
For
now, the government EPC and design-build projects tend to
large and complex – the kind that benefit most from
design-build.
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For
a detailed overview of design-build contracting on government
projects, click
here. |
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For
more information about public works contracting and disputes
in the United States, click here. |
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| VII. |
Pricing
Structures |
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| Construction
and design services are priced in a variety of ways in the United
States. They include: |
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Hourly: Architecture
and engineering services often are charged at a rate of so many
dollars per hour of service provided. Construction costs sometimes
are charged out at an hourly rate. |
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Percent
of construction costs: Architecture services sometimes
are charged based on a percentage of the ultimate cost of construction. |
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Cost-Plus: The
contractor is paid for all of its costs of performance (labor,
materials, equipment, management and other services) plus an
additional percentage for overhead and profit. |
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Cost-Plus,
GMax: This is a variant on cost-plus. While the contractor
is paid on a cost-plus basis, the contractor also guarantees
the owner that costs will not exceed an agreed maximum (GMax
= Guaranteed Maximum Price). Often, the contractor gets a share
of cost savings (difference between the GMax and actual costs)
as an incentive to control costs. |
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Lump
Sum: The contractor agrees to perform the project
for a lump sum or fixed price. |
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| These
methods of pricing tend to be used on particular types of projects and
are driven by factors unique to those projects. Some examples: |
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Renovation
of, maintenance of and additions to factories and process plants.
Because the owner is taking all cost risk, contractors perform the
work for extremely thin overhead and profit margins. |
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Small
repair and maintenance projects, particularly commercial and residential. |
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Renovation
of existing structures where cost of performance may be significantly
affected by conditions that cannot be seen before work begins. |
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Extremely
risky or unusual projects for which the contractor has no basis to
make a cost estimate or would have to include a large contingency. |
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Cost-Plus
Gmax |
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Construction
of apartment and office buildings (low- and high-rise), warehouses
and light industrial buildings. This work tends to be repetitive,
so the risks are relatively low. For owners, this pricing structure
keeps profit margins thin and encourages cost savings. |
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Lump
Sum |
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Nearly
all public works projects. |
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Power
plants and other facilities that are project financed. (Project financing
is obtaining bank loans or floating bonds to build a facility that
will generate revenue. The loan is made or the bonds issued on the
credit strength of the project itself, not of the company putting
together the project.) As a condition of financing such a project,
lenders insist that costs be as firm as possible. |
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Any
kind of project where pricing certainty is desired and the owner
is willing to pay for it. That is, contractors necessarily add contingency
to their lump sum prices. The owner pays for the contingency. In
exchange for that extra payment, the contractor accepts the risk
of all cost overruns – so long as the owner has not caused
them by making changes or asking for extra work. |
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| D. |
A
Note on Quantity Surveying and Estimating |
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| Unlike
projects in parts of the world strongly influenced by the British, few
projects in the United States are performed on a measured quantity basis.
Occasional exceptions are projects involving earth moving and excavation
and pricing of extra work (so much a lineal foot for extra pipe or wire).
Rather, the pricing structures above are used.
There are no quantity surveyors
in the United States. U.S. contractors do measure quantities from
drawings in order to develop their estimate or price for design-bid-build
projects. Such work is performed by estimators, who may be engineers,
former field personnel (former journeyman electrician does quantity
takeoffs for electrical bid) and people trained to be estimators.
The contractor then looks to its prior experience to determine
how many manhours of work it takes to install a particular quantity of work,
for example, 10 lineal feet of large diameter pipe. The estimated
manhours then are multiplied by the hourly wage rate for the workers
who will perform the work.
On
EPC and design-build projects, there are no construction-ready
drawings from which to do quantity takeoffs. Estimates must be
performed on the basis of information from manufacturers (a particular
paper machine needs so much pipe of a certain size to support it),
conceptually (the layout of the power plant ultimately will depend
on the equipment chosen for it, but structural steel quantities
are determined based on a possible layout) or factored (the contractor’s
prior experience shows that for a particular type of facility,
so many lineal feet of power wiring, control wiring, large diameter
pipe and small diameter pipe will be needed). The difficulties
of performing reliable cost estimates without a complete set of
for-construction drawings is another reason why EPC and design-build
contracting can be very risky. |
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For
more information about project management in the United States, click
here. |
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| VIII. |
Business Climate |
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| The U.S. construction industry traditionally
has had low capital requirements and low economic barriers to entry. Contractors
tend to have relatively little fixed overhead. Most of their workforce
is in the field on projects, not in offices. Workers are hired and let
go as needed. Rather than buy large pieces of equipment, contractors often
rent equipment on an as-needed basis.
