Critical Success Factors for a Construction Company

Lasker, G. C.

Purdue University

(email: glasker@purdue.edu)

Schuette, S.

Purdue University

(email: sschuette@purdue.edu)

Cox, R. F.

Purdue University

(email: rfcox@purdue.edu)

Dirk M. Beck

Purdue University

(email: dbeck@purdue.edu)

Abstract

Unlike the majority of industries, the construction industry is not only saturated with a multitude of

small young companies, but also has one of the highest failure rates of all industries in the United

States. Is there a relationship between the age and maturity of a company, or is the failure rate due to

industry specific internal factors? The purpose of this research is to to answer this question and

establish a foundation upon which start-up construction companies could build. After reviewing

related literature, specific factors analysis, and questionnaire survey, this foundation will consist of

establishing the critical factors that must be managed.

Keywords: construction industry, success, acquiring the work, building the work, tracking the work

26

1. Introduction

According to the U.S. Census Bureau, in 2007 more than 3 million construction firms existed, and of

that total, 75% of construction firms were composed of self-employed workers with no paid

employees, and only 1% had 100 or more employees (U.S. Census Bureau 2007). The majority of

those companies were only in business for less than five years; of the 850,029 construction

companies in 2004, only 649,602 were still in business in 2006, with a 23.6% failure rate (BizMiner

2006). The contractor failure rate of new start-up companies is even higher, at 34.4%, a rate that is

second only to the failure rate of food service companies (Dunn & Bradstreet 2007). The following

questions arise:”What is the cause of the failure? Is there a relationship between the age and maturity

of a company that accounts for this failure rate?” So the purpose of the research is trying to answer

this question -- to establish a list of critical success factors essential to construction business survival.

This paper analyzes several industry specific factors and attempts to establish a guideline for

emerging construction companies to follow.

2. Analysis

The construction business can be broken down into three major functions: 1.acquiring, the work, 2.

building the work, and 3. keeping track of the work. Acquiring the work consists of estimating,

pricing, bidding, marketing, and selling. Building the work consists of the project management, field

management, material procurement, and labor productivity. Keeping track is simply accounting,

financial management, administration, and tax reporting. And then the three functions will be

discussed separately as follows.

2.1. Acquiring the work

Acquiring the work consists of many daily activities. Depending on the size of company these

activities may be performed by one individual or several different people. The research was based on

the common fact that all activities can be broken down into three roles: project management, field

management, and administrative tasks. To simplify the results the list of activities was further

narrowed down to seven key activities or factors: planning, marketing, estimating, pricing, selling,

contracting, and bonding.

Planning involves several different aspects of the construction business. The way this was presented

to the participants was at any organization level plan that was formally implemented. It could include

competitive, strategic, growth, or succession planning. The assumption was made that if an

organization places an importance on any type of formal planning that it will also place the same

importance on all aspects of its business plan.

Analysis of Figure 1 indicates from all participants the importance of planning, including all the

aspects listed above regardless of either company size or length of time in business. A progression in

27

its ranking as the company size increases is present due to the fact that the need for planning becomes

increasingly necessary as more people are involved in the everyday operations.

The marketing and selling aspects of a company designate the beginning stages of a project. This is

where a company establishes its identity and determines what kind of projects it pursues and the best

way to differentiate its services from those of another company. Figure 1 indicates that smaller to

mid-size companies put a larger emphasis on marketing than do larger companies. This can be

attributed to the establishment of a smaller company in a new market or niche. A larger company

may rely on public bid invitations and already established relationships to gain projects. Selling,

which is the second part, was ranked as being of average importance. This is due to the fact that the

construction industry is highly price competitive.

Pricing can be the sole basis on the selection of a firm. Estimating and pricing demonstrate little

relationship to the size of a company. While estimating accuracy is consistently ranked as an above

average concern across the board, one may see more of a variation in the importance of pricing. This

can be attributed to several factors, including the concept that as the size of a company grows, the

size of projects grow as well, and with larger projects come smaller profit margins.

