Bigger They Are, Harder They Fall
The well-known construction industry consulting and research firm, FMI Corp., recently published a scholarly analysis titled, “Why Contractors Fail: A Causal Analysis of Large Contractor Bankruptcies.” Among the examples cited were a couple of mechanical contracting entities, Encompass Services and JWP. The FMI study can be obtained by contacting them via www.fminet.com and is worthwhile reading, but if you don’t want to invest the time I’ll briefly summarize its content as follows:
- Construction is an inherently risky business, and the people who get into it are risk takers by nature.
- Contractors are susceptible to financial difficulties due to high leverage. Leverage in this context pertains not necessarily to debt, but also to the fact that the nature of the business allows contractors to do a lot of business with little equity. This means when a big project turns bad, it can drive them into a hole from which there is no escape.
- Workforce issues present a constant conundrum. Skilled field labor and project management are in short supply. Once obtained, the pressure is great to keep booking work even at little or no profit to keep them employed.
- The hard bid process allows little margin for error in cost estimating and marshalling of resources.
- Construction is a notoriously cyclical business that rises and falls faster than the overall economy. Contractors fluctuate between being over-committed and scrambling for work to keep people busy.
- Construction is hyper-competitive.
- Construction contractors have little ability to create demand for their services. They are largely at the mercy of market conditions. Likewise, project timing is dictated by owners’ schedules, making it difficult for contractors to plan and manage resources.
- Most construction executives come from a project management rather than a business background. They are good at building things but not at managing finances.
That is the question of what is the optimal size for a mechanical construction company? People who have followed this magazine’s Pipe Trades Giants issue over the years can’t help but notice the abrupt collapse of many of the firms that have made it to the top or near the top. (EMCOR has enjoyed a long run as the industry’s largest firm and seems an exception to the rule so far; check out this month's cover story here.)
The 1990s efforts by roll-up consolidators and utilities to create national or regional mechanical contracting powerhouses mostly met with miserable failure. Bigness seems so jinxed, it makes some people wonder why any contractor would even want to grow so large.
The biggest reason, no doubt, is that while there’s often a negative correlation between size and profitability, volume does put a lot of money in a lot of pockets at least for a while. Owners and managers who run the biggest companies tend to enjoy more pay, perks and prestige than smaller contractors and their employees.
Another reason probably has to do with a factor cited by the FMI study as contributing to large company failures - contractors are at the mercy of market conditions. Sometimes growth is not planned, but happens as a result of a booming market and contractors trying to make hay while the sun shines. As volume increases, so does bonding capacity, borrowing ability and employment opportunities. This leads to a chain reaction enabling companies to become even larger. It becomes hard to stop the compounding growth, even if you were so inclined.
Still ... the vast majority of mechanical contracting done in this country is performed by local or regional companies. They have formidable advantages of market knowledge, labor access, business relationships and community ties. Occasionally a large mechanical contractor will move out of its turf and joint venture a project with a local company, bringing to bear its bonding capacity, buying clout and other economies of scale while benefiting from the local advantages just cited. This is probably a wiser way for mechanical contractors to pursue work far afield than trying to stretch their own resources.
The question originally posed remains unanswered: What’s the optimal size for a mechanical contracting company? If any of you have opinions about this, I’d love to hear them and share them with our readers. Contact me at email@example.com.