Project Risk

Assessment &
Prequalification
By Ryan Howsam

In construction, money is
made or lost on a project before
the job even starts. The ability
to make the right decisions in
pricing risk before submitting
the project bid directly impacts
how successfully (or unsuccessfully)
margins are protected.

The risk environment in todays construction industry is

greater than any time in recent memory. Having a defensive strategy that protects your companys balance sheet
is paramount. Equally important is an offensive strategy
that helps to ensure your company is compensated for
the associated project perils and that it profits from mitigating and managing those risks.
Research conducted by Thomas C. Schleifer confirms
that, The failure rate of construction enterprises is three
times worse during recovery than during the downturn.1 More competition for fewer projects coupled with
increased backlogs (which, in turn, increases the strain
on working capital) has created a competitive environment characterized by aggressive margins and greater
financial strain on the contractors that are completing
the work.
FMIs Nonresidential Construction Index (NRCI) for the
fourth quarter of 2014 reveals the top three risks that
construction business owners say their companies are
facing today. (See Exhibit 1 on page 18.)
Its important to note that these are not simply insurable
risks, and that such risks require a much more thorough
analysis and understanding of a business than what can
be verified on an insurance certificate.

Current Risk Climate &

Project Risk Assessment
Since money is made or lost
before the job even starts,
the ability to make the right
decisions before submitting the
project bid directly impacts how
successful contractors are at
protecting their margins.

The question is, how do contractors leverage the opportunity that lies in front of them while ensuring that the
right decisions are being made?
For the typical contractor, the difference between a good
year and a great year can equate to just two or three
bad jobs. To keep the number of bad jobs at a minimum,
contractors are adopting more sophisticated approaches
to manage and mitigate project risks than they ever have
before. They understand that competition for projects
remains high and that margins are still low following the
economic downturn. Combined, these two factors are
pushing contractors to be smarter about which projects
they bid on, how they bid, and which project risks they
do (or dont) shoulder.
Adopting these new mindsets is critical because todays
recovering market is helping to produce more work for
contractors. While this is a welcome and positive trend, it
also creates some potentially negative consequences that
must be accounted for and properly managed.
During the recession, for example, many contractors
right-sized their companies by cutting overhead (namely
by reducing labor forces). As the economy picked back
up, and as contractors backlogs have grown, hiring has
also increased. As a result, the overall jobless rate for
construction workers is dropping back to pre-recession
levels. In fact, the construction unemployment rate has
almost aligned with the national unemployment rate for
the first time since 1951.
Part of this is due to a labor pool that has been shrinking
since 2007 a phenomenon driven largely by the exodus
of Baby Boomers (who are turning 65 at a rate of 10,000
individuals per day) from the workforce, and the large
number of workers who exited the construction industry
completely during the downturn.

March/April 2015 CFMA Building Profits 17

To top it off, a national oil and gas boom has lured many
of these workers away with newer and higher-paying jobs.
Combined, these challenges have contributed to a war for
talent within the construction industry, making it increasingly
difficult for contractors to locate quality, skilled, craft labor
for both current and future projects. According to FMIs Craft
Labor Recruiting and Retention 2015 Survey Report, 24%
of respondents will be unable to bid more work and 32% will
experience slow growth if their companies cannot reasonably
meet the need for skilled labor and tradespeople.

Contractors finances are still at risk in this recovering economic climate. Balance sheet health eroded during the recession, with low-margin projects pursued and won as a way to
help weather the storm and keep the lights on, so to speak.
However, as contractors win more work, and as backlogs
increase, the work margins for those backlogged projects still
remain low and have, in turn, put a great strain on working
capital. As a result, contractors are three times more likely to
fail now than they were during the downturn. And for those
contractors that dont fail, project-related quality issues are an
increasing problem due to staffing, skill sets, and working capital challenges.

EXHIBIT 1: NRCI Fourth Quarter Report 2014

Successful Steps for Todays

Contractors

Causes of Economic Uncertainty

So, how does a contractor operate successfully in

this challenging environment? It starts by conducting a robust project risk assessment during the prebid phase that will help accurately identify risks and
build out a risk register prior to placing a bid. The
greatest opportunity to influence project costs and
outcomes exists during the early design phase of
project development. (See Exhibit 2.)

