Any construction veteran expects the economy to contract and expand. However, the global pandemic presents contractors with a challenge unlike any in recent memory.
How should they respond in an environment of such uncertainty? For some perspective, I chatted with Dr. John Killingsworth, a construction management professor at Colorado State University who has conducted extensive research on how contractors can weather economic downturns.
BRUCE
ORR: John, let’s say you’re in IT or are a c-suite
executive at a contracting firm. This event has occurred. What are some of the
questions you should be asking right now?
JOHN
KILLINGSWORTH: For starters, we have to acknowledge that
the uncertainties are so tremendous that many contractors have no choice but to
be reactive in the short term. They’re literally not sure whether particular
job sites will be open or closed tomorrow or whether they’ll go to work next
week. They’re also looking at predictions—from highly qualified statisticians,
public health officials and others—that are just all over the map due to the
limited nature of the data we have at hand.
Nonetheless, as this crisis continues it will
be increasingly important for contractors to dive into their long-term
strategies. In particular, they need to scrutinize the fixed costs associated
with everything from personnel to PPE (property, plant and equipment). Hard
choices may be required. For example, it’s natural to want to hold onto your
best people in the face of a downturn. We all know how difficult and expensive
it is to replace key personnel later when the economy recovers.
However, you need to quantify how much your
margin—and, in turn, your liquidity—will suffer if you maintain fixed costs at
a time when revenues are declining. Now is the time to take advantage of
analytic tools to consider the correlations and trends with all of these
variables. It’s valuable to play out scenarios such as: ‘What happens if these
projects in our backlog fail to materialize in the short term?’ or ‘Here’s how
our margins and liquidity could be affected if we retain 100, 90 or 80 percent
of our overhead personnel.’
BRUCE
ORR: You want to keep as many of those proven project
managers, estimators, marketers and accountants as you can without hitting that point where you’re not meeting your breakeven
volume, right? You’ve got to protect your profits and cash reserves.
JOHN
KILLINGSWORTH: Exactly. Some of these decisions related
to variable costs are fairly straightforward: ‘We may have to hire fewer
interns this summer.’ So, your work-in-progress and your backlog come into play
significantly, and the complexities there can be significant.
Because it’s easier to improve liquidity by making adjustments to personnel than other fixed assets, many companies take the easy path to solving the immediate problem. You need to think through what will happen if projects are canceled. How will you adjust your fixed costs? Will you work to maintain your best employees regardless of the impact on profits?
What are the long-term adjustments that you’ll make if the recession is lengthy? Let’s say you’ve recently acquired and allocated a significant amount of equipment for projects that, unfortunately, end up being canceled outright or put on indefinite hold. Suddenly, these fixed assets are no longer associated with project revenue. So instead of being able to associate that expense as a direct cost to a job, they’re now part of your overhead.
BRUCE
ORR: I suppose a lot of it will depend on how that
backlog looks. If you’re already in preconstruction on a good portion of
projects, you may feel OK about maintaining more of your fixed costs?
JOHN
KILLINGSWORTH: Correct. But if your backlog to your
revenue is weaker, you should be more conservative in terms of how you step
up—if at all—your fixed costs. Clearly, contractors need to be paying close
attention to what’s happening with the global economy and, of course, the
trajectory of the virus. Depending on what happens, that backlog could
disappear pretty quickly as project funding, both commercial and governmental,
dries up.
BRUCE
ORR: Are there some other things that contractors
should be keeping in mind?
JOHN
KILLINGSWORTH: It’s important to remember that you can
still be profitable at a lower revenue rate. The key is to get ahead of the
situation. It’s not uncommon for contractors to say to themselves, essentially,
‘All we need to do is break even and get through this; we’re not making any
cuts.’ Unfortunately, though, when your revenues are declining, you cannot
maintain those fixed costs without significant impacts on your available cash.
And if your liquidity nosedives, then when you come out of the recession you
will be unable to bond projects in the same way as you could prior to the
recession. Your cash position has been compromised, and therefore your bonding
capacity is diminished.
BRUCE
ORR: In that case, you’d have high capacity in terms
of personnel but insufficient liquidity to put those resources to good use.
JOHN
KILLINGSWORTH: Right. That’s why you need to run those
analytics. Try to understand the relationship between maintaining those fixed
costs and the impact on profitability. A good manager feels very deeply
personal about their employees and recognizes that there is a balance between
maintaining profits and reducing personnel costs. So use analytics to inform
that decision, to know what the true costs are. Regardless of how you function,
you have to strive for some level of profitability. All it takes is about a
year without typical profit margins for a good, strong company to substantially
weaken. So have a well-informed strategy for entering the recession and, more
importantly, coming out of the recession.
BRUCE
ORR: Any other tips or recommendations?
JOHN KILLINGSWORTH: A final point I would make is that your
emphasis as a contractor really matters during economic downturns and should
figure prominently in your strategy. For example, companies that are already
established in diverse markets often can weather the storm better. That’s
because they’re able to shift resources to those sectors in which they have
competency that are still in demand. Likewise, certain highly specialized
contractors may perform better due to continued demand for their services.
For example, in the United States, it is clear that healthcare must change. Every hospital administrator here is now thinking about how to increase capacity and be better prepared for the next catastrophe. That means making physical changes—construction projects—that can translate into work for specialized contractors in healthcare and medicine.
Economic downturns typically fuel demand for multifamily housing, an
already robust trend due to the Millennial and Gen Z preference for urban
lifestyles. Likewise, online delivery of groceries and other material goods is
in overdrive right now. There is widespread speculation that, after this event,
consumer behavior will be permanently changed. As a result, I could certainly
see continued, rapid expansion of industrial warehouses and distribution
centers, as well as data centers, globally.
I have confidence that diverse and specialized contractors alike will
pursue such opportunities, which are necessary for safer and more secure
communities and societies.
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