E&C Firms Can Make a Major Leap in Value to Accelerate and Sustain Profitable Growth

In today’s world of digital transformation and constant change, the task of value differentiation is vital for the engineering and construction (E&C) sector. According to McKinsey, this industry employs about 7 percent of the world’s working-age population and is expected to grow by 85% to become a $17.5 trillion business by 2030; yet it remains conservative and reactive. It is serviced by a plethora of similar companies with similar core values and taglines, employing people with similar backgrounds, using strategies with similar dimensions, producing similar designs and building similar projects for similar prices. Customers see the value of these firms’ offerings as indistinguishable and shop for the lowest price. Price becomes a strategic variable instead of a tactical variable, and E&C services are reduced to a mere commodity expected to be delivered at a cheap price. In the commodity business, customers hold the power and are motivated only by price, and sellers have little pricing flexibility. E&C firms become simply a price taker at whatever level the market sets, and many use EFCG’s Peer Benchmarking Analysis to justify comparable performance. As a result, the profitability in the E&C sector is low compared to other industries and the percentage of money spent on innovation is considerably lower than in most other industries. This sector is also facing increasing threat from large companies in rapidly growing economies (i.e., China, Korea and India) seeking to expand outside their home and emerging (e.g., Africa, Latin America and the Middle East) markets and gain market share in developed markets. These cash-rich firms, often heavily supported by their governments, can acquire local players and capitalize on lower costs, making their megaproject bids more compelling to customers focused on price. And an industry shift to public–.private partnerships (PPPs) may give large European firms, with substantial experience in PPPs, a competitive advantage. This is why many civil engineers are arguing that they are witnessing “The end of competitive advantage.” But commoditization implies that customers just don’t value further improvements along particular dimensions. That does not mean there’s no improvement customers would value.

Value creation is always difficult. But it isn’t just centered on further reducing overhead and cost structure, lowering prices and engaging in a price war, because the result is lowered profitability and quality — a vicious cycle for everyone involved. It can also be a matter of drilling down into the core, developing/combining and harnessing technology in a way that is valuable to customers and lead the market, and becoming active seller of this intellectual property (IP). Innovation is perhaps the only brake on commoditization.

There are still two ways to compete and create competitive advantage: low cost or differentiation. Companies confronting commoditization have few strategic options. They can become a low-cost provider in their industries, which will require relentless cost-cutting and trading low margins for (hopefully) higher volume. Adopting digital technologies (e.g., building information modeling, smart sensors, advanced analytics, automation, robotics, 3D printing, online document management systems) can help them boost productivity and reduce project costs and schedules, making them more nimble, agile and efficient. Or they can consider trade-offs in activities and map their firm’s activities to value creation. Among many viable options (e.g., technology consulting, information management), the latter may require E&C firms to not only provide engineering design and construction services; but also to become owners and sellers of valuable IP that makes a separate contribution to their bottom line. This entails a diametrically opposite mindset — a (paradigm) shift to non-time billing practice. Put simply, value no longer resides solely in traditional engineering and construction services.

The old paradigm counsels E&C firms to be strong self-reliant: they must generate their own ideas and then develop them, build them, market them, service them, maintain them, finance them, and support them on their own usually through an internal cost center (generated from a heavy “corporate tax” on all of the profit-and-loss businesses within each firm). IP is viewed and designed to create competitive advantage for the company and contribute to its success in the marketplace. It is created internally, used internally, and brandished in proposals and interviews to ward off and defeat rivals. In many instances, IP is treated as unique project events and similar solutions are reinvented from scratch each time. But mechanisms such as licensing and separate subsidiaries are today important levers in the value creation process. They represent a new path of profitable growth. The potential pay-off can be too great to ignore.

E&C firms can start to explore for technologies in their own organizations that might be useful elsewhere and convert this technological potential into economic value. In fact, almost every built environment project these firms undertake generates some innovative software technology that has the potential for packaging to external sales and become additional revenue opportunities and potential new business platforms. More importantly, it can provide a steady stream of highly profitable revenue (annuity power). A subscription or maintenance revenue model then generates predictable recurring revenues, much as assets on deposit in a bank generate on a monthly basis a recurring revenue stream of interest. Customization and other services (i.e., demand innovation) can also add to the bottom line. Furthermore, an online delivery model reduces the costs of producing and distributing software and allows providers to introduce updates relatively easily. A cloud-delivered offering has flexibility, creating affordable entry points for potential users in emerging markets. And the lack of a physical product (or server or processing control) can deter piracy.

A number of E&C firms have launched such initiatives with varying degrees of success, and many of their IPs were abandoned or ended up benefiting others (e.g., infrastructure software giants like Bentley, Autodesk, Intergraph, and Oracle). MWH Global’s 1996 launch of Innovyze is a quintessential example of a successful IP monetizing initiative. For the next 20 years, the company generated strong double-digit growth in revenue (revenue CAGR of 28%) with uninterrupted double-digit profitability (EBBITA CAGR of 33%), and in 2016 its operating profit margin passed the 59% (of net and gross revenue) mark. That isn’t a productivity advantage – that is a productivity knockout. The company was subsequently sold to a private equity firm for $270 million (one of the highest multiples in the industry), providing further opportunities to its employees and customers. Other firms are also launching new ventures to identify and develop innovative start-ups to transform the natural and built environment.

“Change is the law of life. And those who look only to the past or present are certain to miss the future,” President Kennedy once said. Business, especially today, is anything but predictable and an established position is no guarantee of long-term security. Competitive landscapes are in perpetual motion. Even the most successful companies can be dethroned. Profitable growth remains a tremendous challenge many E&C companies face. Innovation is a powerful way to break out of the commoditization trap to create and sustain value. It can help you create a lifelong annuity of profitability. But it requires a type of leadership that is very different from that needed to pursue a strategy of geographic expansion, cost-cutting, or acquisition. People who are best at running the core E&C business may not be the best at leading innovation and running new IP ventures. Those with the proper schools of experience can maximize these firms’ chances of success. E&C firms can also boost their profitability by moving from a practice-business to a business-practice. They need to expand their competitive fields of vision, gain early reads on emerging customer priorities, and shake off old assumptions that do not match reality. By adopting and leveraging technologies, E&C leaders can stay ahead of the competition and help reshape the future of the industry — or lose out. Success in this business hinges on creating the future rather than being a caretaker of the past. Creating a culture that generates continual improvement and innovation can be your pathway to sustainable competitive differentiation and help you outwit new entrants and reap the greatest rewards. The best competitive advantage is a sustainable one. It’s a combination of people, processes, and technology connected in a unique way. But talent and vision are universal. What you do with them is not, and is largely a matter of conscious choice.