28

Figure 1: Survey Results

Planning

Marketing

Estimating

Pricing

Selling

Contracting

Bonding

Pre-Construction

Budgeting

Scheduling

Job Mobilzation

Documenting

Quality

Productivity

Safety

Material Management

Closeout

Accounting

Administration

Tax Reporting

Cash Flow

Asset Management

Billing

Legal Issues

A7.00

5.009.00

9.005.00

5.001.00

5.008.00

9.004.00

6.009.00

6.008.00

5.006.00

9.006.00

7.009.00

5.008.00

5.00

B7.00

8.007.00

8.006.00

6.001.00

5.006.00

8.005.00

8.008.00

6.009.00

8.006.00

8.004.00

8.008.00

6.008.00

7.00

C8.00

8.007.00

7.005.00

5.003.00

6.007.00

9.006.00

7.009.00

3.009.00

5.007.00

7.008.00

6.009.00

7.009.00

7.00

D8.00

8.009.00

7.005.00

4.006.00

5.008.00

9.006.00

5.008.00

8.009.00

7.008.00

7.005.00

7.009.00

6.009.00

8.00

E6.00

7.009.00

7.004.00

6.005.00

7.008.00

7.005.00

5.009.00

9.008.00

5.006.00

8.006.00

7.009.00

5.007.00

7.00

F6.00

7.009.00

6.006.00

5.005.00

5.005.00

8.006.00

6.009.00

6.008.00

6.005.00

9.007.00

9.009.00

5.008.00

6.00

Average

7.007.17

8.337.33

5.175.17

3.505.50

7.008.33

5.336.17

8.676.33

8.506.00

6.338.00

6.007.33

8.835.67

8.176.67

G7.00

9.009.00

7.007.00

7.005.00

8.008.00

9.009.00

8.007.00

7.008.00

7.009.00

9.005.00

7.008.00

5.009.00

9.00

H6.00

7.008.00

7.004.00

6.006.00

8.008.00

9.007.00

4.008.00

8.009.00

8.008.00

9.006.00

8.009.00

5.008.00

7.00

I9.00

8.009.00

7.008.00

7.008.00

7.008.00

8.008.00

9.009.00

5.008.00

6.007.00

8.005.00

9.008.00

6.007.00

6.00

J8.00

8.009.00

6.005.00

8.008.00

8.008.00

7.006.00

8.009.00

6.009.00

8.008.00

7.007.00

8.009.00

7.008.00

6.00

K7.00

8.008.00

8.009.00

6.006.00

7.007.00

7.005.00

7.008.00

9.009.00

7.009.00

6.008.00

6.009.00

6.009.00

8.00

L9.00

6.008.00

7.006.00

5.007.00

7.008.00

9.007.00

9.007.00

9.009.00

8.009.00

9.004.00

5.009.00

6.009.00

7.00

Average

7.677.67

8.507.00

6.506.50

6.677.50

7.838.17

7.007.50

8.007.33

8.677.33

8.338.00

5.837.17

8.675.83

8.337.17

M9.00

7.009.00

9.008.00

7.007.00

8.008.00

9.007.00

9.007.00

7.009.00

7.008.00

9.006.00

6.008.00

8.009.00

9.00

N8.00

6.008.00

8.006.00

8.008.00

8.008.00

8.008.00

8.008.00

6.007.00

8.009.00

8.007.00

6.009.00

6.009.00

7.00

O9.00

6.008.00

8.007.00

9.009.00

7.007.00

9.009.00

7.008.00

8.009.00

6.009.00

7.005.00

7.009.00

8.008.00

8.00

P8.00

6.008.00

7.007.00

9.009.00

8.008.00

7.008.00

8.007.00

7.008.00

9.008.00

8.005.00

5.009.00

6.007.00

9.00

Q8.00

7.008.00

9.008.00

7.006.00

8.008.00

9.007.00

8.008.00

6.009.00

7.008.00

9.005.00

6.009.00

8.008.00

6.00

R9.00

8.008.00

9.006.00

8.008.00

9.007.00

8.009.00

9.008.00

7.009.00

8.007.00

8.006.00

6.009.00

7.009.00

8.00

Average

8.506.67

8.178.33

7.008.00

7.838.00

7.678.33

8.008.17

7.676.83

8.507.50

8.178.17

5.676.00

8.837.17

8.337.83

Average

7.727.17

8.337.56

6.226.56

6.007.00

7.508.28

6.787.28

8.116.83

8.566.94

7.618.06

5.836.83

8.786.22

8.287.22

50+ Employees

Aquiring the W

orkBuilding the W

orkTracking the W

ork

5-10 Employees11-50 Employees

29

Contracting and contracting terms were consistently ranked as being of above average importance to

