Reinsurance
Product Family
Cheri Hanes

By

Risk Engineer, North America Construction

Originally published as an IRMI Expert Commentary

"Prequalification" has an implication of being a one-time activity, but to adequately address evolving risks, a more robust approach is needed. Strong sub management today demands an ongoing refreshing of qualification information to capture emerging subcontractor and market challenges. Prequalification simply cannot account for the dynamic nature of the construction industry—or the unknowns associated with it. Things change from project to project, and even over the course of a project, which affect project success and profitability. An 18-month-old prequalification cannot help your project teams manage these emerging exposures. CSQ can.

This article focuses on the conditions that require ongoing attention in the current environment, including subcontractors' internal changes, supply chain and escalation challenges, and changing project requirements. We'll also look at how a CSQ mindset can help address them.

Monitoring the Business Plan
While many of the impacts of COVID-19 appear to be receding, it is critical to understand how subcontractors have fared over the prior period, how they have adapted their business plan, and risks that may still be emerging. The following are potential challenges to consider.

Organizational and project leadership. CSQ is an opportunity to assess impacts to a subcontractor's leadership at the company and project levels. If they laid off, furloughed, or otherwise lost key staff during the pandemic, what is their strategy to rebuild their team?

Workforce. As above, understanding how the subcontractor's workforce has been affected is critical. Get the full picture by having the conversations. Updated references—internal or external—can also give an idea of how these shifts have affected the subcontractors' ability to deliver quality work on time. It is common to hear that "the subcontractor may struggle on some projects, but we get the A-team." Have the conversations that ensure you will.

Finances. Did the subcontractor receive funds from the CARES Act or Paycheck Protection Program, and have they received forgiveness? Do they have any receivables over 120 days from owners or developers? Subcontractors have borne many types of direct and indirect costs over the past year that were not anticipated; how has their balance sheet fared? Financial analysis should also focus on right-sizing the subcontractors' single project and aggregate limits with your firm, given the current state of their finances.

Market or geographic shifts. As construction demands change, so do many subcontractors' project pursuits, including considering work in new markets, scopes, or geographic regions. A strong CSQ program can reveal whether a subcontractor has made these adjustments and their related strategies. Through analysis of their work in progress, take the time to understand if their backlog has remained healthy, if there are signs of pursuing different or riskier work, and how they are managing their pursuits.

The crucial message here is that builders should not rely on past experience with subcontractors. Updated internal and external references, a fresh look at workforce and finances, and direct questions about business plans are called for to develop and maintain your understanding.

Supply Chain and Cost Escalation
Supply chain and cost escalation are on everyone's minds today. Qualification processes, though, seldom include a formal approach to understanding these risks. This is a missed opportunity. The industry has dealt with similar challenges before, and we can usually point to specific causes of the situations. In contrast, impacts today are coming from all sides. They are related to COVID-19, Winter Storm Uri, capacity challenges in ports, labor shortages, etc. This results in today's escalation risks being harder to predict.

CSQ is an opportunity to seek out and directly address these issues. How? By asking the questions, working collaboratively, and understanding the ability of subcontractors to bear the risks being pushed down to them.

Communication. Ask questions. Subcontractors and suppliers are closer to the supply chain and have better insight into materials availability. As part of your CSQ, ask what they are worried about or what potential issues they think may arise, then work to understand how they are addressing them.

Collaboration and education. Once risks are identified, builders should work to understand how the decisions made by the project team, designers, and owners affect those risks. Those partners may have blind spots regarding the impact of their decisions around materials, and builders should endeavor to fill that gap.

The crucial message here is that builders should not rely on past experience with subcontractors.

Understanding financial capacity. Subcontracts typically make the subcontractor accept the risk of escalation, so CSQ efforts must clarify their ability to bear that risk. Otherwise, escalation could lead to a default. This means that your CSQ must focus on "right-sizing" the risks to the subcontractor's balance sheet. Don't be shortsighted; if the sub is not adequately protecting against those risks on your project, then they are bearing those risks across all projects—that will catch up to them.

Evolving Project Requirements
The industry is seeing increasing movement to technology, sustainable materials, and other "new" systems and requirements, yet few qualification processes address these factors. Ask these questions. Issues such as disputes over responsibilities, unanticipated change orders, or even defaults of performance can be circumvented with intentional focus early on about these special requirements. Don't wait until interviews or bid leveling to have the discussion. By that stage, procurement teams may be tempted to rely on a low number from a subcontractor that will ultimately struggle to perform given new requirements.

Implementation Road Map
Above are a few of the challenges your qualification process should be addressing today. To truly add value, the process must continuously evolve. The road map to powering this process includes assigning resources, getting the right information at the right times, training internal teams, process improvements, and constant communication.

Dedicate resources. First, someone must engage in constant thought about what's coming, what the impact may be, and how to address it. This won't happen without a resource or committee focused on it.

Right information. Identify the information needed throughout the subcontract cycles to support your CSQ process, then build those requirements into your request for proposal, bidding, subcontract, and other documents to ensure the subcontractor understands the requirements up front.

Train project teams. Make sure project teams understand why effective implementation is critical to your company's success. The purpose of CSQ is to provide your teams the right information, at the right time, to make the right decisions. This includes initial award decisions as well as risk mitigation decisions both up front and throughout the life cycle of the project.

Process calibration. It does no good to have a world-class qualification process if it does not translate into sound procurement and risk management decisions. Make sure the process and systems provide visibility and accountability to ensure this information is being used as intended.

Engage your subcontractors. It may be a breath of fresh air for your subcontractors to have these conversations and realize they are not alone in managing emerging risks. Focus on how this approach benefits them and the value you place on their specific knowledge. Demonstrate your commitment by having these conversations regularly and taking appropriate action when needed.

Conclusion
The continuous subcontractor qualification approach allows you to keep your approach relevant and your information fresh. The heart of the CSQ approach is a commitment to taking an ongoing, holistic look at the situation, using all available information to drive the best discussions, and then actively monitoring the work to proactively adjust when needed, which in turn drives the success of all partners!

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