When Considering Your Strategic Options, Specificity Is Your Friend

Judging by the number of inquiries we receive on a weekly basis, one of the hottest topics these days in the boardrooms of employee- and ESOP-owned firms is the examination of the “Strategic Options” available to create and/or maximize shareholder value. More often than not, this is a serious exercise for these teams to assess whether the current leadership teams and majority shareholder groups want to and/or are able to transition their firms to a next generation of leaders and owners. (Let’s call this the “Transition Option.”) Most often, this strategic option is being compared to the competing options of selling the firm to a third party (“Sale Option”) or recapitalization of the firm with outside equity (“Recap Option”).

Trends collide: Why is this a top-of-mind topic for so many leadership teams headed into the back half of 2022? Essentially, it stems from the collision of two major trends that have been roiling the industry for the past decade. The first of these trends—which is rapidly coming to an end—is the imminent retirement of the balance of baby boomer owners and leaders from their firms. Scanning the industry, this dwindling group still holds significant ownership in their firms, and in most cases their ownership is disproportionate to the value they create. The second trend—which may be coming to an end after 20 years—is the availability of cheap financing for investors to acquire equity in these firms. Increasing interest rates are already throwing a wrench in the plans of a number of smaller private equity groups that have been considering investments in the AE industry. 

Driven to decide: The impetus for leadership teams to invest their limited time and resources to examine their strategic options varies. Some are concerned about the ability of their existing stock repurchase models to support the buyouts of departing shareholders at a time of record valuations. Others are waking up to the fact that they’ve likely deferred succession planning five years too long, while still others have received offers from strategic acquirers or investors and feel compelled (or are required by charter) to seriously analyze the overtures.

What’s Love Got to Do with It? Before a team can objectively assess its strategic options, it has to take emotion out of the equation. This is for many an unanticipated—but very real—challenge to sound, objective decision-making. There is an understandable and risky bias on the part of most teams to favor the “steady as she goes” with the current business model. “Understandable” because of inertia, familiarity, loyalty, fear of change, contentment. “Risky” because choosing the status quo based on bias has significant potential to actually destroy shareholder value in the future—particularly if teams delude themselves about their own leadership and management competencies (happens more than you think). The greater the emotion and bias in the decision-making process, the less optimal the outcome.

Comparing apples to various other fruits: One of the biggest challenges teams face when comparing strategic options is comparing the economic value (underline added for emphasis) created by transitioning the business to a next generation of owners and leaders to the economic value created via a sale or recapitalization. At the heart of the matter is comparing value created over an extended period of time (Transition Option) to value created at a single point in time (Sale or Recap Options). This is where specificity is your friend.

Specify success: It’s critical to specify a point of time in the future (one, three, five, seven, and ten years are all viable milestones) that connects with the definition of a successful Transition Option. (Let’s call this point in time “Touchdown.”) It’s also important to specify what “success” is in this Transition Option. For example, success could mean that 100% of key leadership and management positions have been transitioned in three years and certain key financial metrics (revenues, profits, backlogs) have been achieved to secure the capital model. These financial metrics can then be converted to a firm value. This value can then be compared to the estimated value of a firm sale or recapitalization at any point in time along the way to Touchdown. The delta between the economic value in a firm sale or recap can then be compared (with some time value of money thrown in) objectively. The team can then assess how the shareholder value resulting from a firm sale or recapitalization compares to the value created through transition. 

Leaving money on the table: A sober objective analysis of the economics of their strategic options allows leadership teams to then reconnect with their emotions and biases—as is their prerogative. They can choose to “leave money on the table” should a sale or recap point to greater value if they see beyond the pure economic value of the options assessment or believe that remaining in control and transitioning the business results in a different and more fulfilling set of benefits for employees, clients, and shareholders. 

How are you evaluating your Strategic Options? Contact Mick at [email protected] or 508.380.1868.

Strategic Thinking (Part 3—Achieving a Competitive Advantage)

In last week’s Word on the Street, we covered Michael Porter’s five definitions of strategy and his “Five Forces” model, which provides a structured framework for industry analysis and the competitive dynamics impacting an industry’s profitability. In this issue, we close out the Strategic Thinking series by showing how these concepts are used to develop business strategies that create competitive advantages.

