In This Issue
The Domino Effect
I just got back from speaking at the invitation-only Lockton International General Counsel Forum at The Yale Club of New York. It’s always a wonderful event that brings together the legal eagles from 55+ (which coincidentally is the age range box I check on surveys these days) of the industry’s largest firms.
This year the forum returned in person, and the general counsels relished the opportunity to get together. As Karen Erger, Senior Vice President and Director of Practice Management for Lockton, put it: “Our general counsels took full advantage of the forum’s opportunities to glean ideas, intel, and inspiration from each other and our speakers on how to lead their firms forward in our radically transforming industry.”
I had the privilege of sharing with them our perspective on four trends that will play out over the next five years and then converge in a domino effect to remake the industry. And it all starts with disruptive technologies…
Disruptive technologies: Around the industry, individual firms will continue to invest record amounts of treasure, time, and talent to harness the potential of AI, machine learning, digitization, and in-the-field robotics to improve enterprise-wide performance and profit. Most of these discrete firm initiatives will fail to reach market or realize only marginal impact if they do. (Pro tip: Before you invest yet another million dollars in the “digital triplet” idea from your next-generation leaders, get yourself a copy of The Innovator’s Dilemma.) However, over the next five years the sum total of these collective efforts—in concert with the introduction of external disruptive technologies by VC-backed groups and industry vendors—will forever alter the industry’s pricing, service, delivery, and operations models. The mainstream of these disruptive technologies will trigger a domino effect of change in the industry as we now know it.
Consolidation: The industry will see massive consolidation over the next five years. We’re forecasting that about 3,100 firms—or close to 10% of the industry—will be absorbed by the end of 2026. This forecast factors in both (a) rising interest rates (which will turn the heat down on 2022’s torrid year-to-date increase of 30% to somewhere closer to 20%) and (b) a recession in or around 2023. This five-year shakeout will be driven by a combination of industry fundamentals and stimulus from the Infrastructure Investment and Jobs Act. Domino effect? Consolidation will begin a steady decline after 2026 as firms choose to invest their capital in disruptive technologies that allow them to be more profitable, improve performance, and scale faster than acquisitions of non-tech-enabled AE and environmental services firms.
Recapitalization and revaluation: Private equity will continue to supplant employee ownership over the next five years. Ninety percent of the ENR Top 500 Design Firms that are choosing to sell or recapitalize are selecting a private-equity option when they do. By the end of 2026, better than one-third of the ENR Top 100 Design Firms will be backed by private equity. Of the 3,100 firms that will sell over the next five years, 1,100 of them will be to a private-equity investor or operating firm. As a result, M&A valuations will continue to increase over the next five years. Upper-quartile M&A multiples will hover in and around the mid-teens on trailing 12 months EBITDA. Median multiples will linger just shy of 10x. Lower-quartile multiples will remain flat south of 5x. Domino effect? Overall valuations will begin to decline after 2026 as strategic and portfolio acquirers focus more on disruptive technology investments rather than acquiring traditional AE and environmental consulting firms. Those AE firms that successfully integrate disruptive tech into their businesses will see their values hold if not increase. However, the bottom will fall out for the median and lower-quartile firms as buyer demand will disappear.
Labor’s half decade in the sun: Gone are the pre-pandemic days of annual raises of between 4% and 5%. In 2022, we’re expecting to see a step-function jump in labor costs of about 10% as firms compete for talent like never before. Even with a recession next year, it’s going to be a hyper-competitive market in our industry for talent over the next half decade, and we expect annual labor cost increases between 7% and 10%. Firms are going to continue to throw out long-standing compensation practices and pay scales in order to onboard and retain the talent needed to meet record demand for services. We expect that super-generous loyalty bonuses, immediate (knee-jerk?) counteroffers, more frequent base comp adjustments, more creative benefits, and infinite workplace flexibility (“tell me how and when you’d like to work”) will be the norm to keep talent in place. Signing bonuses—at all levels—will be standard to bring talent on board. (Remember the days of unpaid interns?) Labor cost increases will put tremendous pressures on the industry’s bottom line and will contribute to the demise of weaker players. From a compensation perspective, this will be an awesome five years to be a design or environmental firm employee. Domino effect? Once disruptive technologies are mainstreamed, the balance of power will shift back to investors and management. When they tell you “technology is not about replacing people,” they are telling the truth—if by the truth they mean “technology is all about replacing people.”
Industry M&A is up 38% over the past 12 months: Last week saw six new transactions announced including two in California.
Questions? Insights? What changes do you see ahead for the industry? Email Mick at email@example.com or text him at 508.380.1868.
What Employees Think—the Good, The Bad, And The Ugly
I can’t say for sure, but there’s a decent chance I’ve conducted in-depth, one-one one interviews with more employees in more AE firms than anyone else on the planet. A conservative estimate puts the number of individual, hour-long discussions somewhere around 3,000. I wouldn’t say I’ve heard it all, but I’ve heard a lot. When you talk with that many people who work in a specific industry, patterns in their observations, opinions, and insights tend to emerge. Unfortunately, much of it fails to reach leadership’s ears—particularly their concerns and ideas for improvement (some fear repercussions, some lack confidence, and others have given up being dissatisfied). Since finding, developing, and retaining smart, hard-working people is at the top of the AE industry’s anxiety list, you should gather as much insight as you can about what’s top-of-mind for your employees.
