By Evan M. Musselwhite and Luke C. Tompkins of Ward and Smith, P.A.
Published December 21, 2022
Hank Harris, Director of Consulting of Ward and Smith Business Consulting, shared insights on the current state of the construction industry and tips for how construction business owners can grow and succeed, along with predictions on future trends.
Harris spent most of his career in a national management consulting and investment banking firm, where he specialized in working with privately held businesses. Having worked closely with hundreds of successful business owners over the years, Harris offers an insider’s perspective on the issues that are important to entrepreneurs and privately held businesses.
“An old joke is the definition of a recession is when your neighbor loses his job,” said Harris. “The definition of a depression is when you lose your job.” Harris alluded to the fact that there is not much consensus over whether the US economy is in a recession or not. “Everyone I have been talking to has been building a lot and enjoying good times in 2022,” Harris explained. “This year will end at a very strong level for the overall industry.”
The construction industry encompasses approximately $1.7 trillion in value, representing around eight percent of the GDP. This has resulted in the construction industry being of critical importance to the GDP and the economy. Harris noted: “It’s really hard for the United States to have a healthy economy unless construction is healthy, and vice versa. The two things move in lockstep.”
A Higher Tide Raises all Ships
Referring to the Bipartisan Infrastructure Law, Harris pointed out that around $853 million is going to be funneled into the construction industry. The increased level of spending that is set to take place is likely to take pressure off the major building contractors, creating a ripple effect that takes the pressure off the trade contractors.
“The money flushing into the built environment will, to some extent, lift all the boats. It won’t lift them equally, but it will be good for the overall environment and the future of the industry,” Harris commented.
For the most part, construction industry players currently have a very healthy backlog. However, the industry tends to lag behind major economic trends. Although balance sheets remain very strong, many recent surveys designed to gauge the sentiment of business owners are trending toward the downside.
An ongoing problem the industry faces is the average contractor is trying to do more work than his capitalization can rationally allow. A good rule of thumb is to have at least 10 percent of production volume in working capital. Trying to turn the working capital too much can result in the business going under.
Having too much capital can also become an issue. “If you get over capitalized, you’re watering down your returns and keeping capital locked up in a risky business,” said Harris, “and you’re not really diversifying your personal economics.”
Generally, the sweet spot for a business is to have it stand on its own. Another important tip for business owners is not to sign personal indemnity agreements.
Succession Planning
One issue that has been gaining importance is the concept of succession planning. “Many business owners are still in that baby boomer phase, so there is a great migration going on generationally,” Harris explained.
People are wondering what to do with their companies, but focusing solely on who will become the next CEO is a mistake. Company leaders need to identify the individuals that will be able to fill gaps at every level of the organization in order to de-risk the business.
“If the company is going to perpetuate itself, we have to build young people up, get them interested in the business and bring them into these positions,” Harris added. “This is common sense, but it is a really big issue right now.”
The Five Circles of Risk
Those in the construction industry that want to make money should begin by figuring out how not to lose it, advised Harris. “Many businesses have jobs in process that are bleeding capital. Any construction company is going to have a bad job, no matter how diligent you are. It’s just part of the risk,” Harris noted.
Many companies will not be able to survive the negative leverage of two or three bad jobs at the same time. Harris pointed out that, “It’s not just the lost cash; it’s also the negative momentum that is going to hurt you organizationally.”
To minimize the risk of working jobs that bleed cash, companies should consider implementing the five circles of risk. “I got this from a board colleague, who was tasked with turning a company around that had people bidding on heavy civil projects all over the country. People were bidding on all sorts of jobs, and the losses were mounting,” said Harris.
As a means of initiating the turnaround, all the employees knew that every potential new job would have to pass the five circles of risk, which include:
- Have we done this type of job before?
- Do we have a team in place that can do this job right now?
- Do we have experience working in this area?
- Have we worked for this client before?
- Do we have experience with this type of contract?
For a potential new job to pass muster, the answer would have to be ‘Yes’ to at least four of the questions. An immediate outcome of the implementation of this idea was that volume went down. However, profitability increased significantly.
New Construction Technologies
One of the most famous structural engineers in the U.S. made an exciting new development impacting the construction field by creating a system that allows building the top floor of a skyscraper at ground level.
None of the workers have to go higher than six feet to complete the floor. After it is finished, it is simply jacked up to the top, and the next floor is slid underneath.
Another development that has upended the industry in a positive way is a time and resource management application built for construction. “This is basically your labor, consumption, and utilization reporting, all on your cell phone,” explained Harris.
The way it works is employees add data such as labor utilization at the end of the day into the app. It then integrates automatically with accounting, job estimates, and reporting in real-time. One of the problems with technology is simply getting people to use it. Another challenge occurs when the time comes for people to leave technology behind.
Harris pointed out that companies that find people who are adaptable have the potential to create a competitive advantage: “It’s going to be about who can get their people to spin up on technology fast and then abandon it when the next thing comes along.”
Challenges and Opportunities
Similar to other industries, attracting the right talent is currently a problem for the construction industry. “It’s not like the old days where you can just put the labor out there,” added Harris.
Identifying the right areas for growth can be a challenge, but with enough effort put into the research, the opportunities are significant. “A third of all construction takes place in 12 cities,” notes Harris, “so an obvious thing to consider is where the people are going.”
The war for talent is resulting in companies poaching employees from other companies. If only one employee were to receive an offer for compensation that is significantly beyond what everyone else in the company is currently making, it could cause upheaval for the entire compensation scheme. Many difficult choices would have to be made in this situation, and there is no magic formula for success.
“The economic picture is still fuzzy, but the outlook for 2023 is pretty good,” Harris commented. “It’s time to be cautious in terms of how you calibrate your business and how you run your business.”
Harris anticipates that a modest recession is in the cards, similar to the tech bubble of 2001. An important item for business owners to note is whether their team has managed a company during a downturn before. Having people with experience managing during a downturn is critical, as things are simply not the same, and many tough decisions have to be made.
Another critical success strategy involves thinking strategically. “If you think strategically about your business, you’re going to be ahead of half the people out there. Because I will tell you more than half of the people running these businesses don’t,” explained Harris.
This is a result of construction businesses being run by entrepreneurs, who operate in a certain way because they have to and are always faced with solving immediate problems. “No matter how good a planner you are, when things are coming up all the time, it is very difficult not to get into a reactionary mindset,” concluded Harris.
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© 2023 Ward and Smith, P.A.
Evan M. Musselwhite is a construction litigator and serves as the Co-Chair of Ward and Smith's construction law practice. He represents and advises contractors, subcontractors, owners, and design professionals in all states of the construction and development process. He can be reached at emmusselwhite@wardandsmith.com or 919.277.9196.
Luke C. Tompkins is an attorney with Ward and Smith, P.A. His practice focuses on commercial and construction litigation and disputes before the North Carolina Business Court. He can be reached at lctompkins@wardandsmith.com or 919.277.9176.