Developing “Generic Strategy”

AE firms develop business-level strategy by using company resources and distinctive competencies to gain a competitive advantage over rival firms. It is labeled “generic strategy,” because in principle, the choices of strategy are essentially industry-agnostic. Generic strategy choices involve two dimensions: competitive advantage and competitive scope.

  • Competitive Advantage: In seeking a competitive advantage, an AE firm might choose a low-cost strategy when trying to out-market and outperform the competition. This strategy is the ability of an AE firm to design, produce, and market a service more efficiently and at a lower cost than its competitors. Or an AE firm might choose a differentiation strategy as a means of gaining a competitive advantage.  Differentiation is the ability to provide services that are perceived to be unique by clients and for which they are willing to pay more.
  • Competitive Scope: Besides competitive advantage, AE firms must choose its competitive scope, either targeting a broad or narrow (niche) market. A broad market scope implies that a firm targets a mass market or many market segments, whereas the narrow market scope focuses on one particular buyer group. Bear in mind that an AE firm might choose to pursue and market to a limited number of niche markets—which would still be considered a narrow scope.

Combining Advantage with Scope

Combining the two types of competitive advantage with the two types of target market scopes results in four potential variations of generic strategy options:

  • Cost Leadership” = lower cost + broad mass-market
  • Differentiation” = differentiation + broad mass market
  • Focus Cost Leadership” = lower cost + narrow/niche market
  • Focus Differentiation” = differentiation + narrow/niche market

Pursuing a generic strategy can be a problem if you end up getting stuck in the middle. From a competitive advantage standpoint, this occurs when a firm is unwilling to commit the marketing and investment in developing/acquiring expertise required to pitch and deliver a service that is perceived to be unique, or when a firm tries to keep costs low but does not aggressively pursue low-cost approaches. Regarding competitive scope, a firm can get caught in the middle when it becomes overconfident and spreads itself too thin over multiple market sectors or expands into the mass market without committing the necessary resources to fully reach it.

While achieving a low-cost and high-differentiation position is often temporary, it can be achieved in the AE industry. But it typically only lasts in firms that manage for flow efficiency, investigate disruptions to that flow, and pursue continuous improvement. In any case, firms that establish both low-cost and high-differentiation achieve what’s called a “best-cost” strategy.

Building a Competitive Advantage

The first step for an AE firm to establish a competitive advantage is clarifying the market sector(s) in which the firm competes. This requires defining who the client is, what they need, and how that need will be met. Once those questions are answered, the firm can then begin to seek to differentiate itself from the competition. To be successful in the chosen market(s), leadership identifies a generic strategy that would dictate a set of consistent actions that the firm can undertake to build an advantage over rivals.

A more refined framework for achieving competitive advantage includes the following:

  • Differentiation by Price: In pursuing a lower price, an AE firm may be driven to follow a functional strategy that brings down costs, lowers quality, provides less service, offers fewer alternatives, and so on. Everything else remaining the same, clients always prefer a lower price.
  • Differentiation by Image: To create an image (or brand) is to create a psychological distinction where it does not otherwise exist, through careful marketing. In a sense, this is an artificial form of differentiation, since it is achieved by creating a different perception. However, if marketing involves positioning the firm as an expert by providing information clients find valuable, the “artificial” tag becomes less applicable and the brand more tangible.
  • Differentiation by Support: Support refers to related services that are offered with the primary service.  It may be included with the service or delivered under a separate contract.
  • Differentiation by Quality: The effort here is to make the service/deliverable itself better and not just different. Thus, the service accomplishes everything that competing services do; however, it does so with no rework, no mistakes, more valuable solutions, etc.
  • Differentiation by Design: The focus here is to provide something very different and to provide unique aspects or features. It requires innovation (i.e., bringing something to market that is unavailable from the competition).
  • Undifferentiation: When the firm has no clear basis for differentiation, except perhaps through scope, it is following a policy of undifferentiation. Firms that merely try to copy the actions of a main rival are also following undifferentiation.

Tying it Together

These forms of differentiation need not be mutually exclusive. Some firms may try to combine different forms to stand out. For example, some AE firms will use unique designs and combine them with innovative technology to lower price. In any case, when the market space is segmented based on factors such as geography, how clients select (cost-based, quality-based, etc.), and so on, there are many segments to manage. When such segmentation is combined with the forms of differentiation described above, several possibilities exist to generate competitive advantages.

