5 reasons construction industry digitization is lagging
The construction industry is one of the least digitized industries in the world today.
A well-known McKinsey Digitization Index found it is second only to hunting and agriculture. Yup, two of the oldest industries in the world. One of them is mainly built around killing animals for fun or profit and an industry where nature does most of the heavy lifting.
The following article is a macro analysis that offers a deep dive into why I think this is the case, without settling with the “traditionally late adopters” claim. It represents my personal views and understandings based on my experience as a Product Manager in one of the construction industry’s most innovative startups, hundreds of conversations with construction professionals from various parts of the industry, and my background as an engineer and an analyst. I will describe and analyze the reasons and processes that might have led to this situation and offer my take on how technology companies can successfully cross this chasm.
1. Low-profit margins are a double-edged sword
According to the Construction Financial Management Association, the average pre-tax net profit for general contractors is between 1.4 and 2.4 percent and for subcontractors is between 2.2 to 3.5 percent.
On the one hand, one might claim that this is exactly why innovation is so needed. Growing labor shortage and trained professional rising costs and ever preset rise in materials prices, shipping, and handling charges mean that these margins will narrow as the industry grows. This margin makes streamlining the processes and increasing productivity inevitable if a contractor wants to stay in business.
But, another way to look at it is by examining it through the lens of the acute stress response, commonly referred to as the fight-flight-freeze. It is a physiological reaction that responds to a perceived harmful event, attack, or threat to survival. The reality described in the previous paragraph definitely qualifies as a threat to survival — the threat of bankruptcy. According to this mechanism, contractors faced with this threat can react in one of the following three ways.
They can fight — take action and eliminate the danger proactively. This reaction involves a great deal of risk and energy that needs to be invested. There’s always a chance this would not work, and then, in most cases, they will be exposed to even greater danger.
They can flee — basically rethink some career choices, a luxury, not everyone has or want to do. Additionally, sometimes the upside and premise are not worth the risk.
And, what I think most of the industry is doing — freeze and become immobile. It’s the easiest, and honestly, the most lucrative thing to do in the short run. If I’m a contractor, I can see that buildings are built, there is a process that works, and my tiny margin is not that bad when I multiply it by the total contract values I’m getting. I’m pleased with my profession, and changing too much for several additional fractions of a percent is simply not worth the risk and the effort.
As evidence, we can see two types of contractors adopting new technologies and exploring new ways to operate. We have relatively small and young companies that are not afraid of change simply because there are no old habits to change, and the stakes are still reasonably low. And there’re the construction giants that are big enough to pay the price of experimenting with new technologies and hedge the risk of failure by implementing technology in a gradual, evolving process.
What can technology companies do to help potential customers steer away from freezing towards fighting? First and foremost, a business model ingenuity that de-risks the implementation process and, if possible, provides proof of value right off the bat. Secondly, due to the very concrete explicit nature of the industry, tailor the offering to a specific use case in an actual project they may have and explicitly show how the product or service saves more money than it costs after a ramp-up period.
2. A profound difference in cadence between the tech and construction industries
I can’t think of two industries opposite one another, like construction and the high-tech sector.
Technology companies will usually tackle challenges iteratively to develop products that customers need, love, and work for their business. It means working in very short cycles of incremental value creation, learning, and experimenting from one cycle to the other. This is all part of the industry’s DNA — done is better than perfect, mistakes are essential to the process, and flexibility is the key. Since there is a possible chance that any new technology will eventually fail, the risk is part of every technological venture, especially startups. Therefore processes and procedures to minimize it are not a top priority and are primarily optional. This way of working implies that the receiving end of the value, the users and customers, are an integral part of the process. Their experience using this technology will be an ever-changing risky journey, for better and worse.
On the other hand, construction projects take years, and even decades in some cases, from start to finish depending on their size. Designs are built many years after they were initially planned — it’s usually longer than an average startup’s lifespan. Additionally, strict tendering processes and work content breakdowns agreed upon months and years in advance remove any chance of flexibility. Due to the high financial risks and human lives, the construction industry is very risk-averse. Strict processes and procedures are part of the daily routine, most of the time with good reason. Every mistake might prove to be costly.
These two opposite approaches clash when these two industries collaborate. For a technology company, it is hard to iterate and improve when the cycles are long, and procedures are set in stone. And the customer will rightfully complain that the value is not as expected/promised, and the process is taking too long or consumes too many resources and attention. A vicious mechanism rooted deep in the basic DNA defines these industries.
How can this mechanism’s impact be reduced? Align both sides’ expectations and always be open about the implementation journey’s challenges. Since the processes are so long and complicated, making sure the product or service creates value for an isolated, specific, and frequent part of the processes is a must — this makes iterative improvement and short cycles possible. Operational efficiency and sufficient runway become even more crucial in this industry to ensure Product/Market fit is reached.