all companies, with the leading cause being erroneous contract terms. Larger companies ranked it

slightly higher. The most common explanation was unfair payment and retainage terms and penalty

clauses. With larger, longer products this can be especially critical. Bonding ranks lower with smaller

companies primarily due to the types of projects. As a company grows, so does the importance of

their bonding capacity.

2.2. Building the work

Like “acquiring the work,” this function can consist of countless daily activities, but for the purpose

of this study all said activities have been summarized into ten separate areas: pre-construction

planning, budgeting, scheduling, job mobilization, documenting, quality, productivity, safety,

material management, and project closeout. Although these activities can be further broken down into

the concepts of project management and field management, this study has combined these two

aspects and asked the participants to combine both when ranking the different activities.

Figure 1 indicates that the activities involved with building the work have a natural progression

directly related to the size of the company and size of the project. The highest ranking activities were

budgeting, scheduling, quality and safety. It was also determined that as a company grows and

continues in business, more emphasis is placed on the budgeting and scheduling, while smaller

companies place more emphasis on the quality. Safety consistently ranked highly regardless of the

size of a company. This factor demonstrates the importance of safety not only for the well being of

employees, but also for the direct effect on cost and time associated with an accident, both short and

long term.

Pre-construction, job mobilization, material management, and project close-out all ranked more

highly among larger companies. These factors are more important to larger companies due to the size

and complexity of a project. Documenting and productivity were both ranked as moderate concerns.

2.3. Tracking the work

The “tracking the work” portion of the study consists of accounting, administration duties, tax

reporting, cash management, asset management, billing, and legal issues.

3. Methodology and logical analytic process

Based on the literature review and analysis a questionnaire has been developed and presented via

interview to executive-level individuals who were responsible for organization-level concerns.

Questions were categorized according to the three major functions while respondents were asked to

rank the importance of each item using a 9 point scale. In addition to asking the interview participants

to rank the various activities, they were also asked to recommend strategies for success for new firms

30

in respect to the corresponding categories. Based on analysis of their responses and the data gathered

from questionnaires, nine activity were listed as the main factor affecting the success of a

construction company. While any size organization can use the following information to establish

sound guidelines for their operations, it will be of most benefit for smaller to mid-size companies just

starting out.

4. Sample

Companies were divided into three categories based on their size: 50+, 11-50, and 1-10 see figure 1.

It was decided that the number of employees would be used as the classification. This is due to the

fact that the number of direct employees usually corresponds to the size and amount of work

completed.

5. Critical success factors

The following nine activities were ranked as the highest concerns of professionals in executive level

positions. The following list breaks each down and briefly summarizes the findings. Especially, it is

in this last activity where several construction companies typically fail (Stevens 2007).

5.1. Acquiring the work

Figure 2 graphs the three highest ranked activities in this section which are planning, estimating, and

pricing. The increase in the ranking of planning with the size of the company can be attributed to the

complexity of projects and to the varied people involved in the operations. Smaller to midsize

companies ranked estimating higher due to less room for error with smaller projects. Pricing was

ranked higher by larger companies as said companies found it increasingly important to cover larger

overhead with tighter profit margins.

31

Figure 2: Acquisition Activity Ranked Per Company Size

5.1.1. Planning

The importance of planning was ranked highly by all participants. The questionnaire defined

planning as any formal organization level plan, versus a project level plan, which could include a

growth plan, strategic plan, or any combination of formal planning. The responses from the

questionnaire and information gathered from the literature review and interviews were used to

establish a guideline for a formal business plan. For new companies just starting out it is critical to

their success to establish a plan and constantly review and modify the same if necessary. A good

business plan should consist of the following: executive summary, company description, target

market, competition, marketing and sales plan, operations, management structure, future development

or growth and financials. Sometimes an organization becomes so focused on planning their actual

work,that members of the same company can forget to plan for structure and operation of the

organization.

