Why construction is the next frontier for technological innovations?

At Market One Capital, we’re passionate about all things network effects, and one of the trends within the space we’re focusing on lately are vertical marketplaces. We believe that we’re entering an era of unbundling, with more specialized and focused marketplaces filling the gaps overlooked by large horizontal players. To that end, we’re trying to zoom in on the sectors we believe are the next big arenas for this to play out.

One of the markets that grabbed our attention the most is construction — it’s a large and critical part of the overall economy and yet it remains the least digitized sector, hence being ripe for disruption by innovative tech. Below you can find our analysis on its macro background, key trends shaping today’s construction sites and their possible implications for the future.

Market structure

To start off, let’s paint the big picture with some high-level facts: construction is one of the largest sectors of economy, accounting for around 10% of global GDP, which translates to roughly USD 10tn market value in nominal terms. By 2030, this number is forecasted to grow to USD 15.2tn (full scope of the analysis by Oxford Economics & Marsh on that topic available here). What’s more, around 7% of global workforce is currently engaged in some way in construction & mining according to Foundamental, a Berlin-based venture fund specializing in deploying capital into these sectors.

But no matter how big and how critical for the global economy the construction sector is, it should not overshadow the fact that it’s been struggling with low margins, lack of innovation and declining productivity for quite some time now. If we look at the composition of the Fortune 500 index today versus 20 years ago, majority of the incumbents from the past have remained industry leaders in construction up until this day. At the same time, when we consider all sectors of economy on average, most of them have been structurally transformed in a big way (i.e. 52% of F500 companies from all sectors aggregated have remained on the list until today versus a staggering 85% in construction).

Even more important is the fact that productivity in construction has dropped substantially since the mid-20th century while in other sectors it has grown 6- to 8-fold. This phenomenon, known as the “productivity trap”, is being ascribed to a group of factors, one of them being the fact that one of the defining features of construction is its labor intensity — up to 50% of construction cost of building a single-family home is on-site labor. This is due to the structure of the industry, which — according to Construction Physics’ Brian Potter — very much resembles the services sector, where a great deal of time and effort is spent on providing a tailored solution to the client. Such labor-intensive industries tend to see costs increase gradually over time, which is in turn connected to the Baumol effect, a theory stating that increasing labor productivity in one industry pushes up wages not only in that industry, but in others as well. This may at least partially explain why the overall costs in construction have doubled since year 2000, and the sector alone is responsible for 62% of all inflation since that time. As reported by McKinsey, 98% of megaprojects in construction face cost overruns and/or delays and the average cost increase is 80% of the original value. On the construction sites, foremen and contractors are reported to spend as much as 3–5 hours daily on manual and repetitive tasks. Things do not look any better on the environmental front, as sector’s overall carbon footprint accounts for c. 17% of global CO2 emissions.

Construction is also extremely fragmented — out of approximately 3.2m construction companies in the EU, over 99% have fewer than 50 employees and at the same time deliver 80% value generated by the whole sector, with enterprise-size contractors being responsible for the remaining part. A report published by EC Harris in 2013 suggested that for a large building project in the £20 — £25 million range, the main contractor may be directly managing around 70 sub-contracts of which a large proportion had a relatively low value of £50,000 or less, with much of the industry’s workload coming to it on a one-off, piecemeal basis.

How does innovation spread in the construction industry?

To address that question, it might be useful to first take a look at how did construction innovation uptake look like up to this point. Much of the problems within the sector mentioned above may be connected to the fact that the digitization in construction has been evolving at a truly glacial pace — according to the MGI digitization index, it’s currently the least digitized sector in Europe and comes second to last in the US. Were it to catch up with the overall economy, it could boost the sector’s value added by c. USD 1.6tn (or +2% of global economy).

Why is it so? It seems like much of it comes down to how the costs and risk are distributed along the lifecycle of a construction project. The costs are right-skewed and fat-tailed when compared to a normal distribution, which means that they can easily end up being 50% to 100% higher than initially projected. In order to prevent this from occurring, project managers need to closely control and audit all the processes taking place on a project and have a good understanding of the complex interrelations between them. What’s more, the input failure in a construction process cascades downward. The nature of this characteristic is probably best explained by an example used by Potter:

the nailing is an input that some downstream processes in the construction process is assuming will be completed. If the worker runs out of nails, he can’t finish building the frame. If the frame isn’t complete, the waterproofing can’t be installed, which prevents the electrical from being installed, which prevents the drywall from going in, and so on.

