Risks and Opportunities That Exist for a Large European Contracting Company - Essay Example

Investigate both the Risks and Opportunities that exist for a large European contracting company that is looking to develop its market share in a sustainable manner, assuming that we are entering a period of economic recovery Contents Introduction 3 Discussion 4 Risk analysis of JSConstruction Company 4 Strategies adopted by JSConstruction Company 9 Opportunities of JSConstruction Company 10 Conclusion 12 References 13 Introduction The construction sector is a crucial sector for the UK economy and it consists of wide range of services, products and technologies. The economic and financial crisis has created adverse impact on European economy and the construction industry. In 2010, the GDP of European Union increased slightly and in 2009 the GDP growth rate decreased by 4.5 %. The GDP growth rate of European Union has contracted by 0.4% in 2012 and increased by meagre 0.1 % in 2013. Some sectors like the construction, transport and communications and trade were most affected due to the crisis. The European construction industry experienced steep declines within the last years due to global economic downturn. Further the market upheavals and public savings pressure along with the uncertainty aggravated the situation. In 2010 the construction output declined in 2010, 2012 and in 2013. In 2013, the production output declined by 2.7% in real terms in the European countries but the there was a significant variation in the development in construction. The construction output continued to decline in these countries which were affected by real estate and economic crisis. The construction industry in Eastern Europe was most affected with a decline by -7.7%. There were a few countries where construction output increased in 2013 like Norway, Denmark, Germany, Austria and Switzerland. But the construction sector has favourable outlook and is expected to increase to 2016. In 2011 the construction sector is expected to increase moderately by 0.9%. The construction sector, which is considered as the main engine of economic growth in Europe, faced serious challenges like closure of many companies, postponement or even cancellation of investments, rising unemployment etc. With increased pressure to improve the productivity, competition and reduced costs there is an increasing need for project management and strategies which can effectively and appropriately manage project risk. This report will take a look at the risk and opportunities of JSConstruction Company, a construction company which is trying to expand in the European market. Discussion Risk analysis of JSConstruction Company Costa Concordia, an Italian cruise ship sank in calm waters two years ago while sailing past the island of Giglio because the caption switched off the navigation alarm system on the pretext that the caption knew the sea-beds well. As the construction industry of UK begins to look calmer, any sense of overconfidence can spell a danger ahead for construction industry. Many contractors like JSConstruction Company have gone through the pain of recession, when they had to cut down on the resources used. The company had to suffer many wave after wave of competitive pricing which eat into their profits. But with improved prospect of recovery they are cheerful. But there exist the danger to complacency because during the crisis, they had to downsize and hence neither the supplier not the contractor are now as able as they were before the economic crisis. Reduction of flexibility and resources have weekend them. For a construction company like JSConstruction Company the real dangers of shipwreck is the complacency it develops and takes projects which it cannot deliver effectively because either it didn’t had the requisite skills or lost the skills during the crisis. The real difference between a double digit losses and a single digit profit are bad construction contracts. There have been many instances where JSConstruction Company found that 30 percent of the value of the contracts was lost money and more than 90 percent of the above losses were due to factors which were clear even before the contract was signed (Gladwin, 1993, p. 71). Thus it is important for the company to focus on simple works like construction of one or two storey warehouses and buildings and avoiding complexities of precast concrete frames, basements, roof finishes and fancy curtain walling (Engstrom, 2014, p. 1). In such cases the company can make maximum profit. But these capabilities among the company varied across different countries since there were instances where the company was able to deliver dozens of the area offices profitably. The construction company has varied skill sets and it is based on both skills and capabilities of the individuals who work for it. At the same time, the composite skill set and processes of the entire organisation are important like the ability of the people to work support one another and together with specific resources and skills. For example major contractors like Laing O’Rourke or Balfour Beatty focuses on deliver of complex project since they have the skills in them to complete the projects and thus charge premium price for such projects. Hence it is important for JSConstruction Company to find its own core competency area and try to develop it. It is important for regional construction companies to understand the core competencies through contract profitability analysis of the activities that makes money and ones that don’t. This is the best risk management strategy for the construction company and it enables it to ascertain the core skills (Frankel, 1989, pp. 109-115). The company needs to implement corporate governance processes where the divisional or regional business management know the areas they are allowed to bid without any central guidance. The main focus of the governance framework should be on contract size, types of construction, client advisor, commercial terms and conditions, skills and resources, geography, partner relationships etc. The company should focus on who in their team has requisite skills for delivering the project for them. This approach will help the entire organisation get on board since the analysis is transparent and further it identifies the main core competencies of the business which set the direction for new growth markets where it is best suitable to thrive (Shenkir, 1990, pp. 30-33). For a JSConstruction Company risk management is probable the most difficult aspect. It is important for a project manager to recognize and identify the