{"id":25547,"date":"2024-04-22T13:40:43","date_gmt":"2024-04-22T20:40:43","guid":{"rendered":"https:\/\/essential.construction\/news\/the-unthinkable-has-happened-how-should-contractors-respond\/"},"modified":"2024-04-22T13:40:45","modified_gmt":"2024-04-22T20:40:45","slug":"the-unthinkable-has-happened-how-should-contractors-respond","status":"publish","type":"post","link":"https:\/\/essential.construction\/news\/the-unthinkable-has-happened-how-should-contractors-respond\/","title":{"rendered":"The Unthinkable Has Happened. How Should Contractors Respond?"},"content":{"rendered":"

\"-\"<\/a>
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Any construction veteran expects the economy to contract and expand. However, the global pandemic presents contractors with a challenge unlike any in recent memory.<\/strong><\/p>\n

<\/p>\n

\n
\"John
Dr. John Killingsworth<\/figcaption><\/figure>\n<\/div>\n

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<\/a> who has conducted extensive research on how contractors can weather economic downturns.<\/p>\n

BRUCE
\nORR:<\/strong> John, let\u2019s say you\u2019re in IT or are a c-suite
\nexecutive at a contracting firm. This event has occurred. What are some of the
\nquestions you should be asking right now?<\/p>\n

JOHN
\nKILLINGSWORTH:<\/strong> For starters, we have to acknowledge that
\nthe uncertainties are so tremendous that many contractors have no choice but to
\nbe reactive in the short term. They\u2019re literally not sure whether particular
\njob sites will be open or closed tomorrow or whether they\u2019ll go to work next
\nweek. They\u2019re also looking at predictions\u2014from highly qualified statisticians,
\npublic health officials and others\u2014that are just all over the map due to the
\nlimited nature of the data we have at hand.<\/p>\n

Nonetheless, as this crisis continues it will
\nbe increasingly important for contractors to dive into their long-term
\nstrategies. In particular, they need to scrutinize the fixed costs associated
\nwith everything from personnel to PPE (property, plant and equipment). Hard
\nchoices may be required. For example, it\u2019s natural to want to hold onto your
\nbest people in the face of a downturn. We all know how difficult and expensive
\nit is to replace key personnel later when the economy recovers.<\/p>\n

However, you need to quantify how much your
\nmargin\u2014and, in turn, your liquidity\u2014will suffer if you maintain fixed costs at
\na time when revenues are declining. Now is the time to take advantage of
\nanalytic tools to consider the correlations and trends with all of these
\nvariables. It\u2019s valuable to play out scenarios such as: \u2018What happens if these
\nprojects in our backlog fail to materialize in the short term?\u2019 or \u2018Here\u2019s how
\nour margins and liquidity could be affected if we retain 100, 90 or 80 percent
\nof our overhead personnel.\u2019<\/p>\n

BRUCE
\nORR:<\/strong> You want to keep as many of those proven project
\nmanagers, estimators, marketers and accountants as you can without<\/em> hitting that point where you\u2019re not meeting your breakeven
\nvolume, right? You\u2019ve got to protect your profits and cash reserves.<\/p>\n

JOHN
\nKILLINGSWORTH:<\/strong> Exactly. Some of these decisions related
\nto variable costs are fairly straightforward: \u2018We may have to hire fewer
\ninterns this summer.\u2019 So, your work-in-progress and your backlog come into play
\nsignificantly, and the complexities there can be significant.<\/p>\n

Because it\u2019s 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?\u00a0<\/p>\n

What are the long-term adjustments that you\u2019ll make if the recession is lengthy? Let\u2019s say you\u2019ve 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\u2019re now part of your overhead.<\/p>\n

BRUCE
\nORR:<\/strong> I suppose a lot of it will depend on how that
\nbacklog looks. If you\u2019re already in preconstruction on a good portion of
\nprojects, you may feel OK about maintaining more of your fixed costs?<\/p>\n

JOHN
\nKILLINGSWORTH:<\/strong> Correct. But if your backlog to your
\nrevenue is weaker, you should be more conservative in terms of how you step
\nup\u2014if at all\u2014your fixed costs. Clearly, contractors need to be paying close
\nattention to what\u2019s happening with the global economy and, of course, the
\ntrajectory of the virus. Depending on what happens, that backlog could
\ndisappear pretty quickly as project funding, both commercial and governmental,
\ndries up.<\/p>\n

BRUCE
\nORR:<\/strong> Are there some other things that contractors
\nshould be keeping in mind?<\/p>\n

JOHN
\nKILLINGSWORTH:<\/strong> It\u2019s important to remember that you can
\nstill be profitable at a lower revenue rate. The key is to get ahead of the
\nsituation. It\u2019s not uncommon for contractors to say to themselves, essentially,
\n\u2018All we need to do is break even and get through this; we\u2019re not making any
\ncuts.\u2019 Unfortunately, though, when your revenues are declining, you cannot
\nmaintain those fixed costs without significant impacts on your available cash.
\nAnd if your liquidity nosedives, then when you come out of the recession you
\nwill be unable to bond projects in the same way as you could prior to the
\nrecession. Your cash position has been compromised, and therefore your bonding
\ncapacity is diminished.<\/p>\n

\"plan\"plan<\/figure>\n

BRUCE
\nORR:<\/strong> In that case, you\u2019d have high capacity in terms
\nof personnel but insufficient liquidity to put those resources to good use.<\/p>\n

JOHN
\nKILLINGSWORTH:<\/strong> Right. That\u2019s why you need to run those
\nanalytics. Try to understand the relationship between maintaining those fixed
\ncosts and the impact on profitability. A good manager feels very deeply
\npersonal about their employees and recognizes that there is a balance between
\nmaintaining profits and reducing personnel costs. So use analytics to inform
\nthat decision, to know what the true costs are. Regardless of how you function,
\nyou have to strive for some level of profitability. All it takes is about a
\nyear without typical profit margins for a good, strong company to substantially
\nweaken. So have a well-informed strategy for entering the recession and, more
\nimportantly, coming out of the recession.<\/p>\n

BRUCE
\nORR:<\/strong> Any other tips or recommendations?<\/p>\n

JOHN KILLINGSWORTH:<\/strong>\u00a0<\/strong>A final point I would make is\u00a0that your
\nemphasis as a contractor really matters during economic downturns and should
\nfigure prominently in your strategy. For example, companies that are already
\nestablished in diverse markets often can weather the storm better. That\u2019s
\nbecause they\u2019re able to shift resources to those sectors in which they have
\ncompetency that are still in demand. Likewise, certain highly specialized
\ncontractors may perform better due to continued demand for their services.<\/p>\n

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\u2014construction projects\u2014that can translate into work for specialized contractors in healthcare and medicine.<\/p>\n

Economic downturns typically fuel demand for multifamily housing, an
\nalready robust trend due to the Millennial and Gen Z preference for urban
\nlifestyles. Likewise, online delivery of groceries and other material goods is
\nin overdrive right now. There is widespread speculation that, after this event,
\nconsumer behavior will be permanently changed. As a result, I could certainly
\nsee continued, rapid expansion of industrial warehouses and distribution
\ncenters, as well as data centers, globally.<\/p>\n

I have confidence that diverse and specialized contractors alike will
\npursue such opportunities, which are necessary for safer and more secure
\ncommunities and societies.<\/p>\n

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