This essentially means that any disruption to the process can pose a significant risk penalty that may as well exceed the expected benefits — that’s why innovations in construction generally have to be incremental and evolutionary instead of completely disrupting the present workflows and re-inventing them from scratch, as it sometimes happens in other industries. Other factors contributing to sector’s relative resistance to innovation include:

• too many stakeholders (who should take on the cost of innovation)
• learning curve being too steep for contractors
• lack of simple integrations
• “innovation ROI” is hard to properly estimate and not always visible at the onset (vs costs and risks, which are mostly visible right away)

Looking at adoption rates of construction innovations from the past (BIM, fiber cement siding, fiberglass entry door etc.), when plotted along an S-curve using a framework such as the Bass diffusion model, they exhibit characteristics observed previously in sectors such as automotive and agriculture. This means that the period between technology’s first use and reaching its maximum production share amounts to between 20 and 30 years, whereas the same period for many technologies we observe today in IT can often be as short as c. 5 years (e.g. that’s how long it took for TikTok to reach its first billion users).

Why does all that matter to us here at MOC?

One simple way to answer that would be: because we believe that the greatest value to be captured by bold founders and investors alike is generated at the very frontiers of bits and atoms. What it means is that we want to look for the next big thing in places for which the playbooks haven’t been fully written yet, areas still relatively underpenetrated by “speculative financial capital” of VC investors (to borrow Ben Thompson’s phrasing). And it seems like ConTech is precisely that: however investments in that space have been taking off in popularity as of late, having raised over USD 5bn in 2021 (up from under 0.1bn just 10 years earlier), it still makes up a comparatively small fraction of total VC landscape. It’s visible pretty clearly when we consider how does it look in comparison with some other verticals — while ConTech startups have raised just under USD 16bn since 2000 (or rather somewhere around 20bn once unreported fundraising is taken into account), crypto and blockchain managed to accumulate 33bn in 2021 alone. Combining that with the aforementioned facts about the lowest digitization level among all sectors of economy and the persistent productivity problem, ConTech can essentially be perceived as somewhat of a low-hanging fruit for innovators to reach out for.

Marketplaces

From an investor’s standpoint, ConTech can be sliced and diced in many different ways. When analyzing the sector, we tried to focus on the categories most investable by us and omit those outside our reach, especially since a large chunk of what’s going on in construction innovation concerns building materials, robotics, 3D printing and other categories that can generally be labeled as hardware. To that end, we decided to zoom in on three sub-verticals we deemed most relevant to us: marketplaces, construction fintech and CMS (Construction Management Software). Marketplaces are an obvious first choice for a network effects investors such as ourselves and even more so if we consider the high level of fragmentation in the sector as mentioned above — such situation makes for a perfect breeding ground for startups that aim at connecting the highest number of buyers & sellers possible. Marketplaces in construction range from workforce sourcing companies (e.g. Workrise) to construction equipment marketplaces (e.g. EquipmentShare) to companies helping to find & procure building materials (e.g. Infra.Market). Oftentimes startups that originally started out in other categories, such as distribution & logistics, eventually converge towards marketplace model over time (case in point — Colombia’s Tül). There are already some impressive success stories in this space (such as Infra.Market joining the unicorn club with investments from Tiger Global, Accel, Foundamental and others), but there’s also still few more things to occur in order to fast track the industry’s journey towards the rise of digital marketplaces. One such thing would be improving overall standardisation and interoperability by devising common data structures and agreed-upon language that machines can understand to efficiently use data across the whole supply chain. Another idea revolves around introducing some kind of digital product identification so that all of the products across value chain and product’s lifecycle are clearly identifiable by anyone, be it man or machine, ideally with manufacturer serving as a single source of that data to create higher level of coherence and trust in the process (e.g. with the use of GS1 identification keys). That’s what would need to happen on the level of a whole sub-vertical, but can we already identify some key common threads that may point to a potential of achieving success on a single-company level? It turns out that indeed we can, at least to some extent — by analyzing growth stories of two marketplaces in their portfolio, Infra.Market and Tül, Foundamental came up with a few potential action points for construction marketplace founders:

• Work with distribution to increase their distribution reach and make them more productive or to disintermediate distributors by connecting construction directly with manufacturers.
• Adopt a full-stack approach in which you manage logistics with warehouse and transportation or keep a light-approach in which you act more as a broker coordinating suppliers.
• Find a specific angle to kickstart the business by finding an initial focus that can be a restricted number of SKUs, a given geography, a type of customers, etc.

