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MEGATRENDS AFFECTING THE CONSTRUCTION INDUSTRY Shelley Hartnett Megatrends through the last half of the 1 990s and early 21 st century are already apparent and gaining momentum. Many of these factors have become major influences. Others have only recently surfaced and their direction is less clear. The value chain in construction is being clarified. Results are beginning to show that value creation is clearly shifting toward both the front end (development, financing, design) and the back end (operate, maintain, renovate), while the central component-construction-is being driven to a commodity status. Commodities are purchased solely on price. Service and maintenance are the emerging capabilities for value creation among traditional construction firms. Service, maintenance and renovation comprise well over 50 percent of the total industry revenue now and are seen as primary contributors to added value for customers and users of construction services. Life cycle costing, including increased use of risk management techniques, continues to reinforce the shift in value creation away from pure construction. Thus, value is being built through several alternative combinations of services, not just from construction alone. Specialization and niche focus continue to provide advantage for those firms that have committed to developing truly distinctive competencies in specific areas. Both delivery capabilities and market focus are providing leverageable advantages. Major users of construction, both public and private, are turning to the construction industry providers for delivery of non-traditional services. Often these take the form of outsourced services. Specialization and niche focus now allow the service provider to select those services of value for the user more effectively. Evolving project delivery methods and attendant processes will continue. Owners' increased sophistication and desire for "better, faster, safer, cheaper" are causing major evolutionary forces to redefine work procurement and delivery methods. Partnering continues to build the bases for improved processes through collaboration, cooperation and innovation. Design-build is only one of the many processes that is redefining the traditional delivery methods. All other project delivery methods are also subject to the revolutionary pressures created by a better-informed marketplace. In fact, owner involvement is deemed to be the primary factor driving the rapid evolution of alternative project delivery methods and processes. Informed repeat users of construction services are participating in the definition of these new venues. Collaboration among all parties involved in the process (design, construct, operate and maintain) is contributing to the "new" set of skills required to participate in certain markets. Prequalification criteria are becoming more experienced-based. Competition will continue to increase. The construction marketplace in the U.S. is relatively mature, and the number of firms entering the marketplace to deliver these services continues to increase. Even the consolidations, which are combining many of the larger and/or more profitable firms, are not reducing the pressure of "better, faster, safer, cheaper." Increased competencies are improving results for the more efficient. The companies that remain undifferentiated (the excess capacity) continue to compete on price, attempting to grow in a mature market. Employee ownership is a major longer-term trend. Employee retention and the exit strategies for many of today's construction company owners are converging to deliver companies with different ownership bases and different leadership and management styles from those operating in the last half of the twentieth century. Today's current tax laws make ESOPs an attractive component of an exit strategy for owners of closely held companies. The lapse in hiring among construction companies in the late 1980's and early 1990s has created a scarcity of potential leaders for those newly transitioned firms. MBAs entering the industry are technically competent but leadership challenged. So while the tools and techniques exist to convert ownership in many closely held firms rapidly and efficiently, experienced leaders are only beginning to evolve. This area, alone, represents a major opportunity. The operating structures of the firm are being shaped by another accelerating trend. Greater employee participation in management, leadership and involvement in strategic direction of the firm is increasing. The shortage of experienced project and senior managers is raising pressure for devising new organizational structures geared to increase employee participation and involvement. Smaller, focused business units will be required to achieve the effectiveness and agility desired by more informed customers. Thus, "agile, mobile and hostile" organizations are being created as one response to "better, faster, safer, cheaper" demands. These focused business unit structures, by their very design, require the participant to be actively involved. These activities provide the glue for keeping these key people in the firm. Longer term, this behavior will reinforce the move toward more employee ownership for retention and compensation. Strategic alliances will continue to evolve and increase in effectiveness. The continued pressures exerted by a free marketplace will drive the search for improved performance across all industry sectors. Solutions will be sought to provide sustainable long-term advantage. This does not mean that pressures to control costs will go away. However, it does mean that the past successes realized from continuous improvement processes, which have become effectively internalized, will continue to provide value and are demonstrated selection criteria for firms interested in improving overall supply-chain performance. As in many other major trends, the construction services user or facility owner is becoming