Strategies to increase the profitability for contractors in the construction industry: An empirical study of Norwegian construction clients and tenders
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The aim of this master thesis is to explain the low profitability in the construction industry and to identify what contractors can do to increase their profitability. The contractors are dependent on finding good solutions to this as low margins and large project losses are causing a huge amount of bankruptcies. In order to get a better understanding of the key challenges in the industry, discussions with several executives from the industry were conducted. The main reasons for low profitability has been identified to be that the contractors operates in an industry where they struggle with fierce rivalry, few rare resources and projects with high risk.In order to analyse the challenges from a theoretical perspective, a review of three main theories; competitive positioning, resource based view and risk management, has been conducted. The competitive positioning view revealed that cost-leader is the dominant strategy among contractors as construction clients primarily focus on price in tenders, and that pursuing a focused strategy can be risky because it makes the contractor more vulnerable to a fluctuating supply of suitable work. The Resource Based View analysis concludes that building competitive advantage based on resources would prove very difficult because of the huge proportion of the resources that are actually shared between the competing contractors. The risk management review revealed that an effective management of risks could result in higher priced tenders, which in turn may lead to actually winning fewer projects.The potential solution researched in this thesis, is that the contractors build unique resources that enables them to compete on other criteria than price and that they use market-based pricing to set the price in the tenders. However, in order to confirm that this differentiated strategy could be feasible for contractors, it had to be confirmed that the construction clients actually value other qualities than the ability to complete projects at the lowest possible price, and that market-based pricing is possible in the construction industry. Therefore an investigation of the construction clients? favourable contractor qualities and their perception of the tender process and the laws of public procurement have been conducted. A quantitative study consisting of a questionnaire was used for this research. In addition, an analysis of data in previous tenders was used to investigate if the contractor can price a premium for having favourable capabilities.The findings from both of the empirical studies showed that three capabilities namely; experienced project leaders, good supervision on the work site and the ability to finish on time are most valued by the construction client. The empirical study of the previous tenders showed that the lowest bid won in all cases, but also that the winning contractor, with extensive market intelligence, potentially could have priced their project on average 15% higher, and still won the tender. Finally, the questionnaire revealed that the construction clients think that the tenders? limits their ability to choose the contractors best suited for the project.The thesis concludes with the recommendation that the contractors pursue a differentiated strategy. This should be done by building the three capabilities revealed in the empirical study as most valuable for the construction clients, and in addition utilize market-based pricing in combination with cost-based calculations in order to monetize on the capabilities. This could enable the contractor to win more of the right project at a highly optimized price, hence increasing their profitability. However, in order to succeed with this strategy, several measures must be taken. Firstly, the contractors can only succeed with a differentiated strategy if they also manage to communicate the valued capabilities efficiently to the construction client. A possible solution presented in this thesis is that the contractors invite the construction client to evaluate their project execution, with an emphasis on the three most valued capabilities, after the project is completed. By providing these evaluations in future tenders, one can increase the trustworthiness of the information provided by the contractor in the tender. Furthermore, the contractor can also use this information to build valuable capabilities. Secondly, extensive market information is necessary in order to use market based pricing. The proposed solution is that the contractors develop a pricing-tool based on statistical metadata from previous projects and tenders. A comprehensive database of previous bids and tenders could then be used to estimate, in a more efficient way, the market price of future projects. Lastly, the contractors are advised to invite to discussions with the construction clients in order to address the need for a change in the tender process, in order to ensure that the tenders procedures meets the expectations for both parties.