Skilled Talent Availability

Growing Political Bipolarization
Future Funding Sources for Projects
Health Care Policy
Risk Averse Investors
Other
Status of Immigration Bill
Climate Change
0%

2014 FMI Corporation

5%

10%

15%

20%

25%

Once the project is awarded, the next opportunity to

significantly impact project costs occurs during the
pre-construction phase and will heavily utilize the risk
register developed in the pre-bid phase. After the risks
are identified, they are then quantified, which allows
for reflective pricing, contingencies, and fees on the
project.

Laying the Groundwork for the

Process
EXHIBIT 2: Construction Cost Curve

Moderate

Opportunity for
Cost Savings

Low

Ability to Impact Project Costs

High

Implementing a project risk assessment system and

dashboard can go a long way in making educated bids,
as well as controlling risk-related costs during the construction process. While a final decision on bid pricing,
or whether to bid at all, may assume more risk than
ideal, the project risk assessment will provide a clear
view of the risk being assumed and allow for better
management of that risk.

Design

Preconstruction
Award

Construction
Mobilization

18 CFMA Building Profits March/April 2015

Demobilization

Post-Construction

Although the line item details will differ among companies based on type of work performed, the foundational elements of financial, safety, and insurance risk
must be included for the assessment to be valuable. In
addition, the project risk assessment needs to be supported by three key elements:

1) Processes: The contractor must have well defined processes in place that are consistently executed across
projects.
2) Tools and Techniques: The contractor must have scalable
tools and techniques to address project risk.
3) People and Behavior: Both the delivery team and
management need to own the risk and be proactive
in addressing it; otherwise the processes, tools,
and techniques will be ineffective.
There are two main buckets to a formal risk assessment
approach: external risks and constructability risks. For each
project, potential areas of risk should be identified and placed
in the appropriate bucket, as shown in Exhibit 3. For example,
constructability will probably include: labor, materials, equipment, schedule, project type, and jobsite.
Next, each general area is broken down into its risk components and analyzed, weighed, and scored for risk. (See Exhibit
4.) As an example, when looking at project type, experience
should be considered not just the companys overall experience with the particular project type, but also the experience
of the project team.
The result of this analysis is a project risk assessment dashboard with a green, yellow, or red risk rating for each element. (See Exhibit 5.) This will help the reviewer price the
project while taking the potential risk into account. Depending
on the competitive environment, the final bid price may
differ from the ideal price. The project risk assessment is
then used to proactively manage the additional risk with the
processes, tools, and techniques previously discussed.
Individual Risk Elements

to

EXHIBIT 3: Project Risk Assessment: Risk Elements

EXTERNAL

CONSTRUCTABILITY

Owner
Partners
Subcontractors
Architects/Engineers
Contract
Regulatory

Labor
Materials
Equipment
Schedule
Project Type
Jobsite

FINANCIAL

SAFETY

INSURANCE

EXHIBIT 4: Sample Drill-Downs

CONSTRUCTABILITY
Labor
Materials
Equipment
Schedule
Project Type
Jobsite

PROJECT TYPE
Scope
New Build vs. Retrofit
Modular/Prefabrication
Project Size
Rsum/Experience
Commissioning
Environmental Consideration

RSUM/EXPERIENCE
Issue

Score

Notes

Experience with Project Type

Project Team Experience
Dedicated Personnel (i.e., Safety)
Others?

Consider

Now, examine individual elements of the project risk assessment process. Start with grading each element a process
thats based on the loss potential, the offensive and defensive
strategies tied to the frequency and severity of specific risks,
and the potential financial impacts to the project. Some of
the most common are as follows:
Owner
One aspect of this risk element is to understand how the
owner is financing the project. For example, a high-end
condominium development project was underway in Miami
during the height of the housing bubble. Developers were taking 20% down payments on units. When the housing bubble
crashed, developers walked away from the projects unable
to pay the contractors. Some contractors took units in lieu of
money, becoming de facto property owners and managers.