General
contractors are paid in arrears for their work. That is, they first
perform work and then bill for it – usually monthly. But,
general contractors also pay in arrears by not paying subcontractors,
vendors and manufacturers until they have been paid by the owner. Retention
of 10 percent typically is withheld from payments to general contractors,
which retain a similar amounts from payments to subcontractors and
suppliers. Final payment and retention are due upon substantial completion
of the
project, which means the project can be put to its intended use and
only minor punchlist (or corrective) work remains to be done. On some
projects,
contractors can post bonds or letters of credit in place of retention.
So,
contractors’ capital
needs are fairly confined. They include: |
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Funds
to pay wages and benefits until progress payments for a project begin
to flow. (Wages and benefits typically are paid weekly.) |
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Sufficient
financial reserves to obtain needed bonding capacity if public
work or bonded private work is to be sought. (Unlike public owners,
private owners are not required to obtain payment and performance
bonds from general contractors; bonds are optional. However, many
private owners require them to reduce project risk although the
cost of the bond usually is added to the contractor’s price
for the work.) |
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Sufficient
reserves to complete any money-losing projects. (Failure to complete
a public project almost inevitably will result in a contractor
being disqualified from bidding on more public projects. Failure
to complete a private project almost inevitably will be a fatal
blow to the contractor’s business reputation, resulting in
no future business.) |
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| A 1997 Standard & Poor's survey of 5,214 construction companies found that only 50 of them (1 percent) had assets of more than $50 million. Some 58 percent of the companies had assets of $500,000 to $5 million. A 2005 survey by the Construction Financial Management Association was circulated to approximately 4,100 members, 660 companies participated and 532 companies were included in the study. The results were presented on a composite basis and showed per company assets of just over $33 million. (It also showed net earnings before taxes of just over $1.7 million per company on a composite basis.) The
low capital requirements and low barriers to entry mean that the construction
business is very competitive. Many owners are aggressive
and take advantage of the competition. Profit margins reflect the competition,
too. Measured as a percentage of project cost, gross margin (home office
overhead and profits before taxes) ranges from 2 to 5 percent for commercial
work on cost-plus GMax projects. Pure cost-plus industrial projects
may have gross margins of only 2 to 4 percent. Gross margin typically
is
somewhat higher – 8 to 10 percent – on lump sum contracts because
of the risk associated with them. Subcontractor gross margins often
are in the 10 to 15 percent range, in part because they often are paid
a
month later than general contractors. Subcontractors that specialize
in complex or niche services may achieve even higher profit margins.
Ultimately, profit margins for both general contractors and subcontractors
are dependent on economic conditions. In good times, gross margins
for subcontractors can reach 33 percent.
Measuring profit as a percent of project costs can be somewhat misleading.
For example, suppose a contractor is building a bonded $100 million office
building on a cost-plus GMax basis with gross margin of 4 percent or
$4 million.
But, suppose the contractor had only $10 million of
its capital tied up for the project – in the form of wages and
costs advanced, reserves against losses and reserves to satisfy its
surety. The $4
million in
gross margin represents a 40 percent profit when measured against capital
devoted to the project.
Leverage like that means that good projects can be very good. But, it
also means that bad projects can be very bad. It is not unheard of to have
cost overruns of 25 to 33 percent on lump sum projects. We have had clients
come to us facing losses of 60 or 70 percent. If a contractor is winning
lump sum contracts with 8 percent profit margins, that means one 33 percent
loser can offset all of the profits of four other projects of the same
size. Similar problems can arise if a project owner is unable to pay
for work performed.
All of this explains why there are a lot of rich contractors
in the United States – and why there are some bankrupt contractors, too.
For example, the United States’ largest subcontractor (Encompass)
is about to file for bankruptcy, and its eighth largest general contractor
(Washington Group) filed for bankruptcy a few years ago. Others do
very well and have been in business more than 100 years.
We should note that no government agency in the United States has any policy
of helping or supporting contractors. While the federal government generally
seeks to keep the U.S. economy strong, it does nothing to help the construction
sector in particular.
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| A. |
A
Note About U.S. Construction Cost Terminology |
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| U.S.
contractors divide their costs into project costs for particular projects
and home office costs. Project costs are all costs necessary to build
a particular project: labor, equipment, tools, materials and management
services. Home office costs are those incurred by the construction company
that cannot be directly allocated to a particular project. They include
costs for executives, accounting, marketing, estimating and insurance.
