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Depending on the size of the contract and nature of the work to be done under it, the contractor may engage several subcontractors to perform a portion of the work involved in making the improvement.

The day-to-day management of the project is administered by the contractor. It is reasonable for ensuring the work that is constructed conforms to the agreed specifications. However, the project is often placed under the general supervision of an architect or engineer, who will act as the municipality’s onsite agent and will inspect the work to make sure it conforms to the agreement.

In many cases, the contractor will also perform the related function of acting as payment certifier, determining whether specific portions of the work have been completed and relating the amount of work performed to the payment formula of the contract.

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 performed. These subcontractors may themselves engage the services of further subcontractors.

It is not exceptional to find as many as four of five layers of subcontractors. At each contractual level, the number of parties is likely to increase, so the structure comes to resemble a pyramid or triangle, 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 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 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 service that it apparently requires and would provide a secure market to 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 construction product. The tremendous differences between the types of buildings that may be designed has created a need for a highly flexible, informal system of supply of services and materials.

For example, the construction of one building may require the services of an air-conditioning subcontractor, but the design of another otherwise identical building may not require those services. Specialization by type of building would not be practical as a response to such minor variations between buildings, because the number of specialized firms would be legion and it would likely be next to impossible to find sufficient work to keep these firms employed.

On the other hand, the formation of specialist firms, each of which can provide a service, is a logical response to the technological requirements of the industry. The informal combination of these firms into a single productive team via the subcontracting process provides the opportunity to form a nearly infinite variety of specialist combinations that will have the resources to build almost any type of structure imaginable, without any excess productivity capacity.

Once a project is complete, and indeed even during construction, the productive unit can be disassembled and its various parts (the subcontractors) can then reform into new productive units for the construction of other buildings.

Thus, the subcontractor system enables the industry to meet the variety of demand that is presented to it by its customers. 

Stephen Bauld is a government procurement expert and can be reached at swbauld@purchasingci.com. Some of his columns may contain excerpts from The Municipal Procurement Handbook published by Butterworths.