Closing the Barn Door After the Horse has Bolted

Subject: Overhead 
“CLOSING THE BARN DOOR
AFTER THE HORSE HAS BOLTED”

by Professor Jake Smithwick, PhD, University of North Carolina at Charlotte

Cutting overhead to protect earnings in down markets is a business school cliché. In management theory it is an obvious common-sense notion to eliminate expense that is deemed nonessential. Hands-on/can-do managers love to talk about “cutting the fat” – portraying themselves as proactive managers who can get things done.

The Great Recession

 The 2007-2009 recession significantly affected the U.S. construction industry with construction unemployment eventually peaking at over 20%. Construction in the United States is a significant input factor to Gross Domestic Product (GDP), and is highly interconnected with other sectors. Changes in the construction sector can have far reaching effects, propagating financial distress to a myriad of other industries. One study found that changes in the construction industry accounted for 52% of the overall national decline in employment.

Construction Industry Recession Response

How did the construction industry respond to this dramatic reversal of fortune? What steps were taken to mitigate damage to the balance sheets and income statements of industry enterprises? What were the results of various management initiatives across a wide variety of industry segments?

We Looked at Overhead

Construction company overhead expense has steadily increased and is often treated as a permanent fixed cost. We decided, therefore, to take a look at how the industry adjusted overhead during the 2007-2009 recession.

 The purpose of our study was to examine the degree to which construction companies reduced overhead costs in response to the market downturn.

  • A total of 437 contractors across the United States completed a survey on how much their companies reduced overhead expenses.
  • 92% of the respondents reported that their companies reduced overhead by an average of about 15%.
  • Overhead reduction varied by both type and size of company.
  • There were higher levels of overhead reduction in companies that had revenues of $100 million to $500 million.
  • Roofing companies, on the other hand, had very consistent changes in overhead costs, regardless of their annual revenue. (Roofing work is unique in that maintenance and repair work was less affected by the market decline.)

Conclusions

 The Great Recession of 2007 to 2009 forced many construction and design firms to reevaluate how they manage their business. During the growth prior to the recession, many companies’ overhead costs increased and therefore represented significant liabilities during the downturn.

  • This market declines should stimulate construction and design firms to regularly and intentionally evaluate their overhead costs.
  • Strategic management of overhead helps companies increase their preparedness for future periods of decline, predicated on how disciplined they are during periods of growth.

To Put It Bluntly

  • Don’t sell the horse; close the barn door.
  • Don’t cut overhead; manage it in advance.
  • Overhead expense does not grow organically; managers create it.
  • Strategy is never a response; it is always a plan.

Final Note

 You can find the entire study entitled, Quantifying the Impact of the Great Recession on the AEC Industry – A Call to Reevaluate Home Office Overhead Costs here on our website. Take a minute to review the statistics as they might apply to your company, then publish and post the following sticker around your headquarters:

OVERHEAD IS DESIGNED – NOT CONTROLLED

Read More: Flexible Overhead

Jake Smithwick can be contacted at Jake.Smithwick@uncc.edu