5.1.2. Estimating

The words estimating and bidding are frequently used interchangeably in the construction industry,

especially by smaller, less experienced owners. It is necessary for a company to understand the

difference between the two. “Estimating” is defined as “determining the company’s direct costs and

allocating corporate overhead to the job”. It is important to know just what a company’s overhead

costs are. Intuition and judgment should not be part of an estimate as they are in pricing. Rather,

estimates should be based on hard numbers and job cost records. For smaller companies with limited

resources, and historical cost data, this area leaves a huge vulnerability for failure. Ways to reduce

this risk are to stay within a company’s area of expertise. If growing into new markets create a plan

and consult with other professionals with experience. Guess work should be eliminated from

estimates. Estimating is about reducing risks and eliminating as many variables as possible. For

smaller companies, care must be taken when the same person is responsible for both estimating and

pricing and the two activities should be seen as separate.

5.1.3. Pricing

Pricing consists of determining what a company believes its services are worth. Pricing is based both

on competitor information and on company needs. The construction business is full of risks;

therefore, to justify these risks and to ensure the long term success of an organization, a reasonable

profit must be obtained. When pricing work in the construction industry, research has revealed

several factors which a company must take into consideration; these include: the difficulty of

construction, market rates, length of construction, labor content, location, and current backlog. By

having both accurate financial data and being able to interpret the same, management is allowed to

32

make an educated decision when deciding the desired profit on a job as opposed to “needing the

work.” A company needs to be aware of its hit rate and constantly monitor its success of winning in a

competitive bid situation. If a hit rate is too high, that could mean that the pricing is too low; the

opposite may result for pricing, if the hit rate is too low.

5.2. Building the work

Figure 4 illustrates how safety can be consistently ranked higher regardless of the size of the

company. It is one of the few things that can have such a big impact on cost, schedule, and quality.

Quality can be seen to decrease in ranking with the growing size of a company, a factor which is

misleading, because quality is often assumed for larger companies and projects. This is due to better

defined scopes of work and contracts. Scheduling ranked high for all companies.

Figure 3: Building Activity Ranked Per Company Size

5.2.1. Scheduling

Scheduling has to be a combined effort between both project management and field management.

Finding the right balance between cost, time, and quality is critical to the success of any construction

company. It is essential to identify any material procurement issues early on to avoid scheduling

delays. The key to successful scheduling is the ability to properly forecast available resources with

expected demands. It is necessary to be diligent in updating the schedules and in monitoring the

progress as compared to the initial baseline.

5.2.2. Quality

Quality has to be non-negotiable. It plays an important part in establishing a company’s identity. As

stated above, quality is one of the three factors that must be taken into consideration when balancing

33

it with cost and time. Establishing the expectation for quality of work is critical when starting out. In

a very visual industry such as construction, it can be the greatest differentiating factor between

companies.

5.2.3. Safety

Safety is one of the few factors that can have such a huge impact on all aspects of an organization. It

affects everything from cost (both direct and indirect), schedule, and quality. Two of the largest

expenses for a contractor are workers’ compensation and general liability insurance, both of which

are directly related to a companies’ safety record. A companies “experience modification rating” has

long term effects on a companies’ profitability, and a credit rating of less than one is that which a

company should strive to achieve. Each company that participated in the research identified having a

formal safety plan as a leading factor in a company’s overall safety and rating.

5.3. Tracking the work

The highest average score out of all 24 factors was located in this portion of the study, in cash

management. This was the only factor where over half of every participant of the study rated as a

nine. Other factors that consistently scored high were billing and accounting. Legal issues and asset

management were more of a concern for larger companies, while administration duties and tax

reporting were more of an issue for smaller companies.

