The architecture, engineering, and environmental industry is powering into what is likely to be yet another consecutive year of record financial performance in 2022. All indications are that the fundamentals that have contributed to the industry’s past decade of expansion and success will continue.
However, appearances can be deceiving. The fundamentals are shifting. The rules of the game are about to change. And there are four AEC industry trends 2022 has already spawned that are going to converge over the next five years to result in a very different set of fundamentals:
- Accelerated consolidation
- Rising labor costs
- Record valuations—A seller’s market
- The quest for the holy grail of the digitized AE business model
Here is a more detailed look at the four AEC industry trends and how each will transform the way architecture, engineering, and environmental firms do business between now and 2027:
AEC Industry Trend 1: Accelerated Consolidation
Mergers and acquisitions of architecture, engineering, and environmental consulting firms will increase by approximately 10% per year. With 2022 on pace to smash last year’s previous record-high of 418 U.S. transactions, Morrissey Goodale forecasts that M&A activity will peak with some 650 deals in 2026. Over the next five years, more than 3,250 firms will sell. This is a little less than 10% of the industry overall, but about 75% of high-performing, high-value, differentiated firms.
Essentially, the supply of quality sellers will be largely depleted over the next half-decade. The percentage of acquisitions involving “innovative” or “technology” firms will gradually increase from less than 3% of all deals to north of 7% over the same period. The most active consolidators will have private equity, ESOP, and—to a lesser extent—publicly traded capital models. The pure employee ownership model will continue to decline.
AEC Industry Trend 2: Rising Labor Costs
Here’s the recipe. Start with an overheated market for AE and environmental services right now. Stir in extra demand from a federal infrastructure bill. Mix in the fact that the AE workforce is growing only slowly, is less loyal (to specific firms and the industry itself), and more transient. Add in the throngs of baby boomers who, in the wake of the pandemic, decided to retire and to cash out their ownership stakes to take advantage of soaring valuations. And, voilà! You have the perfect recipe for annual labor cost hikes of 6+% annually over the next five years.
Confronted by the tightest labor market in history and insatiable demand for their firms’ services, AE and environmental leadership teams are opening their wallets wide, sweetening benefits packages, and doling out raises and bonuses like never before. Many firms—particularly those that cannot migrate to a digital model (see below) — will experience declining bottom lines as a result.
AEC Industry Trend 3: Record Valuations — A Seller’s Market
With notable exceptions for certain architecture or design firms focused on retail, hospitality, and commercial spaces, AE industry valuations largely held through the pandemic. This was due to higher-than-expected utilization rates, driven by fewer employees taking time off, and owners and clients across most sectors continuing to push through with their capital improvement plans. The passage of massive public-sector spending packages in the $1.2 trillion 2021 Infrastructure Investment and Jobs Act and the 2022 Inflation Reduction Act — the largest federal clean energy investment in U.S. history — has supercharged industry performance and demand for deal-making while boosting firm valuations above pre-pandemic levels.
Over the next five years, valuations for AE firms will continue to increase, but at varying rates. Upper-quartile firms (current TTM EBITDA multiple of 8.2x) will see faster appreciation than median performers (current EBITDA multiple of 5.9x). Lower-quartile firms (current TTM EBITDA multiple of 4.5x) will see little, if any, appreciation.
Private equity’s appetite for superior returns and improved ESG scores for their portfolios will create multiple multi-millionaire AE and environmental firm owners over the next half-decade.
AEC Industry Trend 4: The Quest for the Holy Grail of the Digitized AE Business Model
Between now and 2027, the industry overall will spend heavily to figure out how to successfully monetize digital business models incorporating artificial intelligence (AI) and machine learning technologies. The four primary paths available to firms seeking a digital transformation are to internally develop proprietary products or services, partner with technology companies, launch tech subsidiaries or ventures, or purchase a tech-enabled business model.
The current patchwork of nascent tech ideas, initiatives, and investments scattered across a variety of AE and environmental players — from the largest industry icons to small startups—will gradually converge over the next five years around a handful of mainstream AE/tech hybrid business models.
Leading the charge will be well-capitalized public- and private-equity firms that are relentlessly looking for scale and efficiencies. Left behind will be employee-owned firms that cannot (or more likely, choose not to because of entrenched older, risk-averse owners) access the capital required to remake their businesses. Make no mistake about it, along the way to this digital nirvana there will be a ton of capital flushed down the drain on pet projects, flawed ideas, poor execution, and failed marketing.
What Happens by 2027?
2027 will be an inflection point as these four trends converge to upend the operating principles of the AE and environmental industry and reframe its future trajectory.
Here’s where things are heading in 2027 and beyond:
1. Welcome to Your Virtual Future
The primary driver of massive change beginning in 2027 will be the industry’s successful monetization of digital, AI, and machine learning technologies. Having learned how to profitably incorporate these technologies into both their service offerings and internal business operations, AE leadership teams will look to prioritize their investments accordingly.
From 2027 forward, the strategic plans of successful AE and environmental firms will focus less on key hires and geographic acquisitions and more on technologies that allow them to scale their businesses and increase margins. In other words, do more with less. Which is — in reality — a euphemism for “make more money with fewer employees.”
2. Declining M&A—A Buyer’s Market
M&A of “traditional” “sell time for money” AE and environmental firms will start to decline in 2027 for two reasons. First, instead of acquiring their way to growth, AE firms will prioritize investments in new technologies that will allow them to scale their digitally driven business models — crowding out acquisitions of fee-for-service design and environmental firms.
Second, with the pool of traditional AE and environmental sellers largely depleted, buyers will be a lot pickier about who they acquire, favoring quality over quantity and allocating their limited M&A bandwidth judiciously. While the total number of acquisitions will decline from 2027 onward, the percentage of innovative or tech firm acquisitions will increase to north of 20% annually.
3. Valuations Slump
As the industry focuses on investments in technologies to drive scale and profits, the result will be less demand — and lower valuations — for traditional AE and environmental firms. It’s impossible to determine the hit that valuations will take, but it’s likely in the double digits, and the downward pressure is likely to continue.
However, there will be one group of firms that will continue to see increased valuations post-2027. Those are the AE and environmental firms that have either successfully developed or deployed technologies that are in demand by larger, better-capitalized consolidators.
4. The End of the War for Talent
And the winner is? Not talent. Outflanked by investments in labor-destroying technologies on the left and new industry capitalization models that value superior returns over “a pathway to ownership for every employee” on the right, the outlook for the AE workforce post-2027 will be markedly different.
Firms will favor technologies to do the work that in the past was performed by employees. Revenue per employee will increase dramatically. The power dynamic will shift from what we see now. We’ll head back to the days of 3% annual labor cost increases. The new power players in the new breed of AE firms will be data scientists and tech gurus.
The Upshot: Convergence of AEC Industry Trends
These four AEC industry trends at play in 2022 will converge over the next five years to remake the industry and invert the value equation for many firms. Your challenge is to determine how you will successfully ride the wave of the next five years and position your firm for success after the inflection year of 2027.
And the experts at Morrissey Goodale are here to help!
With our exclusive focus on the AE and environmental industry, Morrissey Goodale can assist your firm in successfully navigating the changing landscape brought on by these four AE industry trends as well as any other challenges that might be confronting your firm. Our team of expert consultants has helped hundreds of clients transform and grow their businesses into high-level performers through strategic business planning, mergers and acquisition advisory, marketing and business development, executive search and human resources, leadership development, and business valuation and financial advisory services.
Contact us today to find out how Morrissey Goodale can help your firm.
A guide to help you better understand how AE firms are valued and – perhaps more importantly – what you can do to build value now.Read Newsletter
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