EXHIBIT 5: Sample Dashboard

EXTERNAL
Owner
Partners
Subcontractors
Architects/Engineers
Contract
Regulatory

Average
2.2
2.0
1.9
2.2
1.8
2.4

CONSTRUCTABILITY
Labor
Materials
Equipment
Schedule
Project Type
Jobsite

1.6
2.3
1.8
1.8
1.9
1.8

March/April 2015 CFMA Building Profits 19

construction, money is made or lost

on a project before the job even starts. The ability to make
the right decisions in pricing risk before submitting the project bid
directly impacts how successfully (or unsuccessfully)
margins are protected.
In

Today, understanding the risks, developers gravitate more

toward taking 80% deposits, which allows contractors to
reengage in a market that burned them just five years ago.
Partners
From the perspective of a joint venture, partners need to
have the financial wherewithal to see the project through to
completion. If one has a specialized capability (such as tunneling) and then defaults on the contract, the other partner
is responsible for project completion even if it lacks that
particular skill set.
Architects/Engineers
Professional liability is written on an aggregate basis, so even
though the certificate shows a contractor has $5 million in
coverage, those limits may have been eroded by a claim. At
a minimum, that limit is spread among many other clients.
Project-specific limits may be advisable.
Contract

jobsite prior to commencing work each day. At first glance,

the contractor thought compliance could be met by picking
them up and moving them prior to work each day. However,
that was deemed disruptive to the natural habitat. The solution implemented was GPS tracking for each individual turtle
identified. The impact to cost and schedule was an enormous
risk had the issue not been identified and a mitigation solution
predetermined.
Labor
Labor shortages create an escalation of labor costs. This in
turn translates into quality issues if the job is not staffed
appropriately. The more specialized the work, the harder it is
to find talent to fill those positions. One mitigation plan for this
risk is to tie a labor cost escalation clause into the contract for
longer duration projects.
Materials

It must align with the companys expected language. What is

preferred vs. what is given and agreed to? Should pricing be
different for risks? The contract must align with a business
internal risk profile and any risks identified in the process
that are not acceptable must be addressed accordingly.

Determine whether an early buyout of materials will help

lessen inherent project risk. Important aspects to consider
include material availability and potential impact to the schedule. Specialization of certain products (such as Italian marble)
requires more lead time and material damage could impact
the schedule for weeks.

Regulatory

Equipment

There are always provisions that could increase costs quickly.

One contractor had environmental concerns that had to be
addressed. They were required to locate box turtles on the

Idle equipment on standby needs to be managed and priced

accordingly. Does the schedule impact the ability to efficiently
use the equipment?

20 CFMA Building Profits March/April 2015

Schedule
Look at incentives to complete early. What are the risks to
the schedule, both on an increase and decrease in fee? The
greater the likelihood of schedule disruption, the more pricing should reflect the risk.
Project Type
Different project types will determine the risk built into the
project. Max price, for example, features a different profile
than a design-build or T&M project.
Jobsite Conditions
Working in lower Manhattan vs. building a pier vs. constructing a warehouse on an empty lot drives costly decisions
around material delivery, staging, parking for laborers, and
mode of traffic issues, to name a few.
As each element of the project risk assessment is examined,
consider the financial, safety, and insurance concerns as
potential project impacts. Finally, the ultimate project pricing for risk should reflect the severity and frequency of the
risks identified. Ask: Is it billable? How much will the contract
sustain? And, if risk is managed correctly, will the profit be
realized?

Honing the Prequalification Process

considers a project through the microscope of a subcontractor

may identify issues of which the owner isnt aware, or that the
competition missed completely.
In honing the prequalification process, be sure to not only
consider, but also look beyond, the basic components of
financial well-being and safety statistics. While the financial
health of a subcontractor is important, such information can
be dated and thus not very relevant. Likewise, safety statistics such as an EMR are important to consider during the
selection process. Yet, these are historical in nature and do
not tell the entire story.
Financial
Financial reviews are critical to understanding the financial
health of subcontractors. Through ratio analysis, insights can
be gained into A/R, working capital, and utilization of lines of
credit with an understanding of the subcontractors current
project list.
Qualifications
Qualifications are where the rubber meets the road. The
ability to complete the project, and have the rsum and
experience doing so on similar project scopes and sizes, are
paramount to ensuring an on budget, quality project.

