Pipeline & Gas Journal
January issue 2000:

30th Annual Roundtable

Safety, Consolidation Concerns To Contractors

Safety issues and the growing trend toward consolidation is much on the minds of distribution contractors today. Four leading contractors, Dennis Mueller, Group President, MRM Technical Group; Michael Kemper, President/CEO, Northern Pipe Line; Christopher Leines, President, Minnesota Limited Inc., and Jack Gabrielse, President, InterCon Construction, shared their thoughts during the 30th Annual Contractors Roundtable sponsored by P&GJ and Underground Construction. The discussion was held in conjunction with the Distribution Contractors Association fall board meeting in Dallas.

QUESTION 1: Safety
The “Best Practices” damage prevention study was released last summer with plans for a renewed public awareness campaign. Is this the right approach to improving safety in the industry? What else can be done? Public concern over utility hits by HDD and other trenchless methods is growing. How should the industry address these concerns?

MUELLER: The damage prevention study is a nice document but I don’t think it will have a real impact. It’s good public policy but doesn’t get the industry stakeholders involved. From our perspective, the one way to deal with the issue is through the insurance companies. They need to start putting a premium on the construction practices of the contractors and look to see what kind of damage prevention program the contractor has. Utilities say they address these issues through contractor qualification. But, the reality is the pressure for lowest price dictates contractor selection. The insurance companies would be the most effective way of supporting damage prevention by raising the cost of operations for unqualified contractors. We don’t think a government body can come up with any rules that will ultimately change what’s going on.
With respect to HDD, I think it’s a fallacy that it is a more dangerous method of construction. In many cases, if done right, HDD actually has improved damage prevention practices because people are far more conscious of what they’re doing and what is in the ground. Statistically, there are more utility hits today than in the past, but this is due to the fact that the amount of underground construction footage is up agronomically. The average utility hits per foot of construction is probably down. The industry overall has done a better job. The perception problem has to be addressed since the public sees more directional drills and more utility hits. The two are not necessarily related.

KEMPER: A One-Call public awareness campaign needs to reach equipment users through multiple sources. Maybe the equipment manufacturers and rental companies could play a role in awareness and education by providing awareness decals and One-Call instructions.
On the other hand, an HDD public awareness campaign would not be as effective since the general public is not the group that can do much about it; our industry is. The industry has not talked widely about the safety concerns of HDD because we don’t have a widely accepted solution. That’s where any campaign should first focus on developing an acceptable solution to our problem. Industry organizations that could take the lead include the DCA, GRI, PEPG as well as the LDC trade associations.
The first step in finding a solution is to define the problem. While trenchless methods have been used safely for a long time, there are more underground utilities than ever before and more of them are being installed with HDD and other trenchless methods. While good installation practices clearly reduce the likelihood of damage, we still have a real safety issue. That’s why the DCA Technical Committee picked “Object Detection” from a comprehensive member interest survey as the major topic for its educational panel discussion at UCT 2000.
I’ll take the risk of offering up a strawman definition that we, as an industry, can beat up and better define as we go. The safety concern with utilizing HDD and other trenchless methods is the fear that the procedure may either penetrate a utility line or achieve inadequate separation between utility lines. The “elephant-in-the-living room” fear is unknowingly leaving a natural gas line inside a sewer lateral and then later, if the sewer line gets clogged, a plumber runs a rotor-rooter cleaning blade and chews a hole in the natural gas line allowing gas to escape into a home, apartment complex, business, school or hospital.
Possible solutions include a combination of the following: potholing out in front of every trenchless procedure; running a sonde from the home or business to the sewer main; developing better locating technology; better training of plumbing personnel on the risks of rotor-rooting; requiring privately and municipally owned sewer lines to be located by the owners, the contractors or a third party; DCA members banding together in the interest of public safety to develop strict damage prevention procedures for the use of trenchless technology and then following the procedures even if that costs more in the short run; LDCs working with contractors to develop these procedures and then requiring that all contractors follow them even if it does cost more in the short run; and using the new Operator Qualification rule to ensure that users of trenchless equipment are qualified in the safest procedures possible. Each of these possibilities has challenges, but this issue is important enough that we, as an industry, must rise to the occasion.

