The engineering and construction (E&C) sector is happily swimming in a sea of opportunity right now. On the surface, success looks quite uniform—new hires, new offices, bigger jobs, higher revenues and higher margins. But what’s really happening below the surface? If and when the tide goes out, as Warren Buffett likes to say, will some contractors be standing more proudly than others?

During this broad expansionary cycle for United States E&C markets, operating profit margins of nonresidential construction firms analyzed by FMI grew at a 17.3% compound annual growth rate (CAGR) between 2013 and 2017. This breaks down to 24.7% for general contractors, 5.9% for specialty trade contractors and 15.3% for heavy/civil contractors.

Cumulatively, operating profit margins have nearly doubled over the last four years. Those profits can be plowed back into the company to invest in people, technologies, equipment and more. Done right, these investments can yield improved competitive positioning in the long term.

Knowing that the economy is cyclical, the odds that a downturn—no matter how slight or incidental—is lurking around the corner are very good right now. Here are four key areas that should be at the forefront of every E&C leader’s agenda, even (and especially) when times are good.

1. Operations

Broad-based margin expansion can mask many operational flaws. Margin fade from 5% to 4% is much more palatable than margin fade from 1% to 0%, but any reduction should be cause for concern. Even if a project has an acceptable profit, did the project perform as estimated? Were there opportunities to potentially improve gross margin? To understand true project performance, contractors need extreme clarity and transparency on project controls, including schedule, budget, labor productivity, equipment use and more. Project controls must also be repeatable and scalable, particularly as contractors grow and onboard new talent.

2. Risk management

More contractors go bankrupt in a boom cycle than in a downturn, primarily due to overaggressive growth and poor cash flow management. Rapid growth can also result in contractors’ management and manpower resources being stretched thin. Construction companies that have grown over the last few years should ask themselves:

• Have we maintained a healthy balance sheet?
• Have we properly managed cash flow?
• Have we adequately staffed projects?
• If so, could we say the same about our subcontractor partners or our general contractor customers?

Now, more than ever, contractors need tight prequalification controls and go/no-go processes around project, customer and subcontractor selections. It’s also prudent for general contractors to monitor and manage their risk exposure associated with one particular subcontractor or general contractor.

3. People

To manage growth, many contractors have hired early-career employees with relatively little experience and skill. Put simply, not all hires end up being good hires. Invariably, under-performers slip through the cracks of even the best recruiting filters. Unfortunately, many contractors struggle to cull the herd. Having fact-based insights into employees’ performance will give contractors confidence and reduce legal risks if and when they have to face organizational belt-tightening. If a contractor has a mixed bag of talent and lack of clarity on individual performance, it may be time to take a step back and assess and improve talent development strategies.

4. Rewards

Contractors facing pressing staffing needs have probably had to pay more than they would like, or possibly “top-of-market” pay, to recruit certain individuals. On the other end of the spectrum, contractors may have experienced regrettable losses of employees who left the business for higher pay. Sometimes, those departing individuals are dismissed as lacking loyalty or being “just in it for the money.” High fixed (base wages) and low variable (bonus) compensation are appealing to some contractors today because they instill a sense of financial predictability in employees and can mitigate handwringing at bonus time. However, a compensation philosophy that dictates high base wages also increases fixed overhead and the overall risk posture of a construction company. Under any approach, an important question to ask is: Will the compensation philosophy mitigate or exacerbate profitability challenges in a year of poor performance? This is an important question to ask if and when the tide turns toward a period of economic uncertainty.

The Time to Act is Now

Contractors are often reluctant to focus their attention on internal improvements to their businesses in a robust market. However, now may be precisely the opportune time for them to take inventory of their company’s strengths and opportunities for improvement.

For starters, challenge the executive committee to provide a candid assessment of the current state of the business relative to the four areas highlighted in this article: operations, risk management, people and rewards. Fine tune these areas today to position the business for long-term success.

For more information, visit www.fminet.com/fmi-quarterly/article/2019/03/how-to-focus-on-performance-in-any-market-conditions.