Volatile markets, fluctuating indices, an industry hard hit. It is the inevitable zeitgeist; a stress and strain factor on both existing firms and new entrants alike.
As world economies expand and contract in staccato-like fashion, the A/E industry attempts to navigate a course through uncertainty. Chief Economist for Reed Construction Data at the time, Jim Haughey, in a September 2010 issue of Construction Industry Forecasts states, “Total construction spending is forecast to expand…11.4 percent in 2012. This will bring spending by the end of 2012 up to 87 percent of the spring 2007 peak level.”1 Almost in assent, the Architecture Billings Index showed growth for five consecutive months as of March 2012. The score dropped to 48.4 for April, slightly shy of the 50-plus required to show expansion and has been hovering in the mid-forties since, struggling to gain momentum.2 July shows an increase although falling short of the necessary criterion to show growth.
The ability to morph with the times instead of warring with it, embracing it without falling prey to it is vital to sustained industry growth. Converting a threat into an opportunity or a weakness into strength, in strategic terms, is tantamount to the very ethos of being an architect or engineer. Solving problems on a daily basis — creating, innovating, maneuvering constraints, and challenging the status quo — are innate to the “A/E self.” In this forced time-out the industry has had to take, it is the industry’s birthright to be futurist in its thinking, to be fully cognizant of possible sea change, and to be prepared for alternate futures.
Historically, economic downturns have been cyclical. Perhaps not as complex and severe, nor globally far reaching as the one we are currently experiencing. Nevertheless, it is uncannily repetitive. As Lawrence Summers, economist and onetime secretary of the treasury under President Clinton said, “The central irony of financial crisis is that while it is caused by too much confidence, too much borrowing and lending and too much spending, it can only be resolved with more confidence, more borrowing and lending, and more spending”.3Whether we acquiesce with Larry Summers’ thinking or not, the cycle continues while ‘boom and bust’ theories proliferate the journals.
I graduated from Architecture School seventeen years ago and entered an industry filled with ambiguity. Today, the context is similar, but the parameters of uncertainty have changed. If not the dot-com bubble, perhaps an act of terrorism or the collapse of the housing market; more recently, the EU crisis and the structurally compromised European Union, rumblings of corrections to emerging markets, ailing economies and scandal after scandal in the financial sector. Any one of these, or a combination thereof, has the capacity to set off global shock waves.
A phrase attributed to Hyman Minsky, a post-Keynesian economist (1919-1996), “stability is destabilizing,” is decidedly relevant decades on. A distinguished scholar in the field of evolutionary economics, Minsky’s theories were regarded as pessimistic as compared to other finance theories prevailing at the time. Post 2008, he is quoted time and again, with several of his books in reprint.
Today, it seems, a “Minsky Moment” is a fairly common occurrence on the Street. “Minsky held that, over a prolonged period of prosperity, investors take on more and more risk, until lending exceeds what borrowers can pay off from their incoming revenues. When over indebted investors are forced to sell even their less-speculative positions to make good on their loans, markets spiral lower and create a severe demand for cash — an event that has come to be known as a ‘Minsky Moment’.”4
It is futile to predict. “Never make forecasts, especially about the future.” A saying widely credited to Samuel Goldwyn (in spite of its true origins remaining suspect), the Goldwynism to date carries wisdom. Experts remain powerless to draw from precedent, as perhaps there is none to draw from. A curious notion of fumbling in the dark exists. Take for example Apple’s stock; pegged to bask in superior status at $1000 per share, it is currently trading in the lower 600s instead of rising as “predicted”. There is much speculation as to why, but no logical explanation seems to be forthcoming.
In this very simplified scenario as a measure of our times, it is inconsequential if AAPL trades at $644/share or $1000 per share. The onus is on the organization to armor-up to address either scenario; to work within the constraints of one, or the opportunities of the other. If organizations are empowered to “change with change,” opportunities will present themselves. It serves us well as an industry to equip ourselves and be prepared for what might or might not be an alternate future; a future that could very well translate into our present.
Michael Porter of the Harvard Business School provides a “Five Force Model” through which an industry analysis can be conducted. While an in-depth analysis is not feasible here, this article attempts to contextualize some of the opportunities and barriers incumbents and new entrants face within the industry structure. These forces exist in good times and in not so good times. Hence, being aware of these influences and their impact on the industry allows a firm — large or small, new or old — to better ready themselves for more than just the here and now.
Using the Five Force Model as a business tool permits an organization to defend threat and pursue opportunity, being aware of their capabilities and strengths. The model emphasizes the importance of these competitive forces in how they interactively mold an industry, and how it ultimately allows an organization to thrive in it. The five forces are: rivalry among existing competitors, threat of potential entrants, pressure from buyers, pressure from suppliers, and the threat of substitutes.5
RIVALRY AMONG EXISTING FIRMS
Competition exists at many levels within the A/E industry: entrants vs. incumbents, larger vs. smaller firms, niche specialties vs. diversified portfolios and domestic vs. international organizations. When industry growth is slow the playing field becomes naturally more competitive. Existing firms have a clear advantage over new entrants due to the long learning curve entrants must endure. There is no substitute for experience. It dictates a firm’s identity, their capacity to deliver, client risk and ultimately the client-consultant relationship.