the primary driver for procurement and delivery methods. Thus owner leadership will be realized in: · Research and development · Technology application · Project development and ownership The ultimate consumer of each built environment is the owner. With the improved awareness and experience of repeat users, the owners' mantra of "faster, better, safer, cheaper" will be heard more loudly on each new or renovated project. The ultimate trend is individually customized services. Customers will receive individually tailored products/services based upon their own requirements. That does not mean that the entire industry will become a monolithic system capable of delivering totally customized products/services on demand. It does mean that the trend is toward more individualized selection decisions and informed trade-offs. Value chains will be created by multiple self-selections by all longer-term participants in each supply chain. Informed owners, both public and private, will continue to experiment with new or revised procurement and delivery systems. More valuable information, benchmarks and performance metrics will enable the user and provider of construction services to continue to improve performance by self-evaluation and comparison to "best in class." All procurement and delivery methods will continue to be scrutinized and enhanced. Individual supply chains will demonstrate the effectiveness of the overall value creation process, and construction will begin to be seen as a strategic process among informed participants, not as an isolated interruption. Viewing the built environment as a strategic asset with long-term advantage represents a major breakthrough perspective for the entire marketplace. ARCHITECTS /ENGINEERS /DESIGNERS Continuing consolidation toward a two-tiered market. Industry consolidation is accelerating, especially with the availability of capital in the markets. Large design firms keep getting larger. Smaller design firms continue to specialize in niche practices and markets, such as health care or transportation. The dichotomy of the two tiers, large firms with revenues over $50 million and small firms with revenues less than $20 million, leads to a split of the marketplace. Mid-size firms continue to feel pressure to join the consolidation movement or develop alternative strategies to compete. Growth through increasing acquisition activity. The capital markets are making more money available for investment and speculation, and the frenzy in the stock markets makes the prospect of becoming a bigger entity more attractive. Similarly, the idea of organic growth to many companies is just not a fast-paced or as feasible in today's labor market. The easiest method of growth for these companies is through acquisition. It is noted, however, that the rate of acquisitions may decrease as business owners wait on the sidelines to see how the markets and success rates of mergers and acquisitions turn out. Rationalization of merger and acquisition activity. Recent studies indicate that half of E/A merger and acquisition transactions are considered failures, either through culture and environmental clashes or through fewer synergies achieved after the firms combine. In addition, some acquisition prices have become exceedingly high to justify some transactions due to the economic and labor issues surrounding the industry. Therefore, firms are taking a much closer look at the opportunities available to them going into a merger. Such scrutiny is necessary to ensure that the premiums paid, culture and fit, and experience and market base are truly best for the companies involved. Increased focus on larger transactions. More attention has been focused on larger firm transactions, as size and critical mass have become increasingly important to firms. Such mergers as Halliburton Company and Dresser Industries highlight this trend. Although there are more small companies making transactions, the firms paying higher premiums draw more attention and hype. Overall, average transaction sizes are increasing, as more firms realize the deal difficulty bears little relation to size. Increased design firm risk-taking in the delivery process. For years, design professionals have passed along project risk to contractors. However, as these contractors have become more intimate with and responsive to the owners and purchasers of construction services, design professionals have been relegated to a lesser role in the overall process. In an effort to enhance their role, many designers have responded by assuming more risk (e.g., lenient contracts, alternative program management and administration issues) with the anticipation of generating higher rewards. Convergence of design and construction. By 2005, about 50 percent of construction will be performed via design-build. Construction and design firms see a merging of resources as a means of becoming more competitive. Both construction companies and design firms to acquire the other to provide full in-house services to owners desiring to consolidate their project administration. It should be noted that construction companies have been more adept at acquiring and incorporating the design services into their operations than vice versa. Architecture segment lags behind engineering segment in responding to changed marketplace. The architectural profession has been, in general, more risk-averse in its practices, and hence has been slower to acclimate to the changing environment in the construction industry. Extraordinary battle for ordinary people. The market has been spectacular in design and construction, creating a significant demand for skilled labor. Companies nationwide are relentlessly attempting to keep up with the need for talent as construction markets continue to expand. Engineering/Architectural firms excel in marketing, lag in selling. Design professionals have fully recognized the need for marketing their services more aggressively. The selling of services, however, has been slower to get