If You Take Your Eye Off the Ball
You’ll Strike Out
The Last Downturn
The 2008-2012 construction market downturn hit residential construction first. The burst of the $8 trillion housing bubble in 2007, and the subsequent collapse of the financial markets in 2008, created massive disarray in homebuilding. As many as 50% of homebuilders closed their doors, either voluntarily or through bankruptcy filings. In 2007, the Economic Census reported there were 98,607 individual homebuilders in the United States. By 2012 there were only 48,557. Commercial, infrastructure and industrial construction follow this pattern a year later.
Subsequently, researchers asked – In the dramatic market downturn of 2008-2012, why did some firms fail while others didn’t? The external market factors were the same for everyone. The causes of failure must lie in the internal factors that separate one contractor from another. What were these internal factors that contributed to this failure rate?
Here We Go Again
Everyone knows that we have stumbled into a worldwide viral pandemic resulting in a construction market downturn. No one can predict how deep or long this latest recession will be, but no one with any sense denies that it is happening. Can we expect another serious percentage of construction enterprises to disappear? What are the differing internal circumstances that cause so many contractors to be vulnerable? Can any of these factors be controlled?
Internal Factors
Twenty years of research into the causes of construction company business failure during market downturns revealed the following internal factors:
- Optimism
Contractors are problem solvers, and they tend to be optimistic by nature when considering the daily challenges they face. Though they may sense the business may not be on solid financial ground during a market decline, they figure problems can be resolved eventually.
- Heavy Operating Expenses
Permanent overhead designed to manage growth cannot be jettisoned quickly when markets turn down suddenly.
- Lack of Strict Cash Flow Management
Because construction enterprises tend to focus on top-line cash flow to fund ongoing operations, rather than bottom-line contributions to capital, when markets turn down liquidity dries up quickly. Amazingly, this always seems to be a surprise, and corrective action comes too late.
- Pricing and Estimating Deficiencies
The natural response to market downturns is to scramble to compete for the little business that is left. In order to win work in down markets, contractors are often forced to lower their prices, in some cases, below cost and try to make it up later. Most contractors encourage their marketing departments and their estimators to sharpen their pencils and get after any business they can find. The reasoning, of course, is that as long as there is something to build we’re still in business, but if we let the big guys come into our market and take the little business that is left, we’re doomed.
- Underestimating the Cost of Doing Business
After the downturn of 2008-2012, it became apparent that the companies that had sufficient reserve capital to wait out the market survived, while those that were undercapitalized failed. During this current market collapse, contractors would be wise to carefully analyze their balance sheets to determine if they have enough capital to survive and compete in a down market scenario for any length of time?
- Corporate Status
An emotional connection to the position of the firm in the business community is more insidious and dangerous thanmaterial ambition. Seeking to maintain their corporate status or a compulsion to show growth to shareholders is a formula for failure in shrinking markets. Companies that insist on maintaining a self-image often take unprofitable work and erode capital before they realize they are in trouble.
- Unrealistic Growth Objectives
Unprofitable growth is not growth at all. In down markets, larger competitors aggressively compete for smaller contracts and use superior capital strength to subsidize marginal profitability or losses. Smaller and med-size companies should never be tempted to compete for business they have to subsidize.
- Denial
If top management is in denial avoiding facing their organization’s underperformance and does not react to it quickly; when a downturn occurs they end up a casualty of the market decline. Some “marginal” performers can only continue in a growing market because they are supported by cash flow, not profit. Any number of small and med-size contractors have failed because they did not recognize weak performance far enough in advance of a market disruption.
- The Barn Door
Closing the barn door after the horse has “gotten out” is a cliché. However, when external factors overtake our business model, the only functional response is to take a careful internal look at the sufficiency of our business model. Research tells us that, when faced with the dramatic market collapse of 2008-2012, some contractors reacted by trying to alter the “external” factors rather than looking internally. Too many of them failed.
- External Market Factors
External factors that seem to affect your business do not matter very much because there is nothing you can do about them. Do not waste time trying to figure them out—they are the “cause” of what is affecting your company. Look internally. Keep your eye on the ball. Manage your business. Do not try to manage the macroeconomic world it inhabits. Don’t risk striking out!
The Solution
In is easy for top management to become trapped by its natural optimism hoping for the best when the economy or the business environment does not cooperate. The only thing you CAN control is your business. Embracing the relatively new concept of flexible overhead provides a contractor with a rapid and secure response to market ups and downs. It took years of research to develop and to determine that it is the only solution.
