In a typical large contract, the contractor may engage several specialist subcontractors, each of whom will be responsible for the execution of part of the work to be performed.
In many cases this information will be part of the evaluation process when selecting the general contractor for the award of an RFP.
These subcontractors may themselves engage the services of further subcontractors. It is not exceptional to find as many as four or five layers of subcontractors.
At each level, the number of parties is likely to increase, so the structure comes to resemble a pyramid when portrayed in schematic terms. Variations of this pyramid structure are found in most forms of project organization.
The persistent existence of subcontracting between firms at arm’s length to each other is an interesting phenomenon.
If there is a continuing need to employ the resources of other firms in order for a contractor to perform its obligations under the contracts which it assumes, one is tempted to suspect the contractor has not achieved an economy of scale.
In considering the combinations of firms that may engage in a particular project, one may wonder why there has been no effort to integrate the operations of the contractor and its subcontractors into a single firm.
At the very least, such mergers would guarantee the contractor a source of supply of the types of services which it apparently requires and would provide a secure market for the subcontractors.
But as has been noted by many economists who have studied the construction industry, “vertical integration in contract construction is nearly non-existent.”
The reason for the continuation of subcontracting, rather than the emergence of large multifaceted construction firms, probably lies in the nature of the construction product.
The tremendous differences between the types of buildings that may be designed has created a need for a highly flexible information system of supply of services and materials.
While the use of the subcontracting system is mandated by the technical requirements of the industry, that system increases the hazards of construction to all parties concerned.
The municipality faces the realization that part of the work under the contract will not be performed by the person that is hired — the contractor.
By subcontracting out a portion of the work, the contractor is forced to underwrite the proper performance of some parts of the improvement even though the contractor has not been involved personally in their construction.
The subcontractors, for their part, know their ultimate payment may depend on solvency of a payer with whom they have no direct dealings as well as the state of accounts existing between other people.
As the number of levels of contractual relations are increased, the number of payment levels is also increased. The increase in the number of payers increases the chances that a default in payment may occur. The payment of subcontractors ultimately depends on the flow of contract monies down the construction pyramid.
The contractor cannot pay his or her subcontractors until he gets paid by the municipality, nor can the principal subcontractors pay their suppliers until they have been paid by the contractor.
Should the municipality be entitled to a set-off or counterclaim against the contractor, it is possible that no funds will ever flow down the pyramid, or if any funds do flow down, that there will be too little money available to pay all the subcontractors and other suppliers in full. Since the set-off in question may have no connection with the improvement being made, this is obviously unfair to those suppliers.
As a general contractor you must be cognizant of the fact that the subcontractors you select to work with may play a large part in the evaluation process of the contractor awarded the RFP for any large construction project.
Stephen Bauld is a government procurement expert and can be reached at email@example.com.
Some of his columns may contain excerpts from The Municipal Procurement Handbook published by Butterworths.