Assessing Risk When Expanding a Construction Company’s Geographic Footprint or Service Area

The following appeared in the October 19, 2017 issue of Construction Executive’s Risk Management e-newsletter.

The recent momentum of the construction marketplace has provided contractors of every size and sector ample opportunity to capitalize on the continued economic recovery.

Best-in-class contractors have been able to select the best project opportunities to maximize their company’s operational efforts and reap the reward of financial return. Entrepreneurial contractors continue to see vast opportunities and may consider expanding their company’s geographic footprint or industry service offerings to further capitalize on the current market. While financial gain may entice operational growth, contractors should first consider how new strategies can impact company-wide exposure to risk.

Growing contract revenue based on new strategies to ultimately grow return on investment can be an exciting challenge for many contractors. Undergoing significant upfront planning and paying particular attention to new risks will ensure they do not inadvertently expose the core business. Proper venture capitalization is the first step to avoiding financial failure.

There are two critical questions a contractor should ask during the planning phase:

• What additional fixed costs will the new strategy require to be successful? These may consist of a variety of additional expenses, but commonly include additional personnel with expertise the contractor does not currently employ, additional compensation for current personnel tasked with taking on additional responsibility and additional or specialized equipment and/or facilities.

• Can the contractor properly finance the new strategy without interfering with the cash flow of the existing business? Essentially, once the contractor has quantified costs related to start-up and initial operations, can the company or individuals afford to lose that investment without impacting the operating assets needed to continue the success of the existing company? Those contractors that educate themselves about the financial means needed to make new strategies successful and equally understand the extent of the financial investment they are willing to ultimately invest, and potentially walk away from, will significantly increase their opportunity for long-term financial reward.

New opportunities in local markets outside a contractor’s current footprint are natural hunting grounds during times of expansion. Prior to a full-fledged marketing campaign targeted at the identified new geography, a contractor must consider differing demographics, such as the target territory’s unique characteristics of potential employees and clients, local business practices and state and local government regulations. In addition, contractors should have a complete understanding of the territory’s unique reporting requirements including sales and use tax, payroll and unemployment issues, income tax and personal property tax.

Given the contractor has gone through an exercise to understand costs as noted above, consideration now needs to turn toward what that market will bear for the company’s product and service. Contractors should understand the competition in the new territory as well as opportunities to offer new or improve current products and services. The most significant consideration related to strategies to move into new territories is whether or not the clients in the new territory will pay for the contractor’s services at a price that will allow the contractor to achieve a pre-determined return on investment.

Another common method for contractor growth is bolting on additional services that complement the company’s core service offering. Contractors often live by the mantra, “Know what you do, but more importantly, know what you don’t do.” Complementary service offerings can appear to be safe growth; however, contractors need to fully understand quality, legal, compliance and operational challenges of any new strategy. Relying on a professional network to obtain an in-depth understanding of what makes the well-known players in that industry sector successful will go a long way in avoiding learning lessons the hard way. A common pitfall is properly addressing a new industry sector from an operational standpoint, but failing to evaluate the impact within the executive, estimating and finance departments.

Although the contractor may be able to compete well in the field, he may struggle to turn a profit if the holistic view is not considered. Contractors should be brutally honest with, and conservatively understate, their own technical capabilities in the new industry sector until they develop a proven track record. Given the strategy should be centered on long-term growth and return, any initial investment in personnel or consultants that specialize in the field will be worth the upfront cost and provide value well beyond initial operations.

As contractors come to understand challenges and opportunities for new business strategies and look to put their plan into action, they may consider consulting an attorney and certified public accountant that have expertise specifically in the construction industry. Often times certain factors uncovered in the planning stages may make it advantageous for contractors to conduct operations under a separate legal entity or partner with a third party under a joint venture agreement. Fortunately, there are certain legal structures that can help limit detrimental financial implications to the core business or its owners should unforeseen challenges arise.

There are no pre-defined road maps that guarantee success in expanding a company’s footprint or providing additional service offerings. Success will ultimately be realized by not only the contractor’s entrepreneurial drive but also by proper planning, insight, and ongoing monitoring to make sure today’s opportunity translates into tomorrow’s reward.

Common challenges to expanding construction companies:

• The ability to find qualified and motivated employees

• The ability to identify and invest in industry-changing technologies

• Bridging generational differences to achieve coordinated productive efforts

• Finding an appropriate mix of outside financing and owner investment

• Municipality, local and federal government regulation over the construction industry sector