underway. Marketing requires increasing name recognition and awareness, while selling requires more proactive face-to-face interaction. Design professionals have typically been reactive, submitting proposals and mailing collateral material, but have not been as diligent in face-to-face persuasion of clients. De-commoditization: role models seen in sophisticated E & C, EPC, CM and GC firms. E/A firms have become viewed as a commodity - that is, serving contractors and owners and competitively bidding on projects rather than being selected based on quality and service. To counter this, design professionals are stepping forward to provide more services, differentiating themselves from other professionals as program management, contract administration, and engineer-procure-contractor onestop service providers. The more diverse and comprehensive offers the professional can provide, the more the client recognizes value for the services. Environmental market still active despite uncertainties. The environmental market has undergone many significant changes over the past several years, leaving many firms unsure if this is one market they should run toward or shy away from. A few firms believe that consolidation in the industry is inevitable (e.g., mergers of environmental majors Laidlaw Environmental Services and Safety-Kleen Corporation, or ATC Group Services' acquisition of ATEC Associates and Smith Technology Corporation). The "bugs and bunnies" services are undergoing continued scrutiny and liability from federal and state regulators, making performance of services more litigious. Some interest from outside investment capital. Lately, capital markets are amassing huge sums of money to invest in any and all industries - including professional service firms. The vast capital accumulation has heightened both buyer and seller interest so that high premiums are being paid, in some cases without regard for reason. Other, more elaborate, investments are occurring, including rollups of companies, IPOs and LBOs. Globalization. As the construction market continues its outstanding performance in the U.S., so does the market in the international arena. Despite economic woes in Asia, design and construction firms are proceeding with construction and investment in international markets. China, Europe and South America still see growth in their markets, a trend that will draw the highly capitalized designbuild and EPC firms to work in these countries. Cross-border mergers, acquisitions and joint ventures are viewed as simply creating an extension of their base of operations. Design professional role changes. As businesses have become more competitive in the market place, so too have design professionals. This is a change and, to some extent, a major challenge for many firms. It was not long ago that design professionals were revered for their creativity, not their business skills. These professionals had to become more business savvy, learning how to be better financial managers, marketers, sales-people and trainers. Today, these same firms have found that success does not just walk in the door - it must be sought and retained through superior performance and customer service. Designer-led design-build will continue to accelerate, led mostly by engineering firms. Alternative methods of taking the initiative and managing the risks are being explored, as more engineering firms see the need for an aggressive response to the changed market place. Engineering firms will accelerate their level of risk taking, including their approaches to delivery, cost control and contractual liability. The convergence of engineering and construction will continue its growth, as the trends of the large E&C firms work then way down through the midmarkets. By the numbers, architecture firms will find themselves increasingly relegated to a subordinate role in the construction process. Cumulative years of risk aversion, denial of industry changes, and a laggard status in the embrace of business issues will continue to exact a heavy toll on the profession. Exceptions will be found primarily within the larger firms and niche service firms. Finding and keeping talent will remain a strategic priority for most firms in 1998. While the overall design-construct economy will cool, workloads for the years ahead will still be strong. The firms that win here will be those that make extraordinary investments in truing, compensation and training programs. Direct selling and business development activity will overshadow marketing in relative importance. Most firms have marketing programs, but far fewer have sustained sales capabilities. Firms will increasingly see the need for getting someone close to the owner, as both contractors and designers engage in a direct sales battle to gain the owner's attention. An increasing number of design firms will recognize the de-commoditization strategies available through the study of sophisticated contracting firms. Having fought the commodity battle long ago, many of the large E&C, CM, and GC firms will provide worthwhile role models and strategies for engineering and architecture firms confronted with commodity fee pressures. BUILDING PRODUCTS MANUFACTURERS AND SUPPLIERS The obsession for top-line growth continues for many manufacturers with growth fueled both through organic growth and strategic acquisitions. This growth should continue through other North America acquisitions and joint ventures as well as offshore growth. The supply/distribution system as we know it will continue to change as consolidation occurs and manufacturers go directly to the end user. The role of the manufacturers' field sales force continues to change as customer profiles and support requirements change. A multi-tier sales structure will continue to evolve with an elite sales team focused on the mega-customer and a lower cost sales and customer support team in place to handle other customers and support the mega-customer. Electronic commerce is becoming commonplace throughout