Many contractors use the term gross margin to describe the amount (if
any) by which revenue for a project exceeds direct or project costs.
Home office costs must be recovered along with profit from any gross
margin. |
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For more information about managing an American business, click here and here. |
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| IX. |
How to Get Started in Business |
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| Focus is the factor most critical to success
in U.S. contracting. Focus means: |
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Region: Pick
the geographic area or areas that seem most promising for the contractor’s
business plan. Construction is a very regional business in the United
States. Even the large “national” contractors do not operate
in all states at all times. They focus on the states or regions that
fit their business plans. |
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Sector: Pick
the market sector – and sub-sector – that best fits the
contractor’s skills and experience. Be a building contractor
or a heavy contractor. Do not try to be both. Within one of those sectors,
pick a few sub-sectors that fit in with the company’s business
plan. Some very successful building contractors in the San Francisco
area stick to building concrete-framed offices, apartments and light
industrial buildings. They do not try to build schools or hospitals;
they leave those to other contractors. Similarly, heavy contractors
that successfully build process plants and refineries do not try to
build dams. Successful highway builders do not try to build power plants. |
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Appetite
for Risk: Some contractors do quite nicely sticking to a
particular niche and building the same kinds of projects over and
over. The specialization and repetition lower risks and generate
steady if relatively low profits. Other contractors seek higher profit
margins by taking on unique or risky projects. The contractor must
make a candid assessment of its appetite for risk and capability
to successfully complete unique and risky projects. |
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Client
Base: Decide whether to build public or private projects.
Some contractors successfully seek both kinds of work. But, this
is difficult to do because the attitudes necessary to succeed are
so different for the two sectors. Public projects are awarded to
the low bidder, no matter what his personality or disposition. Private
projects are awarded to contractors who provide satisfactory performance
and good client service. If a contractor wants repeat business from
a private client, he must continue to provide a product that subjectively
satisfies the client. A contractor will get repeat business from
a public agency only if it is low bidder again. Because public contracts
are competitively bid, there is stiff price competition. That means
contractors enforce their contracts strictly – even aggressively.
There is no reason not to – being nice will not result in more
business. Just the opposite is true on private projects – contracts
usually must be administered with tact in order to preserve business
relationships and the chance for more business. It is hard to be
one company and to have two such different approaches to business. |
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Size: Decide
what size projects to seek. The decision should be based on experience
and available capital. Contractors that are quite successful at building
medium-sized projects can fail when they try to build a big project.
Similarly, the contractor must have the capital to sustain losses it
may incur on the projects it undertakes. Otherwise, one unsuccessful
project could put the contractor out of business. |
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| Making
the fundamental business decisions necessary to achieve a focused business
plan also shape the contractor’s sales
and marketing plan. If public work is to be pursued, then the contractor
simply needs to stay informed of the invitations to bid being issued by
government agencies that fit with its business plan and bid on those projects
that seem promising. The invitations to bid are a matter of public record
and open to anyone asking to see them. If
the contractor decides to pursue private work, it must begin marketing
itself to project owners and developers that fit with the contractor’s
business plan (buildings or heavy; region; size of project). Because
construction is so competitive in the United States, potential customers
must be convinced that the new contractor has the technical and management
skills and financial strength to successfully complete the owner’s
project. The novice may have to make price concessions or take on additional risks to break into a market.
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For more information about opportunities to bid on American
projects, click
here. |
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For more information about American contractors, click here. |
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For
more information about starting a business in a particular American
state, click
here.
Each state’s official home page describes
opportunities for new businesses. |
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For more information about particular American cities, click
here. The Finding Tools give the Web addresses for particular cities. |
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| X. |
Prospering in a Heavily Regulated Industry |
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| The construction industry in the United States
is heavily regulated. The regulation does not come from one central source,
such as a "Ministry of Construction." Rather, the regulation results because
construction involves a number of important public policies that, in turn,
involve a number of public agencies.
U.S. contractors use lawyers heavily to find their way through the regulatory
jungle. Successful contractors view their lawyers as a resource and a
key team member. Successful contractors involve their lawyers in issues
early to avoid problems rather than allowing problems to develop and
then seeking legal help. It is always cheaper to avoid problems than
to resolve them after they have arisen.
Lawyers fill a unique role in the U.S. economy and legal system. Lawyers
are required by law and codes of ethics to keep communications with their
clients absolutely secret. Complete advice and counsel can be given to
the client only if the client can speak to his lawyer in utter confidence.