3. Market fragmentation and lack of apex predator
Thank you to those who’ve reached this far in the read. The following section will have some economics terminology and concepts. Bear with me; I’ll try not to get bogged down in details.
Construction projects and the businesses built around them are, by definition, localized. The eventual output of the industry’s value chain is a stationary physical structure at a specific location somewhere around the globe. Companies and service providers part of this chain need to be in the proximity of this structure and have the operations, suppliers, and supply chain required to provide service to the project. They will most likely need personnel and trained professionals at hand reach. In short, all the necessary infrastructure to support their business at a specific location. Additionally, this also means that the service providers need to be well educated in their working area’s particular construction methodologies, best practices, and regulations.
A small thought experiment — Try and think of the largest company in this value chain you can come up with — it can be a GC, a construction management firm, a design firm, whatever. Now, try and assess the number of projects they are involved in and their location. You will realize the number of projects is not as significant as you’d expect and are only a drop in the ocean when talking about a massive industry like construction. You will also realize that most of this firm’s activity is focused on a specific territory — it can be a city, country, or maybe, just maybe — an entire continent. Due to the reasons I’ve described in the previous paragraph and the fact that construction projects costs are objectively high, a construction firm’s growth is linear and slow by definition. Unfortunately, it cannot ‘explode’ as tech companies do in recent years. As evidence — five out of the ten world’s biggest contractors were founded in the 19th century (!).
This market structure means that there’s no Amazon whose market share in online retail is more than five times the closest competitor. Or a Walmart-like firm that improved customer service and experience dramatically. It means there’s no Insatacart that holds more than 60% of the online groceries delivery market in the US and forces everyone to align to their high standards. There are no companies like TSMC (50% market share) forcing semiconductors’ prices down with innovative manufacturing technologies. There are no undisputed leaders like Samsung and Apple responsible for 70% of smartphones sales around the globe, improving this product dramatically over the past 15 years.
The presence of an apex predator forces evolution to do its magic if the other species want to walk around the earth in many generations to come. As in the industries I’ve described above, facing these market leaders, companies must evolve and adapt if they want to hold their market share. Unlike these markets, the top 10 construction firms globally have under 5% of the market, most of which, are Chinese infrastructure firms. It means a long tail of small players who cater to the local population and establishments, as most customers prefer construction services closer to their locations. Only 15% of construction companies have over 1,000 employees.
These two unique market characteristics, the lack of apex predators and highly localized firms, should theoretically increase competition, drive prices down, and quality up. De facto, there’s no real ‘market punishment’ in sticking to the old habits, mainly because the market size and needs are constantly growing. There’s no dominant player to impose new and desired behavior on the other players.
How can technology companies navigate this unique market? The naive answer will be the generic ‘market education.’ As a pragmatist, I’m not sure this is a viable answer here. I think that the most impactful thing technology companies can do is minimize the SOM (Serviceable, Obtainable Market) as much as possible. Meaning, find a solution to a particular pain in one market segment only, at least to begin with. This market’s sheer size (over $10T) allows it. An example might be — a product that solves a pain infrastructure general contractors specializing in highways construction in Western Europe experience during the buildout phase. Doing so could reduce time to reach product/market fit, sales/marketing channels can be sharpened and tailored, customer acquisition costs will decrease, and the chances for creating a network effect and growing exponentially increases. Of course, to build an ever-growing business, there needs to be a viable plan for expanding this SOM by creating better products and adding additional services. Additionally, a roadmap for increasing the Serviceable Available Market (SAM) by selling to other geographies (the US, for example) and the Total Addressable Market (TAM) by offering solutions to a whole new segment (City Planners, non-infrastructure contractors, etc.) is needed as well.
4. Contract-based relationships and multiple stakeholders
While raising a child only takes a village, a construction project needs an entire town. The number of different companies, functions, and people with unique roles involved in every project is mind-boggling. Dozens of various entities and professionals, literally. Throughout the process, all of these entities must work together in harmony for the project to succeed. It’s a miracle that big projects are even completed.
The causality between the fact that over 50 different firms are involved in a construction project, and low digitation still needs to be explained. The challenge is not necessarily the number of parties; it is how they manage their relationships — contracts. A few common contract types in the industry accompany any money transfer between one party in exchange for work done by the other. Without getting into the legal and financial aspects of these contracts, the vital thing to note is that they are drafted and controlled mainly by the side with the money, shifting as much of the risk as possible downwards to the service provider while ensuring leverage is kept for rainy days.
The contract defines the basic terms of service and usually specifies what activities and how and when they should be done. Naturally, once under contract, the incentive for doing ‘above and beyond’ disappears. Each side wants to maximize its profit with as minimal effort as possible while ensuring the contract terms are honored. Adopting new technologies usually requires substantial time as well as financial investments and behavioral changes, all of which, unfortunately, are not part of the primary contract. These two factors mean that contract-based relationships incentivize a conservative approach when estimating output and capabilities and encourage stagnation. Moreover, they disincentivize any change in current ways of working. In this case, the colossal chasm technology companies need to cross to reach adoption is a tough one.
