The construction industry is notoriously risky. Every construction project has multiple stakeholders, including property owners, project managers, designers and general contractors, each of which invest time and money upfront. Construction risks multiply quickly as dozens of subcontractors and suppliers enter the scene, adding unpredictability and human error to the list of external risks (like weather) that threaten already thin profit margins.
The most common risks in the construction industry are project delays leading to additional costs, payment issues and low profit margins affecting cash flow, environmental and weather risks, and subcontractor liability. Some of these risks are impossible to see until it’s too late. So, the best thing construction companies can do to lower their risk is to plan for all likely scenarios on the front end.
This guide will teach you how to identify the common risks that could cause trouble for your project, and the best way to reduce each type of risk. Follow these five steps to ensure that every project is profitable, safe, and efficient for each stakeholder.
1 | Identify the Potential Sources of Construction Risk
As they say in the Art of War, Know thy Enemy. Before you can manage your construction risk, you first need to identify the sources that could undermine your project. Common sources of risk in any construction project include:
- Environmental Risks: Natural disasters and other weather disturbances that can cause delays and losses
- Financial Risks: Financial risks can come in many forms, including inflation, local taxes, fluctuations in exchange rates, problems with the economy, and increases in oil or material prices.
- Occupational Risks: Accidents and injuries caused by workers’ actions, work techniques, equipment used, or other external sources. These are not only the most immediate, but also the most common risks in the construction industry.
- Stakeholder Risks: Miscommunication, misunderstanding of project requirements, or insufficiency of funds can result in payment disputes or even non-payment.
- Contractual Risks: Penalties specified in the contract for breaches of that contract, such as inability to complete the job on time
- Logistical Risks: Equipment availability, spare parts, fuel, storage and transportation challenges are examples of logistical risks that can derail your project.
Not all of these risks are present in every construction project. You may also face unique risks that aren’t listed above. In either case, it’s important to start identifying your potential risks as early as possible during the planning phase. Start by brainstorming with your team to identify as many sources of risk as possible. You don’t have to address them right away. Simply knowing how each risk can affect your project will enable you to more effectively deal with any that do happen.
2 | Assess Each Risk, and Determine How to Handle it
Now is the time to analyze each potential risk. Focus on its probability of happening, and the overall impact it will have on your project if it does happen. Prioritize high impact risks with a high probability of happening, and move down the list to make your game plan.
There are four ways you can handle construction risk, each with its own appropriate time and place. You can accept the risk, transfer it to another party, mitigate it, or avoid it altogether. Follow this guide to determine how your risks should be handled:
Accept the Risk
For low-probability, low-impact risks, the best thing you can do is accept that they may happen. This is especially important when the time you would spend trying to avoid or mitigate the risk would outweigh the time you would lose if it actually happened.
For example, There is the possibility that it may rain one day. You could attempt to mitigate the risk by spending hours pitching tents and tarps over your site every morning. Or, you could accept the risk and lose an hour or two of work on the day where it actually does rain.
Transfer the Risk
This is the best strategy for risks that are both unavoidable, and out of your control. As a general rule of thumb, risk should be transferred to whoever would be the most direct cause of it. This is typically done through liability insurance policies.
For Example: A subcontractor breaks an expensive stained glass window during installation. If they have general liability insurance, it will cover the cost of replacing the window, effectively transferring the risk away from you.
Mitigate the Risk
Risks that have a high probability and a high impact, but that you do have some measure of control over should be mitigated. Fully mitigating risks may take more time and resources than you have. It’s perfectly alright to mitigate a risk, then transfer the remainder to a third party, and accept any leftover risk that you shoulder.
For example: Let’s combine the scenarios above. You can mitigate the risk of subcontractors causing damage or injury by properly training them and providing top-quality Personal Protective Equipment (PPE). You can transfer most of the remaining risk by verifying that every subcontractor is properly insured. If it rains, you could postpone work for a few hours to lower the risk of injury, and accept that you’re taking a risk by potentially delaying the project.
Avoid the Risk
Some risks are likely enough, and impactful enough, that the best option is to step back and refuse the project. If the risks dramatically outweigh the potential rewards, it is perfectly valid to turn a project down.
For Example: The project site will likely be hit by a hurricane in the next month.
3 | Use Your Construction Contracts to Set Risk Guidelines
Long and tedious as it may be, the contract is a powerful tool that you can use to manage risks. It is the best place to set guidelines on which party is responsible for handling particular risks. For instance, you may include indemnity clauses in the contract, that will require one party (ex. Subcontractors) to provide compensation to another party (ex. General Contractor) if they suffer losses resulting from the claims of a third party (ex. Homeowner). Contracts are also the best place to flesh out the insurance requirements for your entire supply chain of suppliers, vendors and subcontractors. However, it’s important to remember that stating an insurance requirement in a contract doesn’t mean you’re covered. If the supplier or contractor doesn’t have insurance it may void the contract, but you will still be on the line to pay for their mistakes. For example:
Suppliers: Product Liability Insurance
- An improperly made pipe causes flood damage
Architects and Designers: Professional Liability Insurance
- A design flaw leads to project delays, causing lost revenue for your business
Subcontractors: General Liability Insurance
- A poorly fastened beam falls, causing injury and/or property damage
4 | Leverage Mechanics Liens as Protection from Nonpayment
One of the biggest risks that construction business owners face is the risk of nonpayment. Because clients withhold part of the total payment until the work is done, contractors bear the risk of not getting paid due to work disputes and delays. For this reason, it’s important that contractors protect their right to payment through the use of a mechanics lien.
A mechanics lien is a legal claim filed by a contractor or supplier against a property to seek compensation for the unpaid labor that they provided or materials that they furnished. It puts a public record on the property’s title, making it difficult for property owners to sell or refinance the property. If they fail to settle the payment issue, the court may order them to sell the property, and use the proceeds to satisfy the lien.
5 | Verify and Monitor Certificates of Insurance
The best way to protect yourself against risks that are out of your control is implementing a thorough Certificate of Insurance Management program. Because construction projects need to staff up and start quickly, collecting, verifying, and monitoring certificates of insurance for every subcontractor can often fall to the wayside. There are four main mistakes construction companies make which can lead to significant losses:
- Accepting fraudulent certificates of insurance
- Accepting certificates of insurance that don’t meet the insurance requirements
- Allowing subcontractors to begin projects without insurance, in order to start on time
- Failing to monitor certificates of insurance after a project has begun
Learn More: How to Spot a Fake COI
The best way to solve these four problems, without adding hours of work to your plate or delaying projects, is to work with a Certificate of Insurance Management company that also provides insurance. Bunker helps construction companies by verifying each certificate of insurance to the exact contract requirements (including additional insured endorsements & language), working with subcontractors to fix errors in their COI, and quickly providing insurance to anyone without it. Then, Bunker stores and monitors each certificate of insurance, notifying you when someone changes or cancels their policy. Every certificate can be easily shared with property managers or other stakeholders online. Construction companies can start projects about 20% faster, save themselves 30 minutes of work per subcontractor, and eliminate millions of dollars of exposure by working with Bunker.
Construction projects are a huge and complicated undertaking, so there will always be risks. However, if you’re well prepared to handle them, the challenges won’t seem so daunting. The best way that you can prepare is by proactively identifying the risks, and creating a plan to accept, transfer, mitigate, or avoid them early on.
About the Author:
Patrick Hogan is the CEO of Handle.com, where they build software that helps contractors, subcontractors, and material suppliers with late payments. Handle.com also provides funding for construction businesses in the form of invoice factoring, material supply trade credit, and mechanics lien purchasing.