Constant population growth is the relentless expansionary force that drives all markets. The principles of Survival of the Fittest dictates that only the fittest companies will survive in expanding markets. The rest will either cease to exist or be merged into more efficient competitors. This causes industries to consolidate which in construction will mean fewer contracting firms.
Consolidation is Relentless
- There were over 1,800 automobile manufacturers in the United States from 1894 to 1930. Studebakers, Packards, and Plymouths now reside only in auto collections and museums. The big three, General Motors, Ford and Chrysler are all that remain.
- Pan American, Eastern Airlines, TWA, and Continental fly no more. American, Delta, Southwest, and United are the “consolidated entities” that currently dominate the airline industry.
- Thousands of “Mom and Pop” grocery stores have consolidated into a few “Supermarket” chains.
- Independently operated “Service Stations” in every American small town have been acquired by worldwide energy companies who find it more efficient to let you pump your own gas.
There is One Glaring Exception – Construction
Historically, the total amount of construction provided by very large and some publicly traded corporations has been minor compared with that put in place by more than a million small to mid-size and larger independent contractors. The construction industry is one of the only industries in America that has resisted the natural forces of consolidation—until recently. Why? How?
The Efficient Producer
That the construction industry has been dominated by independent contractors has confounded economists and business school professors for many years.
Our research into this unusual phenomenon has resulted in the opinion that in the past: “The unique nature of construction work contained an efficiency bias toward small and mid-size, boutique, local practitioners.”
- The complex nature and comparatively high skill level required in construction allowed historically fair profit margins that benefitted even the smallest producers.
- Construction was by nature “local” and imposed a certain geographic boundary on most projects thereby favoring local (It used to be hard for a Chicago contractor to build in Los Angeles.)
- Demand for construction often outstripped supply allowing even marginal producers the opportunity to prosper.
Major Market Shifts Have Been Altering the Playing Field
These historic conditions and the unique nature of construction work helped to stall relentless forces of consolidation. However, that has been changing for more than 30 years resulting in the beginning stages of consolidation. Many more construction businesses will consolidate in the face of the following rapidly changing market conditions:
- In the construction industry downturn from 2008 to 2012, the construction market reduced in size by roughly 20% but the biggest contractors in the country (ENR’s top 100) did not decline by nearly as much (15%). This means that the big remained big while remaining companies got smaller. The largest businesses captured more market share while the rest lost market share.
- Both public and private sectors clients have been increasingly considering construction a commodity which drives the selling price down, causing margins to slip to the mid and low single digits.
- New technologies and wide access to information have demystified the processes of estimating and producing the work which also causes construction services to be perceived as a commodity. This has led construction buyers to believe there is little difference between construction enterprises. This causes them to have less concern over which contractor is selected which favors larger firms.
- Contracting arrangements are changing. In the past, Lump-sum projects in which construction firms bare all the risks and effectively guaranteed operational readiness were the norm. This fostered open competition and, in many cases, favored the size firms most suited for the job. The shift to Construction Management, Design Build, and the like, favors the bigger firms.
- Public-Private Partnerships are now causing firms to arrange financing or invest their own capital to participate which is obviously easier for larger firms than small.
It’s a Whole New World
The relentless forces of consolidation have finally found the construction industry which many private and family-held enterprises see as a threat. It is perhaps time for smaller and mid-size firms to formulate strategies to deal with the inevitable. We will continue this discussion of consolidation in construction in future blogs.