In the construction industry, the roster of project trade partners and vendors changes on nearly every project. With so much constantly in flux, how can you confidently know you’ve selected the right subcontractors?
Subcontractor default is on the rise — and it can be crippling to construction firms. Because of the popularity of the product, the marketplace of SDI (subcontractor default insurance) providers has increased in recent years, but this will only emphasize the need for proactive risk mitigation among buyers.
One of the top methods general contractors can use to get ahead of known risk in construction is subcontractor prequalification.
What is subcontractor prequalification?
According to The Horton Group, subcontractor prequalification is “assessing a potential subcontractor’s ability to borrow money and honor that debt.” It’s a crucial element of the preconstruction phase. During prequalification, the risk management team will evaluate the risk of working with potential vendors before the estimating team awards contracts.
It’s all about ensuring you’ve selected the best possible subcontractors for your construction projects. While a subcontractor might be a great choice for one project, they may not be the best choice for the next. Determining “right fit” helps companies eliminate the most risk possible during preconstruction.
What’s the process for subcontractor prequalification?
There are many ways to build a detailed subcontractor prequalification process. Today, companies have an array of options, from simple forms to robust third-party platforms.
Whichever you choose, your process should include:
✔ Initial underwriting on standard metrics (stability, past performance, safety, financial health, ethics, compliance, etc.)
✔ Additional assessment of higher risk trades (e.g. curtainwall) in terms of setting approval authority and limits
✔ Additional assessment of potential subcontractor risk in new markets/geographies
✔ Setting overall company risk tolerance, both in terms of capacity and mitigation strategies
✔ Establishing clear process for review and approval of exceptions
✔ Setting a cadence for updating subcontractor qualifications: annual, bi-annual, or quarterly
✔ Coordinating with project management to create feedback loops with onsite teams
From there, you can establish a database of prequalified subcontractors for your estimating team to choose from. Or, build a list for upfront evaluation prior to bid selection and contract award.
What specific data should you consider in the process?
Many construction leaders talk about subcontractor prequalification in terms of the 3 C’s: character, capacity, and capital. While these are all important factors to consider, it’s better to expand into a wider range of data. Here are some of the top categories to consider:
• Working Capital
• Turnover (Efficiency)
• Debt (Leverage)
• Recordable Incident Rate
• Days Away / Restricted Transfer Rate
• Project Performance History
• Supplier References
• General Contractor References
• Insurance Coverage Limits in Place
• Ownership Breakdown
• Construction Management Team
• State Contractor License Number(s)
• Geographic Territory of Operation
• Scopes of Work
• Company Certifications (WBE, MBE, etc.)
What else can help mitigate the risk of subcontractor default?
Your subcontractor prequalification process should be a single part of your larger risk mitigation strategy. Beyond prequalification, it’s important to consider:
1. Partnerships. How can financers, brokers, and insurance entities support your prequalification process by providing additional information already gathered through their resources?
2. Technology. Many companies continue to rely on outdated, homegrown prequalification systems. Is your subcontractor prequalification process leveraging the best possible technology for the job? It’s important to involve technology throughout the entire prequalification approach, alleviating the administrative burden and ensuring reliable information.
3. Integration. Has the data collected through your subcontractor prequalification process been democratized across your construction organization? Are qualification statuses seamlessly integrated into estimating and accounting workflows? The top construction companies are successful because they tie all their process information into one easy system with total transparency.
“The rebounding construction market is not simply a return to pre-2008 construction levels. It’s a new environment with significant and different challenges. A general contractor’s behavior must follow suit. ‘I trust that guy’ is not a reason to award a contract.”
Today, the risk of subcontractor defaults remains high. Because of this, there’s a demonstrated need for adequate underwriting and prequalification. To ensure your firm’s future success, you must embrace and own a streamlined, recurring, and proactive subcontractor prequalification process.