LEINES: Much of the problem, I believe, rests with the municipalities, utilities and the other One-Call members who need to perform a better job locating. Many times when you call for locates, not everybody shows up or lines are mismarked or there is insufficient data to find the foreign crowning. There needs to be more emphasis placed on marking these utilities by all parties concerned.
As far as the public is concerned over HDD hits, I think the theory is blown somewhat out of proportion. Most of the reputable contractors out there in the trenchless market are doing the right things with respect to one-calls, potholing, vacuum excavation, etc. They’re using the proper protocol and not having a lot of trouble.

GABRIELSE: We as an industry need to take a broad approach to this. One of the biggest problems is locating companies missing locates, or the utility companies themselves missing the locates and not being responsible for them. We’ve had a big problem with missed locates and locating companies not being held accountable for their mistakes. Contractors are held accountable if we hit a line.
As for safe practices, some of the utility companies need to put in contingency plans for emergencies, especially on natural gas or product line hits. As contractors, we train our people on what to do if they accidentally hit a gas line. Everybody should be held accountable for their negligence, not just the contractor.
I agree that it’s a fallacy that HDD is causing more accidents. Years ago when we were using conventional methods, there were probably more hits because we didn’t have the sophisticated locating systems that we have today. I firmly believe it is a fallacy and the associations need to get the public more educated about what is going on.
As our businesses grow, there are more people getting into the business and some of us are using small subcontractors to do work for us. Those subcontractors need to work under our guidelines so that they do not damage our industry’s reputation. At InterCon, we expect our subs to work like our crews and accept our safety guidelines.

QUESTION 2: Industry Consolidation
This has been a hot topic and appears to be even more as 2000 approaches. Will this trend continue? What is the impact on contractors? Will small contractors be squeezed out of business? What will be the impact for utilities? Some of the companies acquiring contractors are utilities. The debate over whether a utility should be involved in construction has been kicked around for years. Why or why not is utility ownership of contractors a good thing now?

KEMPER: When an industry consolidates, it’s not unusual for the industries that serve as its suppliers to consolidate as well. In our case, both customer and contractor consolidation will continue. Most of the DCA members have already been in discussions with acquisition suitors or targets. If they haven’t yet, they will. It impacts us all, big, small, and in between. Typically, industry consolidation results in a few big companies, a significant but fewer number of small niche players, and very few mid-sized companies. The small companies find a competitive advantage that the big companies don’t have while the big companies have economies of scale and/or scope that the small ones don’t, leaving the mid-sized companies with neither the advantages of being big nor being small.
Whether this is a good thing depends on who you are and where you end up. There are two overarching and sometimes overlapping issues involved: 1) what’s best for the customers, operations, and employees, i.e. the business; and 2) what’s best for the owner(s) financially.
The big issues from the business side are the economies of scale and scope. In our industry where labor and related expenses make up such a large percentage of our costs, the cost economies of scale are, in general, limited primarily to tools and equipment. While very capital-intensive, they are a relatively small portion of our costs, especially for the medium and large companies that already enjoy volume discounts. In terms of the economies of scope, bigger companies offer a full line of services to meet customers’ needs; those who don’t will need to find another competitive advantage to survive.
The second overarching issue — what’s best for the owner financially — generally means selling the business at the highest price. Buyers are now paying much more for the high growth, high tech, high margin telecom construction business than for slower growth, lower tech, low margin gas distribution construction companies. In fact, P/E ratios for the former average in the 20-30 range while the latter run around 6-10. While this is great for the seller who gets cash or high multiple stock that holds its value, too high a price in cash or stock may not be good for the employees or customers in the future.
The impact on the utilities as customers will depend on the price paid by consolidators for acquisitions, the investment expectations and strategies of the new owners, the future stock price of the public owners, the economies of scale attained, and the scope of new services required by the customers of the future. This means there is a risk that construction prices could increase as a result of industry consolidation.
The jury is still out as to the success of utility ownership of construction companies. Not many have tried, several have failed, and a few may well be successful. Much depends on the specific utility’s investment expectations and strategy, its operating philosophy and its execution and involvement. The biggest negative of utility ownership is that the “affiliate interest” rules make it more difficult for a subsidiary company affiliate to do business with its parent. On the positive side, it actually helps the construction company provide better value to its non-parent customers because the utility parent offers both insightful input into customer requirements and certain lower-cost, internal services like legal, human resources and materials purchasing.

