
In brief, you have. You have likely had many defaults that have cost real money. The truth is, although catastrophic defaults are not an everyday occurrence, “micro defaults,” those defaults that cause minor delays, or require rework, labor supplementation, or augmentation of general conditions resources are quite common - Maple Insight data shows that about one in four Subcontracts defaults. Remember, default does not mean termination; default is a failure to meet a contractual obligation.
Those failures to deliver a good or service as purchased inevitably cost the buyer. The total cost of rectifying a micro default can be extremely difficult to quantify. Delays are often the product of many individual actions or inactions, and the secondary and tertiary effects are often difficult to connect to a singular default. In the event multiple Subcontractors default, accurate attribution of damages to each party is even more challenging.
There are three fee erosion conditions commonly created by micro defaults: unanticipated general conditions spend, unexpected acceleration requirements, and unrecovered damages. Rather than allowing those costs to quietly erode your margins, it is possible, and is best practice, to identify and quantify them so that you can better control them.
Project budgets are tight. Regardless of the Project Delivery System – Agency Construction Manager or Construction Manager At Risk, or pricing methodology – Cost Plus, Cost Plus with a Guaranteed Maximum Price (GMP), Lump Sum, etc., Construction Managers and General Contractors (CM/GCs) must be lean with their general conditions estimate and often must remove most of the “what if” budget. When a Subcontract defaults and additional CM/GC staffing resources are required to manage the problem, the budget is rarely sufficient, and fees are eroded.
Unanticipated fee erosion affects the project, but also corporate projections and profitability. As an alternative, by identifying and quantifying the default risk and the additional general conditions burden that defaults might generate, CM/GCs can estimate projects more accurately, and use those general conditions resources to manage costs and fee more smoothly and predictably.
Late delivery by a Subcontractor of a portion of work, rework caused by unsatisfactory quality, and unexpected additional field coordination requirements all cause delays. Over time, delays by one Subcontract can affect the production of another Subcontractor. When these compounding delays threaten the critical path, the CM/GC is at risk of significant project delay which, to prevent, can incur substantial acceleration costs. It may feel as if acceleration expenses are incurred to keep the project on track as it has become difficult to pinpoint the original offense that led to the delay, however, acceleration is needed to get the project back on track.
There are millions of variables on a project and without identifying the initial risks that may contribute to a delay or quantifying the magnitude of the delay, it is common to believe the schedule challenges are just “the nature of the beast” and that acceleration is needed to “get the job done.” While it is true that acceleration expenses will never be completely avoidable, they certainly do not need to be unexpected. In quantifying the magnitude of necessary acceleration, we can ensure that the economics of the project support these costs so that they do not come out of fee.
Of course, there are scenarios where a Subcontractor’s default or negligence is easily identifiable, and the costs incurred are back charged to the offending Subcontractor. The CM/GC will quantify as much of the damage as possible and hold the Subcontractor responsible. This is conceptually very straightforward but is very rarely easily employable. Disputes arise over the party at fault and the value of both direct and indirect damages can be extremely difficult to prove.
For example, let us say that ABC Construction defaults, which delays the project by one week. Suppose that the scope of another firm, XYZ Construction, is dependent on ABC’s delivery and to get the project back on schedule, XYZ needs to work two weeks of weeknights and weekends. The CM/GC needs to provide site supervision, safety, and standby trades, in addition to XYZ’s change order for the added time.
Figure as well that coordination between ABC and XYZ is poor. XYZ claims that a portion of ABC’s scope must be reworked, and ABC disagrees. One can easily see, given the contention, how unlikely it will be for any of the three parties to fully recover those amounts to which they believe they are entitled.
We will never eliminate unrecovered losses in our industry, or in any industry for that matter, but we can estimate the magnitude of these losses before they occur. After doing so, we can ensure that projects are financially well-insulated from scenarios such as these and protect our bottom-line projections. The better we can anticipate expenses, the more likely we are to hit margin targets.
Underbudgeted delay expenses, personnel requirements, and overestimated damage recoveries often contribute to deceiving margin projections. We will never eliminate the risk from our projects, which is, in fairness, the reason we collect fees in the first place. However, by anticipating micro defaults ahead of time and quantifying the exposure, we can more accurately arm our projects with the financial resources to protect booked fee.
Completely Unrelated Trivia Treasure: The Olympic marathon distance changed seven times in the first seven modern Olympics, varying from 40 kilometers to 42.75 kilometers. The distance run today, 42.195 kilometers, or 26.22 miles, was first established in 1908 when organizers of the London games lengthened the race by 0.335 kilometers so that the race could start on the Windsor Castle lawn and end in front of the Royal Box.