Another chain of events worth mentioning when trying to understand the technological gap starts with this notion — contracts need to be won. There’s usually a tendering process in which service providers are selected for the job. To remain competitive, they often reduce their prices to the bare minimum, if not less. Because we’re in a zero-sum game, it’s not only perpetuating the low margins issues discussed earlier; it often means that service providers need to find ways to get more money out of this contract if they want to make ends meet. Therefore, from the moment the contract is signed, both sides cultivate a narrative preparing for the final settling. The service provider starts “gathering evidence” that he is doing more work than initially discussed and needs to work harder because of factors he cannot control. On the other hand, the work orderer tries to prove that the service provider is not doing more work; errors and lagging also cause damage to the project. Both sides are driven by fear — the service provider fearing bankruptcy and the orderer fearing being played on. In the final showdown, truth and facts are second to the narrative built and evidence gathered by both sides. Each side holds its cards close to the chest and has its subjective truth. The first and most apparent by-product of digitation is the transparency of the project’s data, ease of access to project information by everyone, and an objective source of truth. Unfortunately, due to the chain of events described earlier, the benefits of digitization I’ve just described can sometimes rattle the subjective truth each side is cultivating and can damage one of the side’s businesses if a contradiction is discovered. This delicate and unique situation needs to be considered when talking to prospects about digitation.
Once understood, I believe technology companies can easily manage this situation and leverage it to their advantage. First of all, the holy grail — technology companies should aim to be included as part of the contract between two parties! Once an agreement anchors the platform usage, platform usage is guaranteed. Another thing companies can do, and actually should — tap into one of the party’s fears and design a product or service that will help them in their arguments with the other side. We can see realty capture and documentation boom in recent years for that reason exactly.
5. The inevitable clash between an ultra-busy professional and a technological gap
The construction industry is one of the most hectic industries out there. As a result, construction professionals’ days are intense, filled with hitches, glitches, and things that need to be handled on the spot. This work environment derives two attributes that characterize many construction professionals — limited attention span and zero tolerance for time-wasting activities.
The busy workday, constantly on the phone handling issues and solving problems leave little room for anything else. Inevitably, learning new technology and adapting the way they work today requires a non-negligible time investment and attention — a thing they have so little of. The primary role of a construction site team is to make sure everything is going smoothly and according to plan. Unfortunately, this is rarely the case, and the vast majority of their day is finding solutions to issues discovered along the way and reacting to change. It means that they demand from their tools and technological platforms to be reliable and expected to give them the peace of mind to handle their stressful day. In the hierarchy of their needs, the tools they use are the base for everything else.
Unfortunately, new technologies are not immune to childhood illnesses, and the adoption process must go through a teething phase. New technological products need to go through several hurdles to be fully adopted by users. First, there’s the value and usability risk — making sure the product creates value for the users, and they understand how to use it and its features. It’s a process that involves a lot of trial and error with the users until a significant value is created and expectations are met. Throughout this process, users might not be receiving tremendous value from the product or service and are still expected to provide feedback and use the product to help it improve. You can imagine how these two factors collide in light of the previous paragraph.
The second hurdle is technological feasibility and integrity. Bugs and performance issues are a part of every new product introduction (NPI). Until field-tested and heavily used, no product is errors free. It requires the users to be forgiving throughout integration and NPI processes that may sometimes take years to complete. It’s a vicious cycle in which users must use the product for it to improve, but to use it they must have a fairly high level of trust in the product that’s hard to achieve in technological products early stages. The two issues discussed here are common to every technological venture that intensifies in ventures aimed at the construction industry.
This is a challenging situation to navigate, but it is manageable. First and foremost, like everything in the construction industry, it’s all about relationships. Especially at the venture’s early stages, close, trust-based relationships with customers will increase the “slack” given to the company by the users, giving it more time to improve the product’s performance. Secondly, expectations management is key for taking the customer across the disillusionment phase of the technology hype cycle. Do not surprise your customers with incompetence and unexpected changes to the product. As funny as it may sound, even failure to deliver can be communicated and successfully managed. Thirdly, and the most crucial thing — know your product’s strengths and weaknesses. Identify the areas in your product that deliver exceptional value and the more challenging ones — highlight the value, and be open about the challenges. It will help solidify the relationship and increase the customer willingness to improve the product — users’ investment is necessary for creating habit-forming products.
Summary and takeaways
The key to building products that customers need, value, and work for their business is knowing your customers and the environment they operate in. Without understanding these two, tech companies will not create products that work for their industry. The construction industry is a traditionally lagging industry in adopting new technologies, making tech companies’ work even more challenging. Luckily, the sheer market size and tremendous opportunities make everything worth it. I genuinely believe that for a tech company that wants to make a real impact and is not afraid of a good challenge, the construction industry is the one to be in.