For the reputable firm with an established track record, the competition comes from similar, long standing firms. The irony is that, on occasion, the competition is from industry “friends” and respected colleagues. To circumvent this, certain industry high performers tend to pool their resources and expertise to form project specific consortiums prior to bidding, enabling them to secure an advantage over their competitors. The collective IQ — talent, experience, resources and niche specialty — provide for a keen negotiating platform.
The world is more-so our oyster these days. It may be that the last of the emergent markets have already emerged. Nevertheless, an architect goes where the work is. In new markets, emergent or otherwise, rivalry from domestic architects can culminate in bidding wars of sorts. To mitigate this, firms can enter into joint-venture agreements with local firms, share expertise and spread liability between the parties. An 80-20 or 90-10 service split assures design integrity while leaving tolerances for local code, know-how, and the infamous on-the-ground bureaucracy some such markets are challenged with.
BARRIERS TO ENTRY AND THREAT FROM POTENTIAL ENTRANTS
According to Porter, potential entrants face several major barriers to entry. These are, among others, economies of scale, capital requirements, switching costs, disadvantages independent of size and distribution channels which, in the A/E industry, can be viewed through the lens of the client-consultant relationship. While an in-depth analysis of each of these barriers will be reserved for later reporting, entry into the A/E industry must be a well thought out process. For example, firms are able to absorb overhead costs based on their economies of scale. A newer firm may find this difficult to do, depending on the number of projects secured. Capital requirements have direct impact on this. Available capital has the power to determine a firm’s project load. This is important for existing firms venturing into new markets as well, as the cost of creating capacity — through marketing, advertising, PR and talent management — involves sustained planning. The risk a firm can expose itself to in a given scenario is crucial to both its domestic and foreign undertakings.
The client-consultant relationship is a critical component to the success of a firm, regardless of geographic bounds, and one that I believe should not be underestimated. A repeat client is probably a firm’s most valued asset — even more so when uncertainty is the new normal. Cultivating such relationships creates a high switching cost for the client in terms of both perceived and tangible risk. A new relationship may or may not be successful; the delivery of the project brief may be compromised; the end product may not match projected ROI. There is the instance where an entrant can make fee concessions in order to gain market share. However, it is prudent for newcomers to understand that a client looking for office structure, resources available, a proven track record and experience, is more likely to continue in the context of the existing relationship to allay risk.
Experience is an advantage independent of scale for the incumbent and a disadvantage independent of size for the new entrant. It is something an entrant will have to contend with for a while. The learning curve is long and sometimes arduous, but is also essential to mature and come of age as a firm of repute. Entrant or not, overcoming these barriers to entry and preparing for these outcomes is crucial to a firm’s resilience in both sluggish and reasonable economies.
THE THREAT OF SUBSTITUTES
There are no substitutes for the provision of A/E services. A categorical statement indeed, but one that can be qualified thus: In response to a Los Angeles Times article, “Do-It-Yourselfware” as far back as April 1995, the then AIA Director of the Los Angeles chapter asserted, “Although the software programs … are useful for a homeowner to visualize their addition and remodeling ideas in three dimensions and even in communicating those ideas to a design professional, they are no substitute for the services of a competent architect. … An architect must take into account building, zoning and energy codes and regulations; soils and seismic issues, and design in terms of space usage and flow, structural systems, building materials, energy usage and construction budget.”6
More than a decade later, at the very least, we can add sustainable design and LEED certification to the list. In this volley of DIY design vs. retaining an architect, the score is clearly not “deuce”. Contrarily, “advantage architect”! DIY design is a risky proposition, and one can empathize why a technologically savvy client may think it easily done. Taking this argument into the future, a trend we can be assured of is the exponential evolution of technology.
A firm’s capacity to keep up with technology is critical to the agility with which a firm responds in defending threat and capitalizing on opportunity. Technology is largely responsible for this nimbleness within a firm’s culture. While it is no substitute for the value an architect’s services provide, not yet at least, it is a force that needs reckoning with. A knowledge base not to be intimidated by nor ignored, it will determine if an organization continues to lead or stays merely as part of the status quo.
PRESSURES FROM SUPPLIERS
New entrants can impact fees. In certain instances low overheads provide the necessary margins to do so. However, fees to a large extent are directly linked to a firm’s brand — its experience, talent, design excellence, capacity to execute within time and budget — its core competencies. Take for example the mobile phone industry, where market saturation allows alternate suppliers to under price their product so as to entice new consumers. A high level of market penetration must be achieved in order to match the competitor’s price point. Achieving a reputation and acquiring a brand are both a time and resource consuming process.7
At the other end of the spectrum, when a group of select firms compete for the same project, those firms are a relatively small segment of the industry, and the specific building typology a relatively small percentage of market share. Consider a museum project as a relevant example in this scenario. Here it is more a case of “let the best woman or man win the commission,” and not so much a situation of an excess in museum designers. It is sometimes interesting to see the usual suspects shortlisted time and time again for a prestigious commission. A firm’s core competencies, in synthesis, allow it to be a significant competitor for that particular building typology, incumbent or not.