root causes of risks which exist in the business and trace the causes of it. It is a systematic and comprehensive way of analyzing, identifying and responding to the risks to achieve the project objectives. There is contract risk which the company faces and needs to manage the risk and unlock the value of it. A contract in such company is usually complex but the dynamics which govern them are simple, achieving largest amount of revenue by smallest expenditure. It is important to keep in mind that the value of contracts are realised only after it is signed. If it is not signed then it will lose out on the benefits sought. There are many types of contract risk like bad planning and demand management, poor or perverse incentives, deliberate contract manipulation, ill-informed buying and miscommunication which can erode all the value of the contract (Solomon, 1984, p. 152). There are other areas if risk like scope creep and quality failures, revenue leakage and cost overruns, damage to business, loss of bargaining power and loss of intellectual property. Thus it is important to manage the contract risk by understanding the contract in depth (Global Reporting, 2006, p. 16). It is essential for JSConstruction Company that the use of risk management strategies starts from early stages of a project, like major decisions of choice of alignment, selection of construction methods are influenced. The benefits of such process include identifying and analyzing the risks associated with a project and take appropriate steps for improvement of construction project management processes through effective use of resources. The success parameters for such kind of project are completion within time, within a predetermined budget and technical requirement (Wolfson and Epstein, 2013, p. 62). The main barriers of the company are the change in project management like global economic downturn. The problem is aggravated by the size of project as uncertainties in project outcome increase with size. Large contracting projects are exposed to uncertain environment because of presence of factors like design, planning, presence of various interest groups, design and construction complexity, resources availability, presence of different interest groups and political and economic environment (Halpin and Senior, 2011, p. 116). The contractual projects are unpredictable and managing risks in such projects is considered a very important process to achieve the overall objectives of the project in terms of quality, cost, time, environmental sustainability and safety. In Europe the construction sector is at most risk of accidents. According to research, the construction workers are two times more likely to get injured and three times more likely to get killed. The costs due to these accidents are huge to the employer, individual and to the society. This forms a significant proportion of the contract price (Hwee, and Tiong, 2002, pp. 351-360). Under normal economic scenarios the risk of default of JSConstruction Company is very high. In terms of business failures the construction industry is the front runner than all other industries. This situation is quiet common due to huge challenges which the industry faces like complicated projects, strong cash flow needs, complicated project schedules and sometimes low entry barrier into the marketplace. In the present economy, which shows signs of rebound, the default problems and contractor failures are heightened (Marsh, 2013, p. 11). The main problem for the company boils down to cash. It is quite evident that recovering economies presents huge opportunities of growth for JSConstruction Company, but to gain something from this growth huge amount of cash is needed and during this recover time the market is relatively cash poor. In such kind of industry, failure and default are quite common but in current economy it makes it all the more common. Though it is quite evident that no contractor will like the recession, there will be some contractors like JSConstruction Company who will hate recovery. Companies in such cases will default faster than anything seen during the 2008 recession compounded by the high inflation level. During the recovery, the margins of the company will remain low since there will be aggressive bidding by large established construction companies until they are satisfied. According to research, the rate of failure of construction enterprises like JSConstruction Company during recovery is three times worse than during economic downturn. Thus it is important for the company to acknowledge this dangerous period (Oforia, 1991, pp. 19-25). During such shrinking market, it would be ideal for JSConstruction Company to accept less work so that the market share of the business remained stable. But still there is a tendency of the company to not accept any reduction in sales and thus they often have to fight vigorously for few projects available during the time and thus driving down the prices for everyone. This kind of tendency persists through initial and intermediate stages of economic recovery because in such cases every project looks like the last project which the company did. Strategy where the company tries to maintain volume during economic recovery to increase the market share entails cost to the company. If a business is trying to be the first one to return to previous size it will create same effect, increasing the risk and limiting profit potential in an already risky business (Warszawski, 1996, pp. 133-140). This situation is aggravated further by the fact that at each stage of recovery after a downturn there is material cost escalation and shortages and labour shortages will increases the prices. There are examples where laid-off construction managers and trade people who have left the industry returns only when confidence have been restored in the industry. During such time material suppliers and manufacturers of companies like JSConstruction Company are forced to reduce the prices and cut back on capacity. Thus regaining the capacity will require huge investment and time resulting in material shortages which will in effect lead to rapid rise in prices. Again such companies are characterized by low margins, high debt ratios, and high failure rates and so on. Hence it is a constant challenge for JSConstruction Company to run it. Thus during economic turbulence the problem gets magnified (Bhalla and Edmonds, 1983, pp. 195-206). Strategies adopted by JSConstruction Company The most effective way of avoiding the problem is to appreciate and understand the market risk which will lead to default. The contractors