BOOM AND BUST
Subject: construction market cycles
The construction recession is finally over and boom times are upon us once again. Everyone is signing new contracts and business plans are bursting at the seams. And this is even before the Republican administration in Washington rolls out its trillion-dollar infrastructure program. We’re all about to get rich. Optimism abounds. Far be it from Let’s Talk Business to throw a wet blanket over the festivities.
However…Better Take a Look
We invite you, first, however, to stand back…take a look at your company…look at its backlog…its forward commitments…its capital structure…its labor force…and ask yourself…could I go bust during this boom?
After researching the causes of contractor failure for more than 30 years, I have uncovered the following reality: Construction business failures are worse during market recoveries than during market slowdowns.
Some will object…
“What? Don’t tell us that! That’s wet blanket stuff. Let’s let the good times roll. We’re coming out of a long dry spell and it feels pretty good. We can finally start to grow again. No! No wet blankets! Not now!”
So, I Repeat…
“CONSTRUCTION BUSINESS FAILURES ARE WORSE DURING MARKET RECOVERIES THAN DURING MARKET SLOWDOWNS.” Optimism during upswings in the construction market causes otherwise professional contractors to ignore the obvious pitfalls in market cycles and fall asleep at the caution switch. Optimism is an emotion that causes us to suspend critical thinking while we are awash in the pleasure of endorphins. Endorphins feel good, but they don’t think good.
Research reveals that there are substantial risks hidden in expanding markets. These risks are in the form of beliefs that we all hold but rarely re-examine.
- Growth is always good.
- Some unprofitable jobs are unavoidable.
- Past success implies future success.
Let’s Look at Growth
During market recoveries, growth often looks like this:
- Having recently been forced to downsize, construction enterprises now have spread their skilled labor force too thin and need to hire people who will be unfamiliar with their methods and bring only limited experience. This, of course, can have a negative impact on efficiency and profitability, dramatically increasing risk.
- Contractors are adding overhead in the form of personnel, equipment, and facilities in anticipation of increased revenues. It feels good to grow the company again, but it thinks bad if you’re only growing overhead and not profitability. As overhead increases in advance of revenues, capital shrinks. Are you already caught up in this euphoria and increasing your risk of failure while enjoying the feeling of more work out there?
- Recessions render construction a commodity as supply exceeds demand and commodity pricing sets in. Eager to participate in the boom cycle, are you being forced to enter into contracts with buyers who have sharpened their negotiating skills and shrunk your margins to high-risk levels?
- A construction recession cycle shrinks profits and weakens the balance sheet. As the boom cycle sets in, new contracts must be financed with capital residing in the post- recession balance sheet. Do you have enough residual capital to finance the growth you’re pursuing?
At first glance the conditions described above do not seem risky. “After all, how can growth be bad? There has always been a shortage of skilled labor. In the past, our firm has been able to gather enough skilled craftsmen to get the job done. And capital? We have always had to chase capital. That’s nothing new.” Etc. Etc. – I can hear you…but the data doesn’t lie…
CONSTRUCTION BUSINESS FAILURES ARE WORSE DURING MARKET RECOVERIES
The contractors that failed during past recoveries didn’t know they were at risk. They didn’t bother to evaluate risk during the euphoria of an upturn in the market, and they overcommitted the capabilities of their organizations. Failure came suddenly and without warning when they relied on optimism rather than data-driven intelligence.
Let’s Look Under Our Wet Blanket
By all means, participate in this current recovery. However, growth must be managed with care rather than unbridled enthusiasm. Do not fall prey to careless optimism. Read more about this topic and similar topics.
In future blogs, we will discuss:
- How to measure the amount of working capital required to pursue larger contracts.
- Ways to add flexible rather than fixed overhead as you take on additional work.
- Methods for dealing with the labor shortage.
- Contract negotiation techniques during recoveries.
- The alchemy of turning risky revenue growth into positive cash flow.