Safety
Just one bad subcontractor can undermine an entire project.
EMR safety statistics are the benchmarks upon which most
All the upfront work in identifying risk and building out the
subcontractors are qualified. For government work, generproject risk register will be wasted if the right downstream
ally an EMR of 1.0 or below is required. An argument can be
parties arent selected. A good project risk assessment and
made that OSHA statistics are more valuable benchmarks to
formalized handoff process combined
with a best in class prequalification proEXHIBIT 6: Subcontractor Management: Prequalification
cess can help ward off potential issues
with subcontractors and suppliers.
In the absence of information, project
teams may assume that all subcontractors working on a project are equally
qualified. Getting to know the subcontractors as well as possible helps identify, manage, and mitigate such risks.
As a result, the project team will be
educated about every aspect of the job
and forced to review the project with
a fine-toothed comb. This will not only
help identify and mitigate risk, but it can
also create a competitive advantage.
For example, the project team that

Components

Financial

Qualifications

Safety

Experience

External Project
Experience

EMR

Formal Super
Feedback

References

OSHA

Internal
Experience

Output Is a Tiered Subcontractor List

March/April 2015 CFMA Building Profits 21

future performance than an EMR that is dated in the past. If

an EMR greater than 1.0 exists, understand what the issue
was and how that contractor has addressed it.
Experience
Experience is the most important information upon which to
base contractor selection. This is generally the best predictor
of how the contractor will perform.
Be sure to have an internal expert evaluate each of these four
areas carefully before selecting subcontractors for a specific
job. Generally, the CFO analyzes financials, safety is reviewed
by the director of safety, and qualifications and experience
are reviewed by estimating/operations/project management.
A weighted score is then applied and a subcontractor
prequalification list created for the company to use. Scores
that meet the threshold would allow the contractor to bid
with no further mitigation plans necessary.
Its important to note that contractors dont always have the
luxury of using ideal subcontractors on all projects. Owner
requirements, price, and geographic location all play a part
in who and why certain contractors must be selected.
Therefore, scores that fall below the stated threshold would
require a formalized exception process that can be designed
so that only the most senior executives can sign off on a
subcontractor that does not meet prequalification standards.
Concurrently, mitigation plans must be developed and
aggressively managed in light of this knowledge.
The more in-depth knowledge a company has about a subcontractor, the more likely the subcontractor will be set up
for success and avoid costly, unidentified risks.

Creating Project Accountability

By using a robust project risk assessment process, contractors can apply the correct project fees and contingencies by
identifying all the associated risks and then building out a
risk register to handoff to the project team.
The risk register allows the team to effectively manage and
create mitigation plans for those risks that the contractor
has agreed to take on. The prequalification process then
becomes an extension of the project risk assessment process
and mitigation plans.

22 CFMA Building Profits March/April 2015

Used in tandem, the project risk assessment and a detailed

subcontractor prequalification process helps to ensure that
an organization is paid for the risks it takes on, as well as
aggressively manages the process in a way that avoids unexpected surprises.
Remember, of course, that a process is only as valuable as
the built-in accountability and consistency practiced by the
project team. Through ongoing training, review, reporting,
and the work of internal committees and champions to design
formal processes that measure accountability, a company can
avoid margin fade and get paid for the risks already known. n
Copyright 2015 by FMI. All rights reserved. This article first
appeared in CFMA Building Profits. Printed with permission.

Endnote
1. Beware the Recovery: What History Teaches Contractors and Sureties,
by Thomas C. Schleifer, ENR, January 14, 2013.

RYAN HOWSAM, CRIS, is a Consultant for FMI

Corporation, in its Denver, CO office, where he delivers
assessment and implementation on all aspects of contractors risk management, including enterprise risk management, project risk assessment, rolling contractor controlled
insurance programs, and subcontractor default insurance.
Prior to joining FMI, he worked in the club and resort
development arena in Telluride, CO, as well as in the
construction fields of concrete, framing, and roofing in
the Rocky Mountains.
Ryan holds a BA in International Studies from Vanderbilt
University, and a master of real estate and construction management degree and International MBA in
Corporate Finance from the University of Denver.
Phone: 303-398-7275
E-Mail: rhowsam@fminet.com
Website: www.fminet.com