Stable Markets: Where All Profits Reside
Two weeks ago, I ended the message by expounding Schleifer’s First Law:
Contractors Thrive During Stable Markets
Today, I begin with Schleifer’s Second Law of Market Dynamics:
There is No Such Thing as a Stable Construction Market
Perpetually Unstable Markets
When we say “markets” we are not referring only to the total of contracts let, but rather the totality of factors that make up the complex marketplace in which we contractors do business. Markets are not only comprised of top-line revenues, but also cost fluctuations, labor relations, competitive tensions, inconsistent government regulations, contract negotiations and the project owners’ evolving commodity view of contracting services. All these factors add up to perpetually unstable market environments that challenge our profitability and can gradually erode a contractors’ capital footings. Contractors are required to plan and operate their businesses under volatile cost, revenue, labor, and regulation conditions. Even if revenues are growing slowly over time, costs are often spiking, labor is uneasy or nonexistent, and the prices owners are willing to pay are limited by their view that construction services are a commodity, and one contractor is as good as another. Here’s what the consultant PBMares had to say about recent construction market conditions.
“When COVID-19 first hit the U.S. earlier in 2020, construction’s place as an essential industry helped to bolster initial fears of a sector-wide downturn. Not all states recognized construction as essential, and even in those that did, contractors faced myriad issues getting employees back to work. The new economic and business environment is highlighted by worker shortages, supply chain disruptions, price increases, new safety mandates, and more.” (Construction Industry Outlook: Volatile and Cautious, PBMares, 2021)
Buy High – Sell Low
Back in the “olden” days, (before the 80s) many contractors were working with double digit profit margins. There was plenty of room for error and contractors enjoyed under-bidding the competition knowing that they always had a marginal ace in the hole. Of course, that has all changed and construction services have become a commodity with profit margins down in the single digits if all goes well. Complex, volatile market forces have put contractors in the unenviable position of “buying high, selling low, and making it up in volume”. (A paradox wrapped in risk)
Managing Stability
Best-in-class construction business management practices are the only way to stabilize these highly complex, perpetually unstable construction markets that have been eroding contractor profits for the past 40 years. We have studied the pitfalls in both expanding and contracting markets and have identified the most common risk factors that must be addressed to avoid working with marginal profit and eroding your capital base. If you think the following statements are true, place a (T) at the end of each. If you think they are false, place an (F) at the end.
Self-Analysis
True or False:
- Contractors only thrive during stable markets.
- All construction markets are by their nature, unstable.
- Stable markets do not come and go. They are delimited by management.
- Best-in-class management practices stabilize naturally unstable construction markets.
- Best-in-class management practices include but are not limited to:
A.) Recognizing and managing risk.
B.) Managing growth risk when entering new markets or selecting new projects.
C.) Promoting CFOs to top management assuring them a seat at the table.
D.) Conducting cash flow and profitability analysis.
E.) Training staff on core skills and investing in staff development.
F.) Bidding only on work you are uniquely qualified to do.
G.) Not always insisting on being low bidder.
H.) Revisiting the contract and ensuring appropriate language is in place to cover delays or price increases that are outside of your control.
I.) Expanding relationships with suppliers and vendors. Not being wed to the familiar or convenient.
J.) Hedging materials to lock in lower prices.
Schleifer’s Third Law:
There are, of course, no right or wrong answers. If you agreed with most of the statements, then you share my view of the volatile world of construction and how to best respond to unstable market conditions. After 50 years in construction, however, I recognize that most contractors passionately share a belief that guides most of their management decisions – Growth Is Good.
Schleifer’s Third Law of Market Dynamics:
Only Profitable Growth Is Good
Next week we will discuss why growth, if not managed carefully, can be unprofitable and is often deceiving. Don’t miss that discussion.
For more information market growth, read more at: https://simplarfoundation.org/?s=market+growth
For a broader view on the construction market cycles, read more here: https://simplarfoundation.org/?s=management+practices
To receive the free weekly Construction Messages, ask questions, or make comments contact me at research@simplarfoundation.org.
Please circulate this widely. It will benefit your constituents. This research is continuous and includes new information weekly as it becomes available. Thank you.