of JSConstruction Company will be under pressure to quickly scale up the business quickly because of presence of growth opportunities. But as discussed earlier the biggest problem for a contractor failure is running out of cash. Hence JSConstruction Company needs to secure cash financing and availability before the company gets too desperate. The company need to understand default risk and take steps to keep the company healthy so that they can run the business for a long time. But these are not enough. Businesses with good cash practices and extraordinary discipline may be safe but not completely safe because the poor practices followed by other construction companies can create a problem for them. Thus JSConstruction Company needs to schedule its cash flow stream to cope with the work problems (Schleifer, 2013, p. 1). It is important for JSConstruction Company to decrease the days sales outstanding and increase the cash flow. The contractor can take a number of steps to avoid the risk of being insolvent. They can enter into lien and bond claim rights. JSConstruction Company must preserve their mechanics liens and bond claim rights. It will have in effect prioritized their invoices above others for projects thus resulting in getting the money first. Also when going gets tough for the company presence of lien rights means that one has the right available which can be a difference between not getting paid and getting paid (Wolfe, 2013, p. 1). There is no way to protect a contractor from failing like credit monitoring and credit checks in the world will not insulate the company from the risk, but presence of bond claim and mechanics lien will insulate the company. Presence of consistent and strong collection and credit policies will help the business in accumulating cash quickly. A credit policy indicates the set of procedures which the company needs to follow to determine company clients who will receive credit terms and those who will not and will specify the terms that will be offered. On the other hand, a collection policy is a set of procedures which the company follows when a client goes into non-payment status. Thus the procedures are important for insulating the company from a contractor default situation. A credit policy will help JSConstruction Company in avoiding risky contracts and a collection policy will help offset the risk of the business by increasing recovery rates, prioritizing the debts and cutting off the clients before their bill gets high (Pruss, 2013, p. 1). JSConstruction Company can enter into joint check agreements, but they need to be careful since it is extremely risky and dangerous. Joint checks are very common in the industry and hence mistakes are also common. JSConstruction Company must understand that joint check agreement is not a security device, it is a floatation device. The joint check agreement is not offered to secure a debt, but it is used to salvage a desperate situation, like when someone is defaulting or having project problems or is out of money. Whenever a customer cannot pay the company, he can extend a joint check agreement offer to keep it forward. Hence a joint check device helps the company while it is drowning (Rifkin, 2004, p. 84). Opportunities of JSConstruction Company The Construction demand is set to sky rocket. According to Richard Threlfall, UK head of infrastructure commented that after many years of slow growth, the construction activity is showing signs of recovery. The sentiments across business have shifted decisively with positive outlook which will help drive high construction output. There has been major improvement not only in residential sector but also in civil and commercial sub-sector. The main limiting fact which is holding the industry back is not the lack of demand within the industry but the ability of the businesses to recruit experienced and sufficient staff. Presently there has been a lot of speculation on the market recovery rate but history suggests that once the mood in the market changes the construction demand will rise. According to CIPS UK Construction Purchasing Managers Index confidence in construction has high rating because of expansion in both orders and workloads in civil engineering and housing. JSConstruction Company have seen steep rise in the workload which indicates the rise in demand in the industry (Assafa, Bubshaita, Atiyahb and Al-Shahric, 2001, pp. 295-303). According to a survey 46 percent of the firms are very confident about the construction sector while only 10 percent see reduction (Gerstel, 2002, p. 162). The increased hiring has increased the confidence level with the employment figures within the industry rising at a solid pace. Since June 2010 housing sector remained the strongest performing sector with its output increasing at a fast pace. But since September 2007, there was a steep rise in civil engineering activity. The same has been the case with commercial construction activities which was previously sluggish in nature and has gathered pace since May 2012. The new direction of the construction industry will bring new challenges and along with it the prospect of insufficient capacity to meet the demands and additional work. It is up to the players like JSConstruction Company to navigate these tensions and manage the supply chain to define its performance for years to come (Staff, 2001, p. 83). Conclusion The Construction Sector has suffered due to global economic meltdown. Construction companies like JSConstruction Company have undergone huge losses and the company is cash short during economic recovery. Though opportunity exists in the industry the presence of cash crunch in the market makes the company vulnerable to bankruptcy. JSConstruction Company needs to first secure cash so that they can bid for projects to achieve profitability. The company can decrease the day’s sales outstanding to increase the cash flow. The company can enter into lien and bond claim rights which will secure the money. Further the presence of mechanics lien and bond claim along with strong credit and collection policies will help the business in securing and accumulating cash quickly. The Construction industry is posed to achieve a healthy growth rate and it is important for JSConstruction Company to take opportunity in achieving healthy growth rate. References Assafa, S. A., Bubshaita, A. A., Atiyahb, S. and Al-Shahric, M. 2001. “The management of construction company overhead costs”, International Journal of Project Management. Vol. 19(5), pp. 295-303. Bhalla, A. S. and Edmonds, G. 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