LEINES: Industry consolidation is a very hot topic and looks to continue to be one for the next several years. If you take a look at all the various types of businesses throughout the United States, mergers and consolidations are a very prevalent occurrence. Take, for example, all of the mergers in the banking and insurance industries. But even closer to home, there is a big consolidation push in the oil business and the gas and electric utility markets. It is occurring everywhere around us, so I think it’s a natural progression for this to be happening to us.
The jury is still out on what kind of impact it will have with the contractors and the utility companies. It is still an evolving market. There are definitely going to be some changes in how business is done. From the small contractor to the medium and large, there are going to be people who are niche players that may go unaffected. Being a bigger conglomeration isn’t always necessarily better on smaller projects. I still think there is going to be a market for smaller contractors dealing with the smaller projects. I think these new conglomerates are going to be more effective on the bigger blanket contracts that are multi-state contracts in origin.

GABRIELSE: Will the trend continue? I think it will. The big question going through our minds is how is this going to impact our company if we don’t merge with somebody? There is a risk out there in going against the big bear. We are concerned about that but I still think there is a niche in the business for us. Will we be squeezed out? No. I think the small contractors will survive. The reason why is that we have done different things to compete against the larger companies.

MUELLER: Actually, I think it (merger and acquisition trend) is going to accelerate. Wall Street sees it as a good investment so acquisition capital is flowing that way. As for the utilities owning contractors, there are two large utilities consolidating contractors with a third about to jump in. Their ownership is for the same reasons as Wall Street; it’s a good financial investment. The utilities have a responsibility to their shareholders and need to prudently invest excess resources. Given the growth and earnings potential of a consolidated group of contractors, it makes a good investment. The utilities that are jumping into it now are building the companies to be completely separate, stand-along legal and financial entities. There is little interaction between the construction arm and the regulated entity.
Does the small contractor get squeezed out? I think the answer is no. I do think, depending upon your size, you need to look at being more of a niche player. That was one of the factors that drove our decision to merge; we were too big to be small and too small to be big. Further, we did not have a unique enough niche to flourish with what’s coming.
Our industry is going to be reshaped based on customer demand, much more than I could have fathomed even six months ago. We really won’t see the full impact for two to three years because construction is so good right now. As the traditional gas and electric utilities merge, there is going to be more of a drive for larger bundled service contracts. The mid-size contractor who has made his living off of just providing a single service to a utility may find himself in a position where he has to have a strategic alliance in order to continue working for that utility, or he may get squeezed out of working for that utility.
The contractor who has set his company up to service multiple infrastructures has a better chance for survival than one who is dependent on only one area. There will always be thousands of contractors in the United States - it’s the nature of the business. To be successful, you have to pick the arena that you want to fight in. There are going to be four contractors each doing in excess of a billion dollars per year; you’ve got to go up against their weaknesses and find areas where you can beat them.
Bigger is not necessarily better. Bigger does lose a degree of efficiency and nimbleness. You lose some degree of flexibility and that’s where the smaller contractor has to compete.
With regards to change, the industry is going to change no matter what. The question is at what rate? In the past, change was dictated by new technologies that were developed relatively slowly. With the Internet, utility deregulation and Wall Street - the rate of change has just accelerated a hundred-fold. Three years from now, it may slow down, but who can guess where the industry is really going to be in three years? It’s going to be a fun, but tumultuous, ride. P&GJ