Last week, Engineering News Record released its 2012 list of the Top 500 U.S. Design Firms. As usual, ENR did a fabulous job of pinpointing top-of-mind issues in the sector while highlighting driving trends likely to impact engineering firms in the near-term. While total sector revenue has not yet recovered to its 2008 level (and likely won’t until 2015), it was refreshing to see top-line revenue growth for the first time in 3 years. This data echoes broader professional services sector data published by SPI Research earlier this year.
After reading the article in some detail, and looking closely at some of the insightful quotes from firm leaders around the country, I see three major trends that leaders of any engineering firm should be monitoring quite closely and minding how to respond.
1. Financing of Projects.
I’ll be straightforward in saying I don’t think this is a positive trend in any way. Participatory financing of projects is a very dangerous trend and one you should analyze very cautiously before choosing to participate. Here’s the thing, large banks have thousands of analysts who’s very job is to analyze risk all day every day. Despite that 80% of the largest ones found themselves on the brink of financial collapse just three years ago because they grossly underestimated their exposure to risk within the consumer housing market. What makes an A/E firm think they could do better in the commercial or public markets? In my opinion, very few, if any, A/E firms have the financial skills required to assess the systemic and macro risks associated with participatory financing. If you’re thinking about entering this arena, do yourself a favor — close your firm and start a bank. At least then you can allocate your funds towards hiring the financial analysts and risk managers you need to have a reasonable opportunity for success in your new endeavor.
2. The Commoditization of Design
ENR notes a growing feeling among firm leaders that design is becoming commoditized. “One of the biggest frustrations among design firms is the increasingly held view that design is just a commodity.” While there are a lot of macro issues driving this trend, the primary explanation is simple supply and demand. The supply of competent, qualified designers and engineers exceeds the demand for their services. I delved into this trend deeply in my January article, The Supply of Professional Services Exceeds Demand. This issue is not going away. No manner of economic recovery will change it. If anything this problem is only going to exacerbate itself over time. While firms can continue to bemoan this trend and the negative effects it has on the designer’s ability to create innovative structures and solutions, the fact of the matter is that the ability to produce great work does not differentiate an A/E firm. The only way to positively respond to this trend is to build deep, meaningful specialized expertise. Clients will continue to spend above average fees with A/E firms who demonstrate deep expertise solving their specific business problems. The only response to commoditization is better positioning. For more thoughts on this topic read my March article, Three Proven Ways to Position a Professional Services Firm.
3. Industry Consolidation.
Consolidation is really an extension of the supply/demand issue I outlined above. When supply exceeds demand, it only makes sense that firms would look to merge or roll up smaller firms. For midsize firms this is all the more reason to deal with the forces driving commoditization as soon as possible. A generalist design or engineering practice, when forced to sell will be lucky to attract many, or possibly any, interested buyers. Dean Oskvig, CEO of the Black & Veatch energy group puts it best in the article when he states, “There will be acquisitions for scope and skill, rather than scale. In this industry, an acquisition to simply make a bigger version of your company very seldom creates value.” When a firm acquires another firm for economies of scope this means it is acquiring the firm’s unique expertise. This expertise is perceived to be both narrow and highly valuable to the acquiring firm. A well positioned, highly focused firm can often find itself having many potential high value suitors when the time comes for firm leadership to exit. So, if the commoditization of design isn’t forcing firms to get serious about positioning, hopefully the opportunity for a higher exit valuation might.
Thanks to the folks at Engineering News Record for another thorough analysis of the sector.
Engineering News Record. “The Top 500 Design Firms Begin To Rise Above Economic Woes” by Gary J. Tulacz. April 23, 2012.