State of the Industry The non-residential construction market typically follows the residential construction market by 6 to 12 months, both into the recession and coming out of the recession. Well, this time around it was not the case.

But I can make a prediction that if the residential market can turn the corner and improve their prospects, then those of us in the non-residential market should see some increased ability to both increase our profit margins and build quality products at a solid negotiated price.

The most recent financial study information from Shinn Consulting shows home builders are beginning to turn the corner toward profitability and gives indications of the effect of their decisions throughout the downturn. (This is great news for the non-residential market!)

Since 1993, Shinn Consulting has been collecting and analyzing financial data about their home builder clients, who have some of the best-run companies in the industry. The trends and benchmarks that Chuck and Emma Shinn have established from this research and other work have become industry standards.

Below is a recap of the results for their most recent study, from a webinar titled “Building Profitability in a Downturn: The Shinn Group's 18th Annual Financial and Operations Study Results.”

• Most of their builders made the right decisions early on, but they faced a couple of problems. They could not move fast enough and nobody expected the downturn to last 5 years.
• From 1993 (when they began collecting information) until 2006, Shinn Group clients saw increases in profitability by becoming more efficient and by being able to raise prices above the cost increases.
• In 2006, the pressure for pricing began, which marked the beginning of the stall in profits. 2007 was saved because of the backlog that was still in place during the first half of the year. 2008 was the first year of full downturn and began the precipitous decline in profits.
• Builders were able to get rid of land, but they were stuck with their existing product. The downturn was so steep that they couldn’t get new product onto the market. So, in order to sell, they had to discount existing product. As a result, they took hits on volume and gross profit. 2009 was almost a duplicate of 2008 with a slight decline. Finally, in 2010 we begin to see a recovery on the profitability front.

• The losses were fueled by two components: Direct Costs and Operating Expenses. Nobody expected the downturn to last this long, so they held on to staff. Many of the builders held on even until last year. So, their operating expenses went from 18% to 25%. Many builders admitted that shedding staff was the hardest thing they had to do, and they especially wanted to keep their core group around.
• During 2008 and 2009, the pressure on prices continued, and the builders tried to reduce cost by negotiating with trades. But they are still building the same product. (There is a limit on how much cost you can cut on those houses.)
• The builders pay a big price for holding onto staff. Now, sales volumes have declined significantly, and the percentage of cost to sales continued to increase because of the down push on prices and the failure to cut cost from the trades while building the same houses as in the past.
• Because sales revenues decline significantly and the builders are maintaining the same levels of staff, they get a double whammy. Operating expenses go totally out of kilter, rising to almost 25%.
• In the end of 2009 and beginning of 2010, the builders were able to make changes to their overhead and get new product in place. In 2010, we finally see the results of some hard choices made by the builders. There is a significant increase in gross profits, which is a result of redesigning the product to meet the new price ceilings adjusting for cost of the structure and specs.
• On the operating side, the builders are closer to reaching a balance between their operating expenses and their sales revenue. Staff has been cut to the levels required to sustain the new volumes. These costs are still above our target as builders are trying to protect their core management team but there has been a significant adjustment from 2009 to 2010.

If you are in the non-residential market, get ready to follow our home builder brethren’s example and turn the corner to profitability and growth.

Labels: Commercial, Construction Industry, Construction Labor, Economy, Industrial

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