AE Industry Intelligence: Issue 87

How Four Trends Will Converge Over Five Years To Remake The AE Industry

It’s 2022, and the AE and environmental industry is powering into what is likely to be yet another consecutive year of record financial performance. 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 trends at play that are going to converge over the next five years to result in a very different set of fundamentals.

Here’s what’s going to happen over the next five years on the way to 2027:

Trend 1: Accelerated consolidation: Mergers and acquisitions will increase at approximately 10% per year—peaking with some 650 deals in 2026. Over the next 5 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. (For those keeping score at home: Capital 1, Labor 0.)

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 (if at all—retirements are WAY up), is less loyal (to specific firms and the industry itself), and more transient. And, voilà! You have the perfect recipe for annual labor cost hikes of 6+% annually over the next five years. Many firms—particularly those that cannot migrate to a digital model (see below)—will see declining bottom lines as a result. (Updated score: Capital 1, Labor 1.)

Trend 3: Record valuations—a seller’s market: 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.

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 AI and machine learning technologies. 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 five years out? 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 headed after 2027:

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.” (Updated score: Capital 2, Labor 1.)
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. (Final score: Capital 3, Labor 1)

The upshot: These four trends will converge over the next five years to remake the industry and invert the value equation for many firms. Your job 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.

2022 kicks off with a baker’s dozen of deals: Industry consolidation powered into the new year. Thirteen U.S. deals were announced in TX, VA, MO, MA, MT, IN, NC, OH, ND, CA, and AL. The pace of industry consolidation is up 34% over the past 12 months.

Congratulations to our friends at Gunda Corporation (Houston, TX): The team at this leading firm in the Texas transportation, ITS, and public works markets announced its acquisition by, and merger with, fast-growing Ardurra Group (Tampa, FL) (ENR #190). We’re thankful that the team at Gunda Corporation trusted us to initiate and advise them with this strategic initiative.

Congratulations also to our friends at Alliance Engineering (Richmond, VA): This week the leadership team at this energy, manufacturing, and process engineering firm announced its acquisition by industry pioneer and innovator Merrick & Company (Greenwood Village, CO) (ENR #113). We feel privileged that the team at Alliance chose us to assist them and make this combination of two great firms a reality.

And even more congratulations for our friends at Civil & Environmental Consultants (CEC) (Pittsburgh, PA) (ENR #96): This week the team at this industry leader announced its acquisition of surveying, geospatial, and civil engineering firm Pickett, Ray & Silver (St. Peters, MO). We’re thankful that the CEC team entrusted us to assist them in bringing these two awesome employee-owned AE firms together.

Snapshot of what we’ve been posting on LinkedIn: Odds are you didn’t have unionization as one of your 22 trends in 2022 for the AE industry.

Questions? Insights? How do you see the industry changing over the next five years? Email Mick Morrissey at [email protected] or call him at 508.380.1868.

Want To Accelerate Innovation? Have An Outward Mindset

With demand for AE services rapidly outstripping supply, it’s all too easy to be consumed by day-to-day issues— meeting the next deadline, making it to the client presentation on time (Teams or otherwise), or resolving the project crisis du jour. It’s day after day of see problem, solve problem, move onto the next problem. There’s no time to reflect, learn, or contemplate. And it’s a tough cycle to break. But your firm can’t afford to lose you like this, especially with all of the fundamentals that will be changing over the next several years (see Mick Morrissey’s article in this week’s issue). Now is the time to figure out what you need to do over the next 5 years to successfully position your firm for the following 20.

So, be “present.” I know. Another clever business term. Believe me, I’m as sick of buzzwords as you are. There’s probably a new buzzword for “buzzword”, so if there is, at least give me partial credit for not using it. But the meaning behind it is important for you to understand. Being present is noticing what’s going on around you while you are in action. It’s also called being in “ownership mode,” which is where AE firm principals must live if they expect their firms to grow and prosper when the tide eventually goes out. And it will go out.

As a leader your job is to work on the business, not just in it. Here’s how:

• First, make powerful observations about what’s going on inside and outside your firm.
• Second, think about the implications these internal and external factors will have on your firm.
• And third, identify the actions that must be taken to grow your firm’s competitive advantages— or create some.

One way to begin reflecting on your firm is to probe aspects of the company that may require more of leadership’s attention. Explore your own reaction to questions like:

• Where are we going as an organization, and is our leadership aligned? If not, why not?
• Our company is perfectly designed to get the results we are getting. So, what needs to change if we are going to achieve our vision?
• What macro forces and trends are going to have the greatest impact on our firm, and what are the implications to our firm if we stay the course in the face of change?
• Are our people learning and developing? Are we developing leaders at all levels in the organization? Are we giving them direction or directions? Do we hire to staff projects or build leadership?
• How does our firm REALLY function?  Is that a good thing or a bad thing?
• What does our client base look like right now? Is it evolving? Does our leadership team even know and agree on how we want it to evolve, if at all?
• How do we deliver projects in our firm? Is there a company “way” we do that? Are we improving in this area? If not, why not?
• Is the firm living up to its core values? If not, why not?

Dig into these and other important questions— and ask your business partners to do the same. If you ask these questions now, you’ll be in a much better position to deal with whatever the world is getting ready to throw at you next.

By the way, if you need a laugh this Monday, check out the most annoying buzzwords of 2021 at The 27 Most Annoying Business Buzzwords of 2021 and see which ones you are guilty of saying. I never use any of them (as far as you know).

To learn more about getting into “ownership mode”, call Mark Goodale at 508.254.3914 or send an email to [email protected].