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RESEARCH AND THOUGHT LEADERSHIP

Risk and Competitive Advantage in the Russian Construction Industry

Risk identification, mapping and analysis are relatively commonplace in other, more developed construction markets. However, in the Russian market, there has been little attention paid to this area to date. This article compares contractor perceptions of the risks they face in Russian versus the US construction industries. The implications for the industry of these perceptions are examined and coping strategies suggested. The results of a survey of the top 100 US contractors are considered. The survey clearly demonstrates that, in the US market, concern is centered on those more operational risks that are typically under the control of the contractor. For example, labor, equipment and material availability, quality of work, and safety. Comparison with a similar survey of Russian contractors shows significant differences between the two industry environments. This raises the question: why do contractors surveyed in the US and Russian markets have different and sometimes counter-intuitive perceptions of some risks? The hypothesis put forward for consideration is that the differences are due to the different industry environments in the two countries. To assess this hypothesis, the survey results are mapped onto well-defined industry environment types and the differences between the two are examined. The suggested conclusion is that the Russian construction industry environment is fragmented. A fragmented industry environment is defined as one in which a large number of companies have varying market share but no companies significantly dominate the market. The characteristics of the Russian construction industry are examined and provide evidence of the fragmented nature of the industry environment. The article concludes with suggested strategies to overcome or cope with fragmentation for competitive advantage in the Russian market.

 

RISK AND COMPETITIVE ADVANTAGE IN THE RUSSIAN CONSTRUCTION INDUSTRY

by

B. Kagan Ceylan, Dr.Eng, MRICS, PMP, LEED AP+, BREEAM Int. Assessor

(Original of this article was published in January 2011 issue of Performance – Ernst & Young’s Global Business Think Tank. CLICK HERE TO GO TO THIS PUBLISHED ARTICLE.) 

The Russian construction industry is characterized by a number of unique risks that pose challenges for international contractors operating in the Russian market. From a risk management perspective, the contractor’s perceptions of individual risks are important at the project level. These risks characterize the industry environment in which the contractors must operate. Although risk identification, mapping and analysis are relatively commonplace in other more developed construction markets, they have received scant attention in the Russian market to date. 

In this article, we present a comparative analysis of contractors’ perception of the risks they face in the Russian and the US construction industry. Using the strategic management theory, we analyze implications of these differences for the industry environments based on the different risk perceptions expressed by the contractors. Finally, we explore some strategies for coping with the construction industry environment in Russia. We also provide field data from practitioners to illustrate these strategies in practice.

Risk Perception in the US Construction Industry

A survey of the top 100 US contractors [1] shows that they are operating in relatively stable project environments with little regulatory or institutional risks to their project performance (e.g., perceived low levels of risks associated with permits and ordinances and government regulations). The relatively high importance assigned by the contractors to risks associated with i) labor, equipment and material availability, and productivity; ii) changes in work; iii) variable site conditions; iv) defective design; v) safety; vi) contractor competency; and vii) quality of work indicate that US contractors are most concerned about operational risks that are typically under the control of the contractor (e.g., labor and equipment productivity, and contractor competency) or project specific risks (e.g., variable site conditions, defective design). The common project risks that are almost sure to suspend or terminate any project (such as financial failure of any party or delayed payment on contract) are also rated as high-level risks by these contractors. The results of this survey are shown in Table 1 below.

Click below for Table 1. Most important risks in construction projects as identified by those among top 100 U.S. contractors [1]

A Survey to Assess Risks in Construction Development Projects in Russia

In a similar vein, Ernst & Young’s Transaction Real Estate Advisory Services in Moscow surveyed construction company executives thereto assess their perceptions of the major project performance risks facing the Russian construction industry based on actual project performance data. The survey consisted of 46 questions covering the following sources of risk, as follows: 

External risks to the project team: complexity of the project, site limitations, remoteness, availability of suppliers, inflation, labor and equipment availability, labor and equipment productivity, etc.

 - Internal risks to the project team: the team’s track record in construction project management, team’s educational and technological experience and competency to successfully undertake the project, sufficient financial sources, etc.

 - Project planning and execution risks: input from all groups involved, permits and regulations, scope definition, etc.

 - Organizational structure and systems risks: reward structure, operating procedures, dispute resolution processes, etc.

Results

The results for each of the two industry environments showed significant differences. For example, while risk associated with the availability and productivity of labor, equipment and materials was rated highly by US contractors, it was the opposite in the Russian construction industry. Similarly, site access/right of way was rated as a high risk by the top US contractors, whereas it was rated relatively low in importance by contractors in the Russian market.

At the same time, risks related to contractor competency, past experience and educational background of the project team members were surprisingly rated low in importance in the Russian construction industry, but were rated highly important by the US contractors. 

Click below for Table 2. Contrasts between the U.S. and Russian construction industries

During interpretation of these results, we caution that the lower and higher importance attributed to these risks are relative in that a risk may be rated as lower importance because it may be obscured by those risks perceived by the contractors as relatively a higher threat for project success. 

Click below for Figure 1.