The lawyer cannot help his client break the law. But, the lawyer is obligated
to use all of his skills to help his client achieve its business goals
in a lawful way.
The legal issues faced by contractors include:
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Business
Structure: Business can be conducted by many kinds of entities
in the United States, including sole proprietorships, partnerships,
joint ventures, limited partnerships, limited liability partnerships,
limited liability companies and corporations.
Choosing
the right structure for a construction company involves weighing many
considerations.
For
example, in California, limited liability partnerships and limited
liability companies cannot obtain contractor licenses. In New York,
corporations cannot offer to perform engineering or architecture services.
So the business structure must be compatible with licensing laws in
the states where the contractor plans to do business.
Taxes
are an important factor, too. Sole proprietorships, partnerships, joint
ventures, limited partnerships, limited liability partnerships and
limited liability companies pay no taxes on their income or can elect
not to. Rather, the income and obligation to pay taxes flow through
to the business owners. Corporations pay taxes on their income and
then their shareholders pay taxes on dividends and distributions, resulting
in double taxation.
But,
exposure to liabilities from the business also is an important consideration.
Liability does not flow through to shareholders in corporations, limited
liability partnerships and limited liability companies. But, liability
does flow through to some or all owners of sole proprietorships, partnerships,
joint ventures and limited partnerships. So, it may well make sense
to accept more tax obligations in exchange for the liability shield
of a corporation. |
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For
a detailed overview of American business structures, click
here. |
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Licensing: There
is no federal construction licensing in the United States. Architects
and engineers are licensed (or registered) in all 50 states. In many
states, their business entities also must be licensed or registered.
There is less consistency in contractor licensing. Contractors are
licensed in about three-quarters of states. In most states, the licensing
focuses on the business entity taking on construction work. But, in
some states, the licensing focus is on individual workers. Life safety
typically is the concern in those states, with electricians, plumbers
and framing carpenters being subject to regulation. States, such as
New York, that do not license contractors may allow local governments
to require contractor licensing.
Contractor
licensing is one of the most arcane areas of American law because
it differs so much from state to state. Some of the licensing laws
are out-of-date or anti-competitive. Even so, violation of the
laws can bring criminal penalties, including jail time and fines.
Most licensing laws provide that unlicensed contractors, engineers
and architects cannot sue in court for payments they are owed.
California now allows owners to sue unlicensed contractors to recover
all payments made to them. Licensing laws also determine whether
and how contractors can offer to perform projects on an EPC or
design-build basis in a particular state.
Ultimately,
businesses usually can be structured to comply with license laws
and achieve particular business objectives. But, the solution may
take time (more than 60 days just to obtain a contractor’s
license in California) and impact business structures (engineering
may not be performed by corporations in New York), which also can
raise tax issues. |
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For an Overview, with Case Histories, of U.S. Licensing, Registration Laws and a Compliance Checklist, click here.
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For
more information about licensing laws, click
here and here. |
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Contracts: Private
owners and contractors are free to negotiate whatever contract terms
they desire. Sometimes they use form contracts developed by trade organizations
such as the American Institute of Architects. Sometimes they negotiate
and draft unique contracts.
On
public projects that are competitively bid, there is little or no
negotiation of contract terms. The contract usually is a part of
the bid package.
Whether
the project is public or private, the contract is a crucial document.
It sets out price, payment terms, scope of work to be performed,
quality standards, risk allocation between the contractor and owner,
schedule, damages, damage limitations, testing and prerequisites
to project completion.
Bad
contracts can doom a contractor to a loss before the first shovel
of dirt is turned. |
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For
a detailed comparison of contract forms, click
here. |
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For
more information about U.S. contracts, click
here. |
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Bonding: As
discussed above, bonding capacity is a necessity to pursue public work
and may be needed to seek private work. This will require bond agreements
with sureties, which will require indemnity agreements with the contractor
and, possibly, with parent companies and investors. Because millions
of dollars in liability exposure are involved, such agreements must be
carefully negotiated and documented. A relationship with a good surety
representative is crucial to a successful construction business in the
United States. Lawyers can assist in establishing these relationships. |
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Insurance: U.S.
architects and engineers can obtain malpractice insurance – insurance
that pays for their legal defense and any damages resulting from their
professional errors and omissions. Such insurance is not available
to U.S. contractors. However, commercial general liability (CGL) insurance
is available to contractors. It pays for their legal defense and any
damages resulting from property damage and personal injuries to third
parties. Lawyers sometimes can help contractor clients | |