Figure 5 summarizes the three highest ranked factors in tracking the work: accounting, cash

management, and billing. Accounting was consistently ranked high because of the essential need to

understand the unique financial aspects of the construction industry. Cash flow ranked the highest out

of all activities for all companies, and billing ranked highly across the board due to its effect on cash

management.

Figure 4: Tracking Activity Ranked Per Company Size

34

5.3.1. Accounting

It is important to understand the unique financial aspects of the construction industry. The smaller

companies that participated in the study recommended that the key to financial success is to use an

accountant familiar with the construction industry; of equal importance, it was understood that the

company owner/operator should be very involved with the finances. In order to best understand the

primary goals of accounting, the owner/operator must have useful data regarding the following:

Track job costs

Estimate new projects

Analyze cash flow

Insurance audits

Tax returns

By developing an understanding of business finances, the owner/operator can then avoid the mistake

of concentrating simply on the current bank balance and will be better able to evaluate the company’s

overall financial performance and to make sound decisions based on the future instead of immediate

needs.

5.3.2. Cash management

This was ranked as the highest single cause of failure. An organization’s ability to manage its cash,

both with initial capitalization and ongoing operations has been regarded as crucial according to

study data.

Initial capitalization is crucial to the success of a business. According to the United States Small

Business Administration, the lack of adequate working capital is one of the top causes of small

business failures. An individual should have at least enough cash reserves to cover oneself and any

initial employees for several months, including initial operating capital for advertising, insurance,

licensing, office expense, and enough reserves to cover labor and material prior to billings.

Forecasting initial operating expenses can be quite difficult if a good financial plan has not been

established. By using an established business plan -- in particular knowing the volume necessary to

sustain goals for the year -- will determine the new business owner’s initial cash reserves as they are

needed.

Once it is established and the company has sustained a regular cash flow, managing the operating

cash requires a developed understanding of the relationship between a project’s cash flow during

duration of each project; moreover, minimizing the lag between peaks is especially important. To do

this a company must maximize and accelerate cash inflow, control cash outflow, and accurately

forecast cash needs. Through the responses from the participants in conjunction with the literature

review, the following suggestions have been made to permit the accomplishment of this:

35

1. Accelerate and maximize cash inflow

Negotiate favorable payment terms

Establish and approve the schedule of values early on and submit your first request soon after

Manage billings, receivables, and change orders diligently

Manage the project schedule, as taking longer than the scheduled time is bad for effective

cash flow

Manage punch list items to minimize delays on retain

2. Control cash outflow

Use cash-flow projections to time large expenses

Utilize payment terms; don’t pay too early, but make sure to take advantage of discounts

Identify cost savings early on in a project

3. Forecast cash needs

Identify cash surpluses and deficits early on and adjust accordingly

5.3.3. Billing

Timely billing and managing account receivables are both aspects that can affect an organization’s

cash flow. The ultimate goal of managing a company’s billing is to limit the funding of projects from

its own cash reserves and transferring the funding to the clients. Companies need to make sure they

are getting paid in a timely manner; in order to be able to guarantee this, all billing must be made in a

timely manner.

References

Atallah P (2006) Building a Successful Construction Company, Chicago: Kaplan.

BizMiner (2006) Construction Industry Specific Statistics.

Boynton A C and Zmund R W (1984) “An assessment of critical success factors”, Sloan Management Review, 25 (4): 17-27.

Dun & Bradstreet (2007) Report of Contractor Failures.

Ganaway N (1996) Construction Business Management. Massachusetts: R S Means.

Gerber M (2003) The E Myth Contractor, Why Most Contractors Business Don't Work and What to Do About It, New York: HarperCollins.

Langford D and Male S (2001) Strategic Management in Construction, 2nd ed., Oxford, UK: Blackwell Science Ltd.

36

Schleifer T (1990) Construction Contractors Survival Guide, New York: John Wiley & Sons.

Stevens M (2007) Managing a Construction Firm on Just 24 Hours a Day, New York: McGraw Hill.

U.S. Bureau of the Census (2007) 2007 Economic Census, U.S. Department of Commerce, Bureau of the Census, Washington, D.C.

37