Speculation about a recession is running high, with some calling for construction contractors to start preparing for a slump that could begin any day and last well into 2023. But what should companies do if they want to heed this advice?

Newly published academic research offers a roadmap by highlighting some of the most effective strategies for preparing for and coping with an economic crunch, based on nationwide research that elicited responses from 61 construction financial officers, CPAs and sureties based in the United States.

The lead author of the research,“U.S. Construction Industry Managerial Strategies for Economic Recession and Recovery: A Delphi Study,” Manideep Tummalapudi, is an assistant professor of construction management at California State University, Fresno.

Tummalapudi and his coauthors investigated construction economic and financial experts with an average of 25 years of experience to rank a total of 40 potential strategies. Having experienced economic downturns before, these industry veterans were well-positioned to judge the effectiveness of different approaches to preparing for or coping with economic volatility.

Finding consensus

The research was conducted in phases beginning in 2019. In reaching out to construction final experts, CPAs and sureties all over the United States, Tummalapudi’s goal was to produce “a roadmap of economic, managerial and financial strategies that can be implemented by construction companies to improve their financial health during different economic cycles.”

Initially, the researchers worked with the construction experts to identify more than 65 strategies that had helped them successfully navigate previous recessions. These fell into six basic categories:

1. organizational and project management;
2. direct-cost;
3. overhead;
4. financial;
5. preconstruction and marketing; and
6. efficiency.

The same experts used a 100-point scale to rate these recession strategies. They achieved consensus on 41 and classified as either “highly effective” (nine strategies) or “moderately effective” (32 strategies). For a strategy to count as highly effective, at least 80% needed to give it a score of 80 or higher. In addition, the experts could flesh out numerical ratings by submitting written remarks.

Highly Effective Strategies

The nine strategy descriptions that received that “highly effective” ranking fell into three categories: organizational and project management, overhead and financial. In the first of those three categories, the strategies rated as highly effective were: “Use previous successful planning to design a sound business financial plan focused on cash flow and operational efficiency” (mean score: 85.7) and “The company should always be looking for sound, more efficient, more profitable practices and strategies” (86.9).

In the overhead category, the two strategies earning the highest designation were: “Prior to and during the recession, build a company culture to reassure employees they are valued despite cuts” (90) and “If there are sacrifices to be made (i.e., pay, bonuses, staffing, etc.) during a recession, the owners of the company should participate to the full extent that they ask their employees to participate” (88.7).

Cash reigns supreme

The financial category had the largest number of highly effective strategies—a total of five. They included the following.

1. “Establish strong cash reserves prior to the economic downturn. Retain profit in the company during good times; it helps the firm survive during downturn times. Retain capital to support the business during a downturn.” (93.4)
2. “Focus on cash flow.” (93.4)
3. “During the recession, maintain a healthy balance sheet with strong liquidity, sufficient equity, strong working capital and manageable debt load.” (93.8)
4. “During the recession, focus on profits, not volume. Know your breakeven point continually and generate bottom-line profit.” (90.9)
5. “Have a bank line of credit established and do what is necessary to maintain it in good standing with the bank.” (89)

The CPAs, financial officers and sureties were nearly unanimous on the importance of retaining profits during good times to cover salaries and other operational costs when the economy tanks.

Other advice included maintaining access to a bank line of credit and limiting indebtedness: “A balance sheet with limited debt, ability to restructure loans and a strong cash position allows for greater flexibility” during downturns, one respondent observed. Earlier research by Tummalapudi also showed that surety bonding companies focus disproportionately on financial stability when choosing whether to underwrite projects. And, of course, a strong cash position helps companies recover faster.

But several of the highest-rated strategies centered on strengthening and maintaining ties with owners, bankers, sureties, CPAs, vendors, customers and subcontractors. One financial officer pointed to the role of company culture in retaining valued employees during tough times. For their part, the researchers encouraged contractors to engage in “honest, forthright discussions with bankers, CPAs, lawyers and surety agents … hiding true financial conditions can damage those relationships.”

Context matters

While the nine highly effective strategies elicited the broadest consensus, differences of opinion related to contractors’ varying needs and perspectives could account for the moderately effective rating of the remaining 31 strategies.

Indeed, some of those moderately effective strategies could be workable options depending on the contractor’s size, financial resources, cash position and other fundamentals.

An estimated 92% of the 850,000-plus U.S. construction companies have 19 or fewer employees and annual revenues of less than $36 million, according to the paper. But larger construction firms that bring in annual revenues of at least $200 million tend to be more resilient, the researchers note. Greater capital reserves and access might also allow these larger companies to avoid recession strategies with costly downsides, such as bidding on low-profit jobs.

As explained in the paper, when contractors drop fees to “buy work” in this way, the goal tends to be to maintain cash flow, keep projects rolling and retain personnel. Some contractors may even try to “find” that missed profit by submitting more change orders.

While Tummalapudi and his coauthors caution that taking low-profit jobs “creates chaos and has significant repercussions,” some of the respondents appeared to be open to this approach. Indeed, one advised contractors to “reduce profit margins as necessary to maintain a reasonable backlog of work.”

In response, a surety participant commented that “buying work is a precursor to failure; it never works.” Based on the ratings, though, the 61 respondents were divided on this point: Only a slight majority, 52.6%, down-rated the idea of pursuing low-margin work to stay busy.

This divided opinion makes sense, given that the respondents hailed from companies of all types and sizes. Similarly, another common strategy during downturns—laying people off—may be more avoidable for some firms than others. As observed in the paper, layoffs can help companies survive but tend to be costly over the long term. Thousands of laid-off construction experts left the industry for good during the Great Recession and its aftermath, a contributing factor in historic labor shortfalls that continue to this day.

Additional “moderately effective” strategies covered in the paper related to areas such as:

• adopting Lean construction;
• selling underused assets;
• restructuring equipment and capital loans to turn equity into cash and reduce the burden on monthly equipment debt payments;
• seeking advice from mentors;
• training employees and managers to watch expenses;
• ramping up supply-chain and operating efficiency;
• retaining talent by formulating creative incentive and compensation plans, such as reducing the base wage and increasing bonuses;
• cutting back on non-essential expenses such as travel, meals or consulting; and
• confirming all financing on private jobs prior to signing contracts.

The right mix

In their conclusion, the authors offer some additional advice, such as paying more attention to economic trends and principles and avoiding situations that could overextend the company’s capacity.

On this latter point, many contractors responded to the Great Recession by trying to diversify and pursue wholly new markets and verticals. But doing this during a downturn, the researchers contend, “is risky and often leads to failures … the time to diversify markets is during sustained growth periods and while the company has cash reserves to invest in the costly learning stage.”

Ideally, the U.S. construction industry will be able to dodge a severe or protracted recession in coming months—along with the onerous risks that can include, as noted in the paper, “cash-flow problems, legal disputes, low-profit margins and marketing difficulties.”

But as construction veterans know, the prudent course is to prepare for a downturn—a message that is particularly important for newer companies that have never been through a recession. As Tummalapudi and his colleagues see it, all construction contractors can bolster their odds of surviving and thriving by “adopting a mix of effective strategies that mitigate the risks associated with economic cycles.”

This article is the first in a four-part series offering strategies for preparing a construction business for the upcoming economic downturn.