the distribution channel and will become even more so. The impact of this will benefit both the manufacturer and its channel partners with greater distribution efficiencies. This technology will be required by all parties just to play the game. Most manufacturers sell to fewer, larger customers and are concerned about the shift in power to these large customers. Manufacturers will re-evaluate and, in some cases, alter the selling-direct vs. selling-through distribution decision to change this balance of power. Roll-ups and IPOs within customer groups are a growing concern with building product manufacturers, particularly in the HVAC, electrical, roofing and insulation trades. These consolidations also help to shift the power away from the manufacturer and create tremendous uncertainty in the distribution channel. The good times of the past five years have fueled capacity expansions that will result in an excess capacity situation in many industry segments. This excess capacity will cause prices to soften as manufacturers fight to keep share when the market inevitably turns. Creating highly differentiated, value-added services continues to be a quest throughout the distribution channel. Manufacturers selling to distributors, retailers, dealers and contractors search for unique methods to build greater loyalty and to create exit barriers for their preferred customers. Look for more sophisticated shared knowledge networks provided by the manufacturer to enable customers to become more competitive and more of a strategic partner. GENERAL CONTRACTORS General contractors continue to look for ways to distinguish themselves from competitors. Two patterns are emerging. A smaller number are turning to increased self-performance in trades ranging from masonry to framing. A larger number seek differentiation through broader project management roles, including program management, design-build, and EPC. The design-build delivery method will continue to grow and will become the preferred method of procurement. Manpower issues. Contractors continue to face more challenges in finding qualified craft workers. Creative hiring and recruiting practices are being used to find new hires within the industry. Many contractors are paying "bounties" to current employees who refer new hires who accept a position and stay with the company some minimum time. There will be an increasing opportunity for local contractors to create alliances with large national and international contractors on local projects, particularly in the industrial sector. Multiskilling. The construction Industry Institute (CII) has conducted research on the concept of "multiskilling". Multiskilling involves teaching open-shop craft workers a new trade, allowing them to perform multiple tasks on the same project. This reduces the total labor requirements on a specific project and provides employment continuity for the workers. Projects that utilized the multiskilling concept experienced less rework and significantly reduced hiring requirements. Foreman involvement. The most progressive contractors are involving their foremen earlier in the pre-construction phase and sometimes in the pre-bid phase to provide input into project bidding and planning. This "open book" policy has become the norm for the most successful contractors, as they openly share estimated and actual production feedback with foremen. Technology in the field. The move to improve communication and reduce paperwork in the field has some contractors experimenting with hand-held technology to enter time and cost code information. In addition, more and more foremen are using laptop computers to enter daily production information and track performance against the estimate. With unit-priced work, some foremen are using computers to enter daily time and production information, with the output being a crew profit-and-loss statement for the crew on a daily basis. Planning. The "leading edge" contractors are committed to both pre-job planning and short-interval planning in the field. Some contractors are measuring the number and percent of emergency, last minute calls into their shop as an indicator of quality field planning. Measurement. Contractors are beginning to measure more than just down-stream results, such as job costs and productivity. More focus is being placed on measuring the correct behaviors and processes that lead to improved productivity. These critical processes include pre-job planning, short-interval planning, and daily planning and goal setting at the crew level. If compliance to these critical processes is measured and reinforced, the result is improved productivity. Capacity and skilled labor. Pre-engineered steel building contractors will face both capacity limitations from steel manufacturers and skilled labor shortages. Expect peak season shortages. Strong demand is producing more sole-source contracts and high profits for those contractors willing to be selective in their projects. HEAVY/HIGHWAY CONTRACTORS State DOTs will increase their use of performance contracts such as those used in Europe and will continue experimentation with new asphalt specifications and mix designs. The bridge reconstruction market is still huge, but contractors struggle to make money in the face of enormous concealed risks. Specialization will increase. Failure to invest in high-tech maintenance facilities and equipment means that highway contractors are losing skilled mechanics to commercial enterprises. Reluctance to invest significant dollars in indirect costs of the business also means that the industry will be less attractive to candidates for this vital skilled-labor arena. FMI Corporation serves as management consultants to the construction industry. For more information on the issues discussed in this article or for FMI services, contact Shelley Hartnett at (303) 377-4740. Return to the List of Articles Return to the Association for Project Managers Main Page |
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