We asked why contractors surveyed in the US and Russian markets have different and sometimes counter-intuitive perceptions of some risks? In an effort to understand the reasons for this, we hypothesized that the differences are due to the different industry environments in the two countries. To assess our hypothesis, we mapped the survey results onto well-defined industry environment types according to the research [2] and identified the differences between the two industry environments in the US and Russia.

Russian Construction Industry Environment –A Fragmented Industry?

A fragmented industry environment is defined as one in which a large number of companies have varying market shares, but no companies significantly dominate the market. In fragmented industry environments, the market leaders typically lack the power to shape industry events [2]. The characteristics listed below provide evidence of the fragmented nature of the Russian construction industry. 

Absence of ‘economies of scale’ or ’experience curve’: Most fragmented industries are characterized by the absence of significant scale economies or learning curves in any major aspect of the business. The Russian construction industry’s transformation from a controlled economy to a competitive market only began in the late 1990s. Th first decade, in particular, this was a turbulent transformation process, with many small and mid-size construction firms leaving the industry as new ones entered. The high market turnover was exacerbated by high employee turnover in the construction firms that managed to survive. As a result, the institutional and expert experience of the companies was often lost. Despite this loss of experienced workers, contractor competence, labor and equipment productivity may be the perceived as low risk level because the companies managed to survive and projects were completed. But this does not mean experience is not important for project success in the Russian construction industry. Rather institutional contractor experience has not yet become a major competitive advantage factor across the industry, indeed, it is often overshadowed by other issues that are perceived more critical for project success (e.g., permits and ordinances). 

Local Regulation: Local regulation which forces companies to comply with standards that may be location-specific, or politically sensitive, can be a major source of fragmentation in an industry[2]. It is common to see conflicting regulatory practices in the current Russian construction market, some of which are not always in the public domain.

Low Overall Entry Barriers: Nearly all fragmented industries have low overall entry barriers. The low risk perceived in the Russian construction industry regarding labor and equipment availability and contractor competence, are signs of low entry barriers. Similarly, the absence of the emphasis on labor and equipment productivity in the Russian industry environment potentially facilitates new entries into this market, since it is not necessary for a new entrant to demonstrate high labor and equipment productivity (based on experience, project governance and other skills.)

The U.S. Construction Industry Environment – A Mature Industry?

While it was not within the remit of this study to analyze the US construction industry environment, in order to establish that our conclusions are not typical for the construction industry in other countries, we mapped the findings of the US survey results to the same industry structure reported in the research [2]. One trend we observed is the greater emphasis in the US market on cost and service due to increased competition. As a result, sophisticated cost analysis becomes increasingly important in order to price projects correctly. The US contractors’ high ranking of risks for: 1) labor and equipment productivity; and 2) contractor experience indicate the greater emphasis on cost and service in the US construction industry and the need for a sophisticated cost analysis to remain competitive. Also, the relatively low importance attributed in the US to risks associated with permits and ordinances also indicates that the regulatory environment in the US is stable – a tendency attributed to a mature industry.

These observed differences between the US and Russian construction industries support our hypothesis that these two countries have fundamentally different industry environments. The Russian construction industry is young and fragmented, whereas the US market is mature.

Strategies to Overcome or Cope with Fragmentation for Competitive Advantage in the Russian Market - Creation of Economies of Scale or Experience Curve to Overcome Fragmentation

Mechanization and high levels of capital intensity are essential requirements for consolidation in the manufacturing sector. Having said that, the construction industry is typically labor intensive, which means that the same factors do not apply. However, one respondent to our survey, a project executive with one of Russia’s largest international contractors, explained how their organization achieved economies of scale and experience curve. They relied on the following:

- Access to large labor and equipment pool that can be mobilized across a range of projects thus creating a form of economies of scale (the ability to conduct multiple projects simultaneously)

- Well-established internal operating procedures, including cost control and other control systems

- A project team that that works effectively and efficiently together as well as with the designers , which reinforces the experience curve of the company

- Use of complete design documentation

- Cultivating relationships with the bodies that oversee the project to overcome the regulatory risks

Finally, the regular use of standard design criteria and construction processes resulted in a commodity-like facility, as opposed to a more costly tailormade process, which further enhanced the economies of scale and the experience curve in the construction operations.

Other strategies that can be used to overcome and cope with fragmented industries can be extended to other sectors, such as adding increased value to services and providing basic/no frills services representing cost effective results and support operations. Construction contractors in Russia can find the right strategy by carefully analyzing the industry environment, observing those strategies that already proved successful, and matching the strategies identified with the internal strengths and weaknesses of their organizations.

 

References:

[1] Kangari, R., “Risk Management Perception and Trends of U.S. Construction”, ASCE Journal of Construction Engineering and Management, Vol.121, No.4, 1995, pp.422-429

[2] Porter, M., Competitive Advantage, Frer Press

Figure 1. Comparison of major risks in the Russian and the U.S. construction industries
Table 1. Most important risks in construction projects as identified by Top 100 U.S. contractors
Table 2. Contrasts between the U.S. and Russian construction industries as to perceived project risks

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