Focus on Insurance: Guest Commentary

May/June 2009

Cutting Costs Now Can Lead to Much Higher Costs Later

During the recession, contractors must be careful not to take materials and maintenance shortcuts that could lead to bigger problems down the road

It is increasingly evident that contractors are facing another belt-tightening year as construction project starts continue to decline after a 12% drop in 2008. The challenge for contractors is to find a way to cut back on expenses without unintentionally creating increased costs at a time when they are least manageable.

Todd Bateson President

John Komidar Vice President

Travelers Insurance provides insurance products and services for construction contractors and subcontractors. Todd Bateson is president of Travelers Construction and John Komidar is vice president of Travelers Construction Risk Control. Travelers is a member of multiple AGC chapters. E-mail: tbateson@travelers.com OR jkomidar@travelers.com

Three areas in particular may attract budget scrutiny as feasible targets for cost cutting: quality of materials, preventative maintenance and safety initiatives. However, cutting corners on any of the three may have expensive and even dangerous consequences.

Contractors know the quality of materials they use on a project makes a difference in the final result. Nonetheless, with the cost of materials making up a significant portion of the budget for any project, the temptation is strong to save money by buying lesser-quality items. This is particularly so today when projects draw 10 to 15 bidders, compared to fewer than half a dozen in the past. In this highly competitive environment, the work often is awarded to a contractor that not only keeps its profit margin thin but also reduces its cost for materials. But this penny-wise, pound-foolish approach may lead to construction-defect claims after a project is completed.

For example, one contractor working on a large complex of buildings bought cheaper plumbing fittings from an overseas source. Unfortunately, the fittings were manufactured with substandard materials that caused them to deteriorate soon after installation. Within six months after the project was completed, the fittings started leaking throughout the project and had to be replaced at a far greater cost than if the contractor had initially purchased high-quality materials.

In 2006, Quality Built, an industry consulting firm that tracks the prevalence of construction defects, surveyed 75,000 residential units built as part of more than 2,600 projects. Although not all defects were materials-related, the firm found the cost to correct construction anomalies averaged $6,724 in single-family homes, $7,155 in multifamily homes, and $4,391 per unit in mid-rise and high-rise construction. The unavoidable conclusion is that settling for lesser-quality materials can be a costly choice.

Maintenance Mayhem

Because of the vast array of equipment that contractors rely on—ranging from heavy-duty cranes and front-end loaders to jackhammers and radial-arm saws—there are no universal figures on how much firms should spend on preventive maintenance. But it is a budget item that can multiply rather than trim costs if it is handled badly.

In one recent example, a contractor apparently disregarded federal prohibitions against using retreaded tires on the front wheels of a dump truck. In the midst of a project, the tread on one of the front retreaded tires shredded, causing the dump truck to collide with other equipment and inflict extensive damage and injuries.

In addition to causing mechanical malfunctions that potentially can injure workers and bystanders, poor maintenance practices can also sideline needed equipment with breakdowns and further increase costs through project delays. Poor practices also may increase the costs of repairing the equipment. For example, a badly maintained part may cause other damage, such as a $500 bearing failure ruining a $7,000 transmission.

Contractors must remain vigilant in their safety practices despite their desire to save money. Construction is a dangerous industry, even though there have been improvements over the years in safety oversight and training. This can be seen from the U.S. Dept. of Labor’s Bureau of Labor Statistics data. There were 1,178 construction fatalities and 371,700 lost-time injuries in 2007, the latest year for which statistics are available. Such a level of fatalities and injuries shows that safety should not be ignored.

Companies with a strong safety culture that permeates their organization are in a stronger position to make judicious cutbacks compared with contractors that have placed safety responsibility in the hands of a single person who may suddenly be laid off in a downsizing of the workforce. But even the best companies need to be careful when it comes to cutting back on training, new employee orientation and safety processes because of the ripple effect that bad practices can have on a project.

Setting Priorities

The need to keep safety foremost extends beyond a contractor’s own operations and into the way subcontractors do their work. In one case, a subcontractor with an untrained crew erected scaffolding that was not properly secured. The general contractor relied on the subcontractor’s scaffold, and a worker was badly injured when it collapsed.

To maintain a strong safety program in tough economic times, contractors can turn to their insurers for assistance. While an insurer is not in a position to function as a safety guardian 24/7, the ones with strong experience in working with contractors typically have in-house risk-control experience they can share with customers.

With little optimism for a quick industry recovery, contractors have good reason to be concerned about their ability to stay afloat until the economy turns the corner. Nonetheless, they will be best served by avoiding reductions in materials quality, preventive maintenance and safety programs. Saving pennies today may cost big dollars in the future—a very expensive bargain that may only add to their financial worries.