Rock Bottom?

Dec 1, 2008 12:00 PM, By Beck Ireland, Staff Writer

Downside risk

The numbers for the 2009 construction forecasts depend on the success of recent actions from Congress and the Federal Reserve Board, such as the Federal Housing Relief Bill in July, the $700 billion bank rescue that also included extensions for tax credits for renewable energy sources, and the coordinated cut in interest rates with foreign nations. They also anticipate further fiscal stimulus for investment in construction projects, such as an infrastructure bill supported by the Associated General Contractors of America (AGC), Arlington, Va. Yet, even with continued measures, construction is expected to remain in the red. “The steps taken to help the frozen credit market will work, but with time,” Murray says. “But even before these events, we were dealing with a tough credit market.”

However, a recession is preferable to a state of panic. “We think the genie's going to get put back in the bottle,” Haughey says. “We anticipate that within a month or so credit costs and availability for non-financial firms and consumers will return to where they were back in July and August. Unfortunately, that's not a very pleasing prospect because we were just on the verge of a recession, but the panic will be gone and people can stop talking like it's 1929.”

There is a lesson to be learned from construction's history. “All of us who live long enough are ultimately going to become believers in economic cycles — and economic cycles come and they go,” says Harris. “In the 1970s, for example, some people thought our problems were so large they were going to last forever. Obviously, that's not the case, but we do have some serious challenges ahead of us as an industry right now.” (See Strategies for Hard Times on page 30 for more information).

According to Harris, past recessions took as long in recovery as they did in the making of them. “The down period lasted about as long as the preceding up period,” he says. “So there could be an argument to be made that this recession — from a construction standpoint — could go for a long, long time because the construction markets have been basically bullish for 16 years, at least on a national level.”

However, Harris thinks a prolonged recession is doubtful. “There are so many demand drivers behind so many different forms of construction that it's hard to imagine it would take a decade to come back,” he says. Yet, he's unable to make predictions beyond it being soft for several years. “My best guess is we're in for some very difficult times in this industry in the next couple of years. It may be soft for as many as three or four, but again the cycles come and go.”

Instead, FMI examines the impetus behind construction spending. “Consumer demand and demographics are ultimately what drives construction activity, especially in a vertical market,” Harris says. “Most of us tend to think that our projects are somewhat derived from the developers or private spending or public budgets, or whatever the immediate issue might be, but it's always good to peel the onion and look at what's behind that money.”

Sidebar: Strategies for Hard Times

Under any economic condition, you want to position your firm for success. However, in a weakened economy, revitalizing your strategies for success may mean the difference between keeping your doors open or shutting them for good. “You always want to get your business ahead of the money,” says Hank M. Harris, president and managing director, FMI Corp., Raleigh, N.C. “You always want to try to get your business to where the demand is.”

Therefore, in order to position yourself for success, you should have a contingency plan. The following are suggestions for formulating your own:

• Check for warning signs. A key indicator that your region is headed for tough times is an increased number of project delays and cancellations in your area.

• Look outside your own sphere of influence. Gather and read as much economic and market data as you can from the outside. The AIA Billings Index is a reliable indicator. “Beginning in January 2008, the Billings Index gave us an indication that there was less work on the boards,” says Lee Smither, managing director of the management consulting group for FMI Corp. “It was certainly a shot over the bow, if you will, back in January.”

• Challenge your old way of conducting business. The strategies you use during good financial times might not work under a weakened economy with increased competition. “The things you believed were true before may not be true now in your marketplace and for your future,” Smither says.

• Examine the incremental economics of your business. Track your metrics, such as the number of new contracts versus the previous year, gross profits, overhead, cash flow, labor productivity, liquidity ratio, rate of backlog fill, amount of work on the boards, and age of collections. “What are some of those incremental economics that are business-specific?” Smither asks. “Get back to the balance sheet, and look at how strong you are.”

• Contingency planning for the next six to 12 months. Using your metrics, put a plan in place for at least a 10% shortfall in revenue or work. If the recession lasts longer, from nine to 12 months, or spans more than a year, begin to develop a long-range plan with critical actions you can take that will ensure your survival and establish a mechanism for cost-cutting in your business based upon sound financial analysis and advice.

• Look at your organizational structure. Get back to basics. Implement best practices project management to reinvigorate productivity. Look at your general conditions. Reward employees who are margin aggressive. Fix or eliminate any marginal locations. Ask yourself if your structure works based upon what you think is coming in the future. “Will there be too much redundancy in places where one time it was good because you were so busy you couldn’t see straight, but now becomes burdensome?” asks Smither. “We have a lot of clients that have admitted that over the last five to seven years, they’ve gotten sort of lazy with regard to their project management practices; they were just trying to get work done.”

• Undertake scenario-based business planning. Perform exercises for changing economic environments. Hold a planning session to discuss the best-case/worst-case/expected-case scenarios. “If you’re a multi-divisional company that has vertical markets, you go through all the different scenarios for each division,” Smither says. “Each major department does it, too. This whole process takes about a month or two to go through, but it’s well worth it.”

• Keep score. Track risk management: Check over subcontracts before they’re signed, keep insurance certificates up-to-date, implement or refresh safety programs, and verify and perform due diligence on the project funding before breaking ground.

• Establish cost-cutting hierarchy. Non-people-related cuts come first, followed by office staff, and then professionals in the field. Examine your different locations and profit centers. Delay capital expenditures. Look at hiring.

Source: FMI Corp.