Masonry Magazine June 1997 Page. 16
The conclusion is clear: construction is considerably more risky for an investor than virtually any other industry, yet the returns are below those available to investors in other types of businesses. The risk vs. reward relationship is clearly out of balance in the U.S. construction industry. So what is wrong?
Competition is the reason most commonly given for low profits and low returns to shareholders in construction. The U.S. construction capacity is significantly greater than the demand for construction services. Since 1967, the volume of non-residential construction in the U.S. has increased a total of 33.0 percent in real terms while the number of contractors has increased 140 percent. This supply and demand imbalance caused prices to decline and profits to decline (or disappear).
Conventional economic theory says that this situation will correct itself as the less efficient, under capitalized companies go out of business, leaving the more efficient companies to continue providing high quality, cost effective service at a price level consistent with returns demanded by shareholders. However, the theory seems to have broken down, and the over supply of contractors appears to be permanent. Ease of entry into the industry is certainly one of the problems. Anyone with a small amount of money, a small amount of experience, and a lot of intestinal fortitude can become a contractor (and most do).
However, there is a more insidious problem plaguing the industry that is exerting tremendous downward pressure on prices. That problem is the contractor's bias toward ever increasing volume. When asked how their business is doing, today's typical contractor responds by quoting sales volume or backlog figures. Rarely are profit margins, return on equity, or changes in profitability used to express the condition of the business. Most construction companies are still driven by the idea that bigger is better. Unfortunately, the volume-is-king mentality persists throughout the construction industry.
What is driving this quest for volume at any price? There are several forces at work:
1. Growth is Good - Somewhere in the American psyche there is buried a bias toward growth. "Grow or die." "If you're not going forward, you're going backward." Unfortunately, trying to grow into a stagnant or declining market requires lower and lower margins-ultimately resulting in losses. We need a paradigm shift in the industry from growth in volume to growth in quality, growth in technology, growth in productivity, and growth in profitability. Who cares about volume?
2. Growth is Rewarded - To be fair, a contractor gets lots of positive feedback if his volume increases, and negative feedback as it declines. Employees, subcontractors, suppliers, surety agents, surety companies, trade associations are all pleased (and financially rewarded) if the contractor's volume increases. Conversely, they are generally penalized if the volume declines. Also, the contractor's ego is massaged by being noted in the "top contractor" lists (ENR 400, local Business Journals Top 25, and INC. magazine's fastest growing companies, etc.). Why doesn't someone create a list of the most profitable contractors?
3. Organization is Good - One of the primary motivators in the pursuit of higher volume is to "keep the organization together." The current team has been hired, trained, and developed at considerable expense and effort. Plus, they are friends and neighbors. Without increased opportunities, the best young talent may leave the company. This is a difficult dilemma. However, creating unprofitable growth to meet these needs can spell disaster for all employees-including the owner.
4. Overhead is Growing - One of the least legitimate reasons for growing the business is to cover increasing overhead (it's inflation, you know). There is a perception by many contractors that their overhead expenses are unique and that there are laws of economics that say those expenses will go up every year and definitely cannot be reduced. The reality is that all
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