Building Owner at Disadvantage without Intermediary

Posted on September 13, 2010

0


A major obstacle for building owners in the process of getting a project built is finding a way to either get as knowledgable as the builder about the costs of the project, or find someone who can represent the owner and protect his interests to nullify the effects of asymmetrical information.

Asymmetrical information is an economics term describing when one party in a commercial transaction has more knowledge about a product, market or part of a transaction which allows it to leverage that information to economic advantage. This is one reason why insider trading is illegal, because it is believed company managers have access to information the general public does not; this disparity allows company managers to ‘know what’s coming’ before the public does, so they are prohibited from trading in their own company. Asymmetrical information is often controlled via regulation to protect consumers, which is common in law, finance, medicine and education.

This also happens in construction projects. Author Barry LePatner elucidates this point in his book Broken Buildings, Busted Budgets. Building owners cannot easily compare building price and quality at any stage—before, during, after—of a construction project. No one is knowledgeable enough about materials and labor to challenge a general contractor’s (GC) budget, and an owner’s only alternative is to reduce or eliminate features to adjust a price. Because switching costs are high once a project has begun, a GC can easily raise prices during construction.

Other factors work against building owners:  buildings are growing more complex, and designers are increasingly less interested in participating in construction administration (CA), where an owner’s interests are most vulnerable and need protection. An owner simply cannot challenge the cost of a change order without an independent method of determining price because a delay in completing the work will cost even more.

Perhaps most frustrating for owners is the inefficiency, incompetence, industry waste and low productivity that plague construction are passed on through pricing, to the owners.

Due to information asymmetry, an owner needs an intermediary looking out for his interests, someone LePatner feels is not actively participating in the project. This person would reduce asymmetric information and help enforce the fixed price nature of a contract. LePatner thinks this could be achieved in one of three ways:  1) Construction Manager; 2) Guaranty Company; or 3) Independent Owner’s Rep / Project Manager.

By changing some owner expectations and early project processes, information asymmetry could be readjusted. Currently, owners expect free bidding. For a car repair, an estimate is easy and cheap. In construction, it can cost $10k or more. Builders base their bids on experience, comparable projects and risk with a fudge factor to adjust up or down based on workload and owner reputation. Instead, contractors should be compensated for “cost planning / preconstruction services” with the architect and owner. An owner pays for information that helps eliminate the disparity, and the estimate the owner paid for is a good guarantee and basis for negotiation with the architect and bidding contractor.

When an owner has an intermediary on his side, information balance is restored and project execution becomes more manageable and affordable.

Advertisements