In the meantime, here’s a sample of The Good, the Bad, and the Ugly (Clint Eastwood spaghetti Western reference) I am hearing these days from employees throughout the AE industry:
Note to readers: The quotes below have been lightly modified to protect the innocent…
Despite all of the teeth-gnashing about losing company culture due to the effects of the pandemic, employees still seem to appreciate their work environment
“Even though we’ve grown, we’ve maintained what’s important to us. We get each other’s backs—we don’t stab them. There’s a lot of collaboration here despite (and maybe because of) remote working, and people continue to enjoy working together.”
“I love the culture of integrity and respect at my company. If you have to take care of a personal issue, leadership is in your corner. You are treated like an adult here.”
“We don’t view employees as a number. We treat each person as a member of a family. The people here create bonds, make friends, and build valuable relationships.”
Entrepreneurialism appears to be alive and kicking
“It’s entrepreneurial here. There is support for growth and trying new things. I love that we have started to diversify into other areas. We have multiple niches now. Those things light my fuse. I am excited to see where we take the firm from here.”
“We’ve never gotten comfortable with our own success. We’ve kept the energy going and are always looking for the next mountain to climb—whether that’s launching a new service, entering a new market, or opening a new office.”
“I like that the company has a spirit of growth. We are trying to take on new challenges and capitalize on opportunities. Growing keeps things interesting!”
They like being pushed out of the nest
“I got thrown into the fire and learned a lot. I have been on an accelerated path with project management and leadership. They won’t roll out the carpet for you. You’ve got to want it. But if you do, they won’t stop you from any career path you want to pursue.”
“I have been given the opportunity to open doors for myself. There are no real restrictions on what I set out to achieve. I am not held back and I take on as much as I want to take on. In fact, I have been able get in front of clients from the very beginning of my career.”
“My company has given me a lot of opportunities. I am kind of a jack-of-all trades and I’ve been encouraged to go and explore what I am good at doing. I love coming to work to solve business problems and the challenges that come with it. My gratitude is enormous for having those opportunities.”
Communication is nearly always at the top of the list
“There is not enough information shared from leadership to the rest of company. How is the company doing financially? I never know. It doesn’t feel like most people in our company have that grasp. It’s hard to feel part of the company when it’s on a need-to-know basis, and it’s been decided that I don’t need to know. I think it’s worthwhile for management to keep checking in. How are we doing? Where do we need to improve? What are our goals as a company? These things matter to the employees.”
“Sometimes finding our in-house experts can be difficult. We have a lot of offices and office managers, and it feels like they are silos. We have some bottlenecks at the office manager level and it makes communicating with other offices harder than it needs to be.”
“Communication could be a lot better. Some people recognize it as an issue but others don’t consider it to be an issue—which is probably why it’s an issue.”
Accountability! Accountability! My kingdom for accountability!
“Sometimes people coast, and it’s so obvious. They avoid taking on anything and try fly under the radar because they know they can get away with it. But they still get paid and get a raise every year regardless of what they contribute. I try not to let it get to me, but it’s frustrating.”
“We keep employees who aren’t pulling their weight. We need to have expectations for them and move them on when they don’t meet those expectations. But we don’t have the hard conversations we have to have.”
“The project managers at my company are not held accountable for completing projects on time and on budget. It’s been an issue since I started here.”
Wait, what? I thought you just said you’ve had a lot of opportunities to learn and grow
“My main concern is we don’t really have a formal mentoring and training program. We are not great about rolling out training programs. I feel like I am falling behind.”
“We have a project management training program. It’s fine and all, but if we could tie it to a mentoring program that got us some experience outside of the office, like taking younger staff to meetings to interact with clients, it could be beneficial. Maybe something like a deputy project manager mentoring program would be good. I know I could use some training on the non-technical aspects of managing a project.”
“Career development is hit or miss. The sentiment is there, but the follow-through is not. A year ago, I was told I could move up into a new position, and we are a year later and nothing has changed. Still no mentoring to help me prepare. I hear a lot of talk, but I can’t get any traction on it.”
FROM THE SUGGESTION BOX
Get out of the weeds— and out of the way
“As we get bigger, our principals need to remove themselves from the details and empower the next level of managers. Otherwise, that next level will try to get to where they’re going with another company.”
“Our leaders need to give more autonomy and power to their direct reports. There is a lot of micromanaging here. Hiring entry-level staff requires an act of Congress. Once you do get them on board, it’s another act of Congress to get them out of the firm if they don’t perform. Our leaders need to trust their people and stop micromanaging from the top.”
“Our top principals need to get out of the weeds. They need to graduate from that. They should be mentoring and developing client relationships.”
Pave the way for more back and forth
“Our leaders request feedback on things, but maybe they could take that feedback a little better at times, or consider it a bit more. There can be a reluctance to speak up because grudges are sometimes held based on what you say. It can be hard to get around people’s feelings sometimes.”
“Our president should try to be a little more relatable. He tries to have personal conversations, but a lot of times you feel a little intimidated.”
“Balance the good and the bad when talking with employees. Don’t just communicate the ten bad things and leave it at that. It’s discouraging. The bad stuff shouldn’t be buried, but mix in the positives, too. That creates a path for discussion and engagement.”
Money isn’t everything—but it’s not nothing
“We talk about wanting to hire and keep the best people, but when we pay salaries, we always shoot for the median. It drives me nuts. If we want to attract and keep the best people, pay them like they are the best people.”
“Put more compensation in our compensation structure. That’s just the way the world is right now.”
“Invest more in retention and incentives for our younger employees. Once they get to that four- or five-year level, they get their license and that’s when we lose some of them.”
“If you haven’t walked the shop floor in a while, put it near the top of your to-do list. It will help you take better care of your firm’s most valuable assets.”
For guidance on raising the level of employee engagement in your firm, call Mark Goodale at 508.254.3914 or send an email to firstname.lastname@example.org.
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