Notable companies: Workrise, OfBusiness, Infra.Market, EquipmentShare, BuildDirect

Models that seem interesting to us: materials marketplace, workforce sourcing marketplace, equipment marketplace, distribution & logistics marketplace

Construction fintech & insurtech

As in any other industry in which value is being exchanged, financial processes are construction’s bloodstream that enables new projects to be funded, payments to be made in time and risks hedged with the use of insurance. Currently, a lot of these processes within construction aren’t really living up to the standards that were set by fintech innovators that disrupted other sectors: average number of days required to receive a payment is 54, which roughly translates to USD 40bn impact from carrying forward fees and costs of slow payments. Poor workmanship and defective products account for 36% of global insurance claims and, in terms of construction lending products, 3.3% of total project costs are made up of finance expenses from floating payments. All of the above signify a big opening for novel fintech solutions to enter the space and seize the opportunity right now.

Construction, as a process involving multiple stakeholders with different goals and time horizons, is bound to be dotted with all kinds of misalignments when payment flows are considered. Workers and suppliers are supposed to be paid by the hour / by delivery and irrespective of the final outcome, while GCs and contractors receive their gratifications based on milestones — the list goes on. Combine that with customarily late payments (only 12% of construction companies are always paid on time and the median DSO amounts to 90 days) and the fact that the sector is largely composed of SMEs, usually unable to tap into affordable sources of working capital or lending, and there’s your case for why payment orchestration may be one of the next big trends within construction fintech. Other interesting area to zoom in on is insurance of construction projects: with construction-related premiums expected to rise in the years to come and sub-par quality of work delivered by contractors being an ongoing industry headache, insurtech innovators may have quite favourable environment to flourish in. Areas such as risk mitigation related to worker injuries, limiting property damage on construction sites or collecting & providing more accurate and current site data for improved underwriting are probably one of the most interesting business cases they might focus on in the near future.

Notable companies: Built, SmartBid, Levelset

Models that seem interesting to us: materials financing, invoice management, financial risk analysis & insights, lien rights & waiver management, loan managers

Construction Management Software (CMS)

In this category fall all of the startups that aim to improve productivity and streamline a myriad of complex processes that take place on construction sites. As of right now, most of the construction management and operations teams manage the project end-to-end, with functions such as document management, data and insights, accounting & financing etc. All this intricacies translate to a system of highly interrelated, complex and taxing paperwork associated with each project, which in turn calls for constant communication and alignment across these stakeholders. Construction management software tools in the likes of Procore and Viewpoint are creating new ways for contractors to orchestrate and track the aforementioned processes more smoothly along the whole construction value chain, from conception and design, through pre-construction and execution to post-construction document management.

There’s a seemingly still untapped (at least in Europe) opportunity to build a verticalized, end-to-end ERP system for construction SMBs. Most of its modules, like CRM, project management, inventory management, finance & analytics, HR etc. can be efficiently scalable across European markets as it was the case with other, more generalist ERPs of the past. Construction, however, calls for a more verticalized solution that is tailor-made for its specific needs, such as contract amendments, managing multiple stakeholders on a construction project or making a quote based on the work of an architect. A noteworthy sub-component of a wider ERP/CMS landscape is Building Information Modelling (BIM) and its usage in the context of managing the construction process to minimize frequent re-works and misalignments between how the structure was designed and how it is being assembled on a construction site. The main premise behind achieving that goal is centered around making use of a 3D model, a digital twin based on a construction blueprint that is used by multiple stakeholders during the entire lifecycle of a project. While in the past BIM models were developed and stored on-premise, usually not allowing for much communication and cooperation between all parties involved, modern SaaS BIM solutions operate in the cloud, are based on an open architecture and are capable of being used and operated reciprocally between all stakeholders while being enriched by data on materials (e.g. composition and prices).

Notable companies: Procore, Viewpoint, Aconex, PlanRadar

Models that seem interesting to us: communication facilitators, data management & collaboration software, design coordination

If you’re an ambitious founder that aims to tackle some of the challenges mentioned in this piece or an investor interested in the space, I’d be eager to get to know you and exchange views about the current state of innovation in ConTech — feel free to shoot me an intro email at szymon.brodziak@moc.vc