'Great Dispersion' Coming For Smaller Construction Firms As Competition Increases

It’s about to get more difficult to operate as a small or midsized construction firm in the U.S., with increased competition and market challenges anticipated in the coming years as the industry specializes and consolidates while becoming more mobile through the adoption of remote technologies.

It may seem premature, given the relatively high demand, to suggest trouble in the sector. But the beginnings of a slowdown are cropping up — the Association of General Contractors found nonresidential construction activity dipping for the third straight month — and many analysts see underlying shifts in industry economics threatening firms in the future, including rising supply prices causing profit compression throughout the industry. The Associated Builders and Contractors recently reported that construction input prices are up 20% year-over-year.

“In July 2022, there’s more than enough work to go around,” Rider Levett Bucknall North American President Julian Anderson said. “There’s simply not enough labor to go around, so people are constrained. The problem is when the music stops, and everyone races for the chairs.”

Part of the shifting landscape has to do with the “great dispersion,” according to Robert Shear, vice president of strategy for OpenSpace, which makes software for the commercial construction industry. 

In recent years, his clients, based mostly in big markets like New York or Chicago and focused on office construction and build-outs, have gotten more business in secondary and even tertiary markets they didn’t work in before. Fast-growing cities such as Boise, Idaho, or Asheville, North Carolina, are especially active, he said. Developer Trammell Crow, for instance, has seen an increase in business at its Raleigh, North Carolina, office.

Alliance Residential is another developer that’s moving into these fast-growing areas. The firm kicked off its first Idaho development with a project in Boise late last year.

“I can see a big surge in construction in Boise, especially different, more complicated construction,” said Jeremiah Jolicoeur, Alliance’s Pacific Northwest managing director.

There’s suddenly more opportunity in smaller cities like these, which have attracted the demographics and density to support projects that attract out-of-town builders. 

The proliferation of video calling and other technologies that have become commonplace in the last few years also extends geographic capabilities for large firms, generating more competition for the smaller regional firms that once had their local markets all to themselves.

In addition to new technology, larger construction firms seeking access to new markets are increasingly partnering with local subcontractors to gain the on-the-ground expertise they need and combine it with their experience and scale. Others simply use mergers and acquisitions to break into new markets, whether geographic or property type.

Firms like New York-based STO, for instance, merge with competitors to create a more prominent industrial player on the national stage. A recent analysis of merger activity in the sector by the consultancy FMI found that buyers have sought to expand their geographic footprint or range of capabilities, targeting new clients and markets.

Nick Grandy, a construction analyst at RSM, said he’s also seeing firms operating with “less geographical bounds,” with larger contractors following clients to different cities. Looking at the ENR Top 400, a list of the industry’s biggest firms, he sees quite a few examples of companies going beyond just a handful of cities. 

“Companies disaggregated during Covid,” Shear said. “A lot of clients are looking for regional hubs instead of new headquarters, instead of six floors in midtown New York City, they’re spread around six offices in the Berkshires, or wherever.”

Firms want to stick with the general contractors they know and to facilitate that, they’re willing to pay for centralized design and oversight for decentralized office growth. Shear compares it to the approach of Banana Republic or Starbucks, firms that know distributed design and building projects, entering commercial construction.

The shift mirrors other examples of specialization within the industry, according to Rider Levett Bucknall’s Anderson. At the same time that larger clients have pushed into smaller cities, larger construction firms, like Mortenson, AECOM-Hunt and Turner, have also assembled teams to focus on stadium projects and other specialized, large-scale building types. 

Smaller firms simply don’t have the experience or résumés to compete, Anderson said. In addition, bidding for these projects has also changed, with tenders focused on past experience and done under arrangements such as construction manager/general contractor or design-bid-build, where experience and qualifications are key, as opposed to lower prices, eliminating the ability of local firms to win on price alone.

“I don’t think it’s that they’re being pushed out,” he said. “It’s that there’s so much new development and competition, and small firms find themselves saying ‘we wanted to be able to go after that.’ If you want to design and build a ballpark and don’t have a team that’s done it before, you’re dead.”

This is one of the reasons there’s such a war for talent in the industry, according to Anderson: Firms looking to take on new specialties or move into new markets need to buy their way in.

“The war for talent is fierce,” he said. “They’re trying to get anybody they can and pick them off.”

Shear, whose firm provides remote viewing technology to manage remote construction sites, not surprisingly says that technology has helped accelerate this existing trend, especially the first few projects in a new market.

The tech itself was more widely adopted during the worst parts of the pandemic to avoid in-person contact. Anderson agrees, saying that in the Zoom era, it’s just more acceptable to manage projects from a distance. 

And it can’t be overlooked that private equity consolidation, especially within architectural and consultant firms in the industry, is also driving the great dispersion, Anderson said, pushing firms to seek more gigs and profits. 

This consolidation is leading to bifurcation within the industry, RSM’s Grandy said. 

“The primary factor being the market reached an all-time high in 2021, and many construction company owners who are in their late 50 to 60s saw this as an opportunity to be able to exit their business and begin retirement,” Grandy said.

Since 2016, private equity firms have been increasing their number of transactions within the construction space, with 16% of all transactions being PE-related in 2016 and up to 41.5% in 2021, according to Grandy’s analysis of data from Capital IQ, Pitchbook and Capstone.

That same research found there were approximately 560 transactions for construction companies in 2021, up from a pre-pandemic average of 377 for fiscal years 2017-2019. FMI expects activity to remain robust through 2022. 

With supply costs set to remain high, and an increasingly competitive landscape showing little sign of slowing, there’s a reason older owners are looking at taking private equity buyouts.

“It’s a murky picture at the moment,” Anderson said. “Like I said, when the music stops, it’ll get pretty ugly pretty quickly.”