To alleviate pressure applied from saturated industry components, diversification is key. It allows for strategic planning and the implementation of new thinking. Whether in the form of a strategic business unit, product line or an expanding global footprint, a diversified portfolio gives a firm clear advantage in retaining market share, both locally and internationally. In the now not-so-new markets of Brazil, India and China, presenting a differentiated portfolio assists in alleviating some of the pressures exercised by domestic architects. To further moderate this, my experience has been that a fee index for that specific market — which is most likely less than standardized fee levels in western geographies — eases entry into the market.
PRESSURES FROM CLIENTS
During times when the industry is experiencing normal growth, clients exert pressure on firms to be competitive with their fees. In turn, a principal may succumb to fee reductions due to various underlying factors. The prestige level attached to the project, and how it upgrades a firm’s portfolio, a target client, or reasons purely personal, may influence the decision. In depressed market conditions these choices get tougher. When work is scarce, clients can wield enormous pressure not only on new entrants but incumbents as well.
Knowing the value the firm brings to the project has a direct correlation to fees charged. Being cognizant of the value component is imperative to countering such pressure. This is one of the reasons well-established firms that exude excellence are able to charge outstandingly high fees — even in plunging markets. This value allows a firm to be judicious and selective about the projects it pursues, enabling it to weed out work that carries high liability and is potentially pernicious to the sustenance of the firm. Invest in acquiring superior performance and a superior brand will follow. The payoff will be significant when up against the power of a client.
In summary, market inertia is a key challenge the industry must learn to calibrate with. A/E firms tend to face this phenomenon from time to time exclusive of the extreme conditions since 2008. The President of the Boston Society of Architects (2009) once said, “…architects at some level are kind of the canaries in the mine. When development dries up, architects are probably the first people to know.”8 WSJ’s “The Source” from March this year blogged that the ABI is a reliable index: “ … if you are still in the market for a decent, real-activity, economic indicator then don’t despair. … The Architecture Billings Index from the American Institute of Architects and the Market Research Group … [is] often not a bad indicator of broader economic conditions either. For example, the index’s low of late 2008 came a little before U.S. stocks’ post-crisis nadir in March 2009.”9
As we now know, the ABI shows a decrease since April on par with other economic indicators. Stringent austerity measures in the EU have slowed development in the U.K. and on the Continent with several EU nations experiencing double-dip recessions. The plight of the Euro and the ramifications thereof change on a daily basis. Reports indicate a downward trend in China’s economic growth although its growth is still stronger than most world economies. A great irony it is safe to say, that opportunities still exist in the geographically vast PRC as in other nations of the BRIC/S network.
Jim O’Neill, chairman of Goldman Sachs Asset Management who coined the term BRICs, discussed the power of growth markets in a March 2012 segment. “Goldman Sachs has adopted the term “Growth Markets” to describe some of the world’s most dynamic and fast-growing economies. Some of these markets are already transforming the global economy; others offer the potential for significant growth in the coming decades.”10New landscapes for business have and continue to emerge. Finding access to these emergent markets in ways that alleviates the cost attached is something entrants to these markets need to be creative about. Partnering up, joint venturing, creating a presence virtually if not physically, kinetic marketing strategies and creative advertising are ways in which this access can be achieved.
Further, technologically savvy firms naturally have an edge over the rest of the competition. How architects visualize, produce drawings, communicate with their clients and manage their consultants are challenges that must be mitigated. Existing firms working within the framework of larger economies of scale have the margins to keep up with evolving technology while newer firms may find it more difficult to absorb the costs attached in doing so. However, being able to swiftly implement new technologies into a firm’s framework must be emphasized if a firm is to keep up with current trends in the industry; whether in building systems and technologies, presentation tools, or communication methodologies. Being at the mercy of a tablet and mobile device is something of a standard that seems useless to resist in today’s currency.
A Financial Times article from April, “U.S. Economy: A Market on the Move,” discusses at length the improving housing market and concepts of deleveraging as part of the recovery process. Mostly good news, the article ends with the following sentiment: “The financial system may be returning to health — but its heart beats more slowly than before.”11 Indeed, the U.S. economy as a whole is recovering from a massive myocardial infarction and healing is slow and complex. Regardless of elusive market indices and technological advances within the industry, an organization must evolve — not only to withstand the current milieu, but rather, to progress into the future; it must engage and transform to accommodate change if it is to retain its place in the industry.
Having worked extensively in the U.K. and the U.S., Kishani De Silva is the founder and principal of 2A + D, which was established to provide management services for large‐scale and boutique design firms. 2A+D assists firms with their strategic planning missions, providing the requisite analysis and tools to help achieve their vision.
6 http://articles.latimes.com/1995-05-07/realestate/re-63288_1_architect-s-ideas-architects-services-homeowner, 1995
7 Blees, Jasper; Kemp, Ron; Maas, Jeroen; Mosselman, Marco (2003). Barriers to Entry. Differences in barriers to entry for SMEs and large enterprises, 43