Schleifer’s Dictionary of Business English
Compression: the domino effect of the downward pressure applied to construction pricing by large contractors during market contractions.
Compression occurs during construction market downturns when the larger and biggest contractors, determined to take any available work to keep their people employed and move down into smaller projects they would not normally be interested in. With their greater capitalization big contractors are able to use aggressive pricing, to take smaller jobs away from firms not quite their size. They take work from firms in a market they do not normally compete in. These firms are then forced to go after the size work of companies smaller than themselves and so on through mid-size contractors and on down to smaller and smaller companies. The lowest level, the smallest contractors have nowhere to turn and some may be forced out of business.
Thirty years of research into contractor survival during market contractions revealed that, if a construction market decline lasts more than six months, compression always occurred. Although I have talked about this phenomenon for years, I have always felt uncomfortable publishing it because, quite frankly, I had no idea what the smaller contractors could do to avoid being crushed by compression. Then, one day, a young up-and-coming contractor gave me the answer.
A successful sprinkler pipe fabricator and installer was doing about five million dollars a year when the construction market downturn hit his company in 2009. This young contractor experienced the cancellation of a million dollars of backlog within a thirty-day period because his clients on several projects lost their bank funding.
The contractor contacted me to discuss his circumstances explaining that larger contractors were taking work in his market below his costs. He said his remaining backlog was uncertain and that he could not see any work on the horizon that he might be able to get for anything but a loss. He did not have enough work on hand to make a profit with the size organization he was trying to maintain.
His business was at the bottom of the compression taking place in its market and was being pushed down with nowhere to maneuver. He wanted to stand and fight, take cheap work and try to ride-it-out, but his calculations and his gut told him he would end up in bankruptcy. He made the monumentally difficult decision to shut down his business immediately, reducing overhead costs close to zero, and keeping just enough resources to complete the work on hand. It took almost a year to complete the projects.
A little over two years later his market leveled out and began a slow recovery. Small at first, he was able to re-start his business primarily brokering work, but a year later moved to larger offices with a fabrication shop and yard. By 2019 he was doing $8.5 million a year with 50 employees, a 10-man fabrication department, and record profits.
I am not recommending that anyone go out of business. I use this dramatic case study as an “extreme” example and demonstration of compression to explain and teach the concept. Years of research discovered this concept that I call “compression”. You can call it what you like, but you need to add it to your knowledge base because it is essential that you understand it. It happens every downturn and should be expected. Compression highlights the reality that cutting the cost of doing business and downsizing is the only defense during a declining market. The high failure rate during construction downturns is a direct result of contractors fighting the losing battle of trying to maintain sales while a construction market shrinks. It cannot be done at a profit and inevitably causes losses which is financial suicide. This has been happening for decades. Compression has not been recognized in the past because it was an unknown and unidentified dynamic. Now that we know about it we can deal with it.
Compression is a very real and dangerous reality in a construction market downturn lasting longer than six months. If contractors don’t understand this dynamic, they will not recognize it when it occurs and will not be prepared to react appropriately. You can’t fight the avalanche once it begins and the only defense is to refuse to take work at a loss which means downsizing to cooperate with a declining market. The only way to “fight” a declining market is to continuously lower your prices as larger competitors force their way into your market which causes losses you should not incur and may not be able to afford. All of us know “to get out of the way” of an avalanche because defying a landslide is a deadly choice. If you are limber enough to get out of the way, your business can be protected to prosper another day.
Note: Information on Flexible Overhead and overhead management can be found on this site, letstalkbusiness.net click on “Manual” and go to Managing Overhead in the table of contents.