The design and engineering (D&E) industry is going through a period of rising revenues but declining profits, a period that began with the global financial crisis of 2008–09 but has largely been the result of a perfect storm of factors. These factors include a market preference for bringing in one firm to fulfill all of the requirements of a design and build contract — as opposed to paying firms separately for design and construction contracts — as well as less global demand for building new greenfield structures. And although technology can create new demands, it has also led to simplification and modularization of designs, so that customers have less need to hire D&E firms at premium prices. Significant portions of the work have become commoditized, resulting in a climate where most firms are forced to compete largely on price, rather than on excellence of design and execution, as D&E firms have traditionally done. Yet few have been able to create high-volume businesses that turn a consistent profit.
Although D&E firms know they need to adapt to change, recent efforts to achieve scale through consolidation haven’t been as effective as they could be in boosting profits and productivity. What most firms need is a more strategic plan for achieving scale — an economy of scale that comes from investing strictly in assets and acquisitions that will strengthen the areas where the company excels, so that it develops what we call a “right to win” in select, targeted markets. The plan revolves around three imperatives: build scale where you have a right to win; invest in getting the operating model right; and have an explicit strategy for technology and innovation.
Many design and engineering firms have sought to counteract market pressures by building scale through acquisition. There has been a wave of consolidation over the last decade or so, resembling the early stages of the rollups that took place in the assurance industry and in strategy consulting.
The consolidation in D&E is driven by the pursuit of growth in slowing markets, not by client needs — clients do not value scale for scale’s sake. As options for profitable organic growth diminish, players are seeking other sources of value. Many publicly listed acquirers have taken advantage of capital markets arbitrage, exploiting differences between their own relatively high valuation multiple and that of a more risk-averse, privately held target (typically lower). Longer term, the consolidation is providing value through economies of scale in resource pools, greater cross-boundary leverage of skills and expertise, and volume benefits across the companies’ fixed investments.
The most prevalent example has been the emergence of Aecom as a global one-stop shop powerhouse. The company, headquartered in Los Angeles, began as a spin-off from Ashland Inc. of Ashland, Ky., in 1990, and has seen unparalleled growth in recent years through major acquisitions including Earth Tech (2008), Davis Langdon (2010), Tishman Construction (2010), and, most recently, URS (2014). Other firms have been following suit, including Arcadis (most recently acquiring Hyder), Amec (Foster Wheeler), and Stantec (MWH Global).
Yet for the most part, consolidation hasn’t led to the expected competitive advantages. We see a way to get there, however.
Our approach requires an integrated operating model built around a plan for strengthening the company’s greatest capabilities. In practice, this means taking a few steps back before a company jumps into the race for scale, and asking a couple of questions: What are we good at? What do we want to be good at?
From there, the company must create a fully integrated business in which every division, every offering, and every regional office has a clear role in the overall strategy. Most international design firms still operate as an amalgamation of local businesses. Few have truly integrated their non-client-facing activities, even at a regional level — and certainly not their client-facing activities (e.g., account management, resource deployment, and marketing).
It is understandably difficult to achieve this kind of integration in an industry in which clients value local experience (and often local presence) over and above an international track record, for all but the most complex or “signature” work. Furthermore, it takes time to successfully integrate two large organizations and extract the benefits, and frequently this integration is only partly achieved before management time and attention moves on to the next internal initiative or the next acquisition target.
However, we have found that if they have a plan for growth, D&E firms can achieve the scale and efficiencies they’ll need for a rapidly changing world. We have broken down the growth plan into three broad strategic imperatives: Build scale where you have a “right to win”; invest in getting the operating model right; and, related to your right to win, have an explicit strategy for technology and innovation. Each of these imperatives, outlined below, is designed to fuel more indepth discussion about what the firm wants to be and how to reach its goals.
Changes from the outside are forcing D&E firms to look inward in ways that will strengthen their business over the long term. Although most players in this industry tend to start out small and tightly focused on a few specialties, they often grow through acquisitions, adding on highly diverse services as they expand. The expertise they acquire is complementary in theory, but the approach to bottom-line concerns such as staffing, sales effort, thought leadership, and strategic planning might vary from one division to another.
Now, however, with profitability in jeopardy across the industry, it is imperative that a D&E firm adopt a capabilities-driven plan that it can implement throughout the company. To a large extent, specialization has given way to commoditized services in the industry, but a company can still enlist all of its divisions in determining where its own best strengths lie. With that kind of evaluation, the firm can determine which capabilities are worthy of premium prices, which areas are most important to the business, and which capabilities it should boost with more investment. In a global marketplace that has recently presented a number of surprises and a healthy degree of uncertainty, D&E firms that are clear on where they have the right to win, and then invest in getting their operating model right and stay prepared for technology disruption, will be best positioned to plot a path of sustainable growth and profitability.