Warren Buffet says the true role of any Chief Executive Officer is to be the Chief Risk Officer. In no business could this be truer than in construction. Here are three risks Buffet focuses on that could benefit contractors too.
- “Accept only those risks that they are able to properly evaluate – staying within their circle of competence.”
Staying within what you know best is something Buffett talks a lot about. He explains that it’s not the size of the circle that counts but staying within it that matters for long-term success.
Some people might counter, “What about the growth and innovation that comes from trying new things?” There’s no doubt that venturing into new areas can be important and profitable, but for contractors, the issue is more a matter of degree. Too often, I see contractors jump head first into a new market or type of work risking the wellbeing of the entire company instead of dipping a toe and starting small with one project at a time.
- “Limit the business they accept in a manner that guarantees they will suffer no aggregation of losses from a single event or from related events that will threaten their solvency. They ceaselessly search for possible correlation among seemingly unrelated risks.”
This principle is particularly important for contractors. Not only is it imperative to avoid “betting the farm” with new ventures, it’s critical for contractors to consider the possible impact every project or investment can have on the company.
All of our best contractors seem to ask not only whether a project is a good fit for their company, but whether that project could have any catastrophic impact on the company as a whole if there are issues. This same logic applies to other decisions like investments into equipment and real estate. When these assets are purchased using company cash, it can deplete working capital and make the company more vulnerable. Similarly, incurring a lot of debt to make these purchases can add a significant monthly burden and put the company at the mercy of third-party creditors should a downturn occur.
- “Avoid business involving moral risk. No matter what the [amount of money], trying to write good contracts with bad people doesn’t work. Doing business with the few exceptions is often expensive, usually extraordinarily so.”
I often see contractors struggle with this when deciding which owners or general contractors to work for. I think that is because tough owners and general contractors can sometimes be confused with immoral ones.
Many of my contractor customers take on work with some of the toughest owners and general contractors in the industry when the work passes Buffett’s first two tests above and they (1) Are aware of the reputation and requirements when bidding the job and (2) Can price the job properly relative to the quality of the plans and information they have at bid time.
On the other hand, I rarely have customers that work for an immoral owner or general contractor and get a good result. Even when my customers can put a large profit margin on a job, it generally ends up a below-average project at best and many times ends up being a loser. In my opinion, it’s simply impossible to factor in enough profit to make up for poor character.
So, while Buffett’s Berkshire Hathaway conglomerate of companies are very different from the construction business, they are very similar when it comes to successfully navigating risk. This was summed up well by a very successful and bright client of mine that said, “I’m not in the construction business, I’m in the risk management business.” What business are you in?