The general contractor challenge
August 30, 2016
Subcontractor default is a large risk for general contractors. Construction project costs can escalate quickly in the event of subcontractor default. Zurich Insurance helps its customers identify and mitigate subcontractor default risks, including the use of Subguard risk management and insurance. Subcontractor prequalification can help reduce the risk of subcontractor default.
One of the biggest risks to project success is the default of a subcontractor. It’s not unusual for a subcontractor’s contract on large projects to reach $50 million or more, so having a subcontractor default can seriously impact profitability for a general contractor.
The challenge today is to identify subcontractors who have the knowledge and skill to work on demanding, time-sensitive projects. The pool of skilled subcontractors has shrunk since the economic downturn that began in 2008, and some reports indicate that the subcontractor pool is only three-quarters what it was pre-recession. This suggests limited market capacity and high demand for the most talented workers.
General contractors experiencing a subcontractor default may suffer multiple damaging effects, including balance sheet disruption, project delays, distracted management and project team, increased costs, dissatisfied owners and reputational risk.
So, what should a general contractor do to identify a subcontractor who can deliver the project on time and within specified quality and safety standards?
One strategy is to consider the three Cs — character, capacity and capital — when evaluating a subcontractor. Here are some questions to ask yourself when evaluating a subcontractor using the three Cs:
- What is the reputation of the firm and the principals?
- Have they ever defaulted on a contract?
- Are they in litigation?
- Do they have a strong claims management program?
- Do they have a history of successfully completing contracts similar to yours in terms of scope, size, complexity and geographical area?
- What is their safety record?
- What is their current manpower and is it sufficient for the project under consideration?
- What is their quality record and QA/QC program?
- What is the strength of their balance sheet?
- Do they have sufficient equity and liquidity to support the work?
- Do they have a good credit/pay history?
- Do they have a surety relationship?
The three Cs can be a useful reference for a general contractor as their executive management team develops a structured subcontractor prequalification program. The goal of a prequalification process is to help ensure that accurate, appropriate information is compiled and evaluated in a way that allows those responsible for selecting subcontractors to make sound business decisions regarding the utilization of subcontractors on a project.
A subcontractor prequalification program that addresses both the subcontractor’s operational capabilities and overall financial strength can help a general contractor quickly and efficiently determine whether or not to include a subcontractor in bidding opportunities. Ideally, an established subcontractor prequalification process will become part of an organization’s corporate culture, similar to safety and quality management, as a tool of a successful general contractor.