For more information on strategic planning, call Mark Goodale at 508.254.3914 or send an email to [email protected].

50 in 50: Maine

50 states in 50 weeks: U.S. states economic and infrastructure highlights.

Key Economic Indicators

GDP: $61.8 billion

GDP 5-year compounded annual growth rate (CAGR) (2017-2021): 2.2% (U.S.: 1.6%)

GDP per capita: $45,823 (U.S.: $58,154)

Population: 1.4 million

Population 5-year CAGR (2017-2021): 0.7% (U.S.: 0.5%)

Unemployment: 3.1% (U.S.: 3.9%)

Economic outlook ranking: #44 out of 50

Fiscal health ranking: #30 out of 50

Overall tax climate ranking: #33 out of 50

Key Sectors and Metro Areas

Top five industry sectors by 2021 GDP:

Sector
GDP ($ billions)
% of total GDP
Real estate and rental and leasing
9.8
15.9%
Health care and social assistance
7.0
11.4%
Manufacturing
6.3
10.3%
State and local
5.2
8.5%
Retail trade
5.2
8.3%

Top three industry sectors by GDP 5-year CAGR (2017-2021):

Sector
GDP 5-year CAGR
Management of companies and enterprises
14.4%
Finance and insurance
6.5%
Mining, quarrying, and oil and gas extraction
6.4%

Top three metro areas by GDP:

  • Portland-South Portland
  • Bangor 
  • Lewiston-Auburn

Top three metro areas by population percentage increase in 2021 vs. 2020:

  • Portland-South Portland
  • Bangor 
  • Lewiston-Auburn

Infrastructure Highlights

Infrastructure: ASCE Infrastructure Grade (2020): C-

Maine will receive upwards of $2.3 billion in funds from the Bipartisan Infrastructure Law (BIL) over the next five years, which will help the state address critical dams, hazardous waste, roads, transit, and wastewater infrastructure issues. A variety of projects have been announced for Maine communities. Rural roadways and water utilities are special focal points for improvements throughout the state. Baileyville, Bingham, and Fort Kent, for example, will use funds to improve storm drains and water lines. Additionally, the EPA granted funds to the University of Southern Maine which will not only prevent industrial pollution but also improve best practices and resources in the craft beverage industry across the state. Maine’s BIL funds will address the following categories of projects (additional funds may be deployed as federal grants get awarded to states):

Funds
Improvement Area
$1.3 billion
Roads and highways
$390 million
Water infrastructure
$234 million
Public transportation
$225 million
Bridges replacement and repair
$100 million
Broadband (minimum allocation)
$74 million
Airports
$19 million
Electric vehicle (EV) charging network
$13 million
Cyberattacks protection
$10 million
Wildfires protection

Construction spending (Value of Construction Put in Place – CPiP):

  • Private Nonresidential 2021 CPiP: $1.2 billion; 17.7% 5-year CAGR (2017-2021), above overall U.S. CAGR of 1.4%
  • State & Local 2021 CPiP: $1.4 billion; 36.1% 5-year CAGR (2017-2021), above overall U.S. CAGR of 4.0%

AE Industry

ENR 500 firm headquarters (2022): 1

M&A activity since 2018:

  • 14 deals with buyers from Maine
  • 18 deals with sellers from Maine

For customized market research, contact Rafael Barbosa at [email protected] or 972.266.4955. Connect with him on LinkedIn.

Weekly M&A Round Up

Congratulations to T-O Engineers (Meridian, ID): The 200-person full-service consulting, planning, and engineering firm joined fast-growing Ardurra Group (Tampa, FL) (ENR #114). T-O Engineers will serve as a platform for Ardurra’s expansion in the aviation market and geographically in the Northwest. We’re thankful that the T-O team trusted us to initiate and advise them on this transaction.

Industry M&A is up 23% over the past 12 months: Last week we reported a total of eight domestic transactions with new deals announced in ID, NC, MN, D.C., LA, FL, CA, and MA. It was a particularly busy week for consolidation in the architecture sector. You can check all the week’s M&A news here

If you’d like to know more about our M&A services, and how we can help you either confidentially sell your firm or grow through acquisition then please contact Nick Belitz, Principal, at [email protected] or 303.656.6151.

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