Zaid Rahman is founder and CEO of Flexbase, an automated payment platform for the construction industry. Opinions are the author's own.
While the construction industry may have weathered the COVID-19 pandemic better than others like retail and hospitality, 2020 was still far from an easy year — with millions of lost construction jobs, disrupted supply chains and stalled projects.
The good news is there are some positive economic indicators on the horizon. The Federal Reserve expects the U.S. economy to grow by 7% in 2021, and historically construction has been a major contributor to this economic growth. The industry currently has several strong tailwinds at its back, including a booming housing market with an upsurge in housing starts; a bipartisan, $1.2 trillion infrastructure plan passing the Senate; and overseas businesses expanding rapidly into the U.S., which is likely to give commercial construction a boost.
Just don't expect any of it to come easily, especially for small- and mid-sized (SMB) construction companies. While recovering from the pandemic is creating a wealth of new opportunities, these companies also face significant challenges:
- Hyperinflation: Economists are bracing for what could prove to be the strongest period of inflation in decades, as the combination of a swift re-opening and trillions of dollars in stimulus are expected to lift prices at their fastest rate in recent history. As a rule of thumb, a standard inflation increase of around 2% per year drives a significantly larger increase in construction materials costs.
- Material and labor shortages: According to recent statistics, the surge in lumber prices this spring led to a $36,000 price increase for the cost of building a new home. Prices for many types of materials have skyrocketed as a result of shortages over the past year, including PVC pipe, steel, plywood and more. Construction labor costs also rise faster during periods of high inflation. Taken together, this has the potential to put many SMB construction companies out of business.
- Public projects: Many SMB construction companies have their eyes set on the bipartisan infrastructure plan, which is being heralded as a "once in a generation investment in America." But these companies will have to be careful; public projects don't offer the same financial protections as private projects, such as the ability to place a lien when an invoice is late or not paid. Also, many public projects do not offer cost escalation clauses in their contracts — meaning they won't help absorb unexpected increases in materials costs. This may leave a construction company scurrying to find suitable substitute materials, which, of course, delays projects and decelerates cash flows. Generally, government agencies are aware of the financial insecurities SMB construction companies face, which is why larger companies often get the first shot to bid on public projects, whereas SMBs often don't even get a chance.
So what can be done? A look back at the 2008 recession provides some answers. Construction companies that came out furthest ahead after that crisis invested heavily in digital technologies and cleaned up their balance sheets, according to McKinsey & Company. It's all about getting one's financial house in order.
In a post-pandemic era, SMB construction companies are going to need to follow suit. First, they must embrace digitization and automation, doing away with time-consuming, manual paper-based invoice processes. This is the key to getting paid on time and staying cash-flow positive, which means not only having cash on hand to bid on more projects, but also making more timely outflows — including paying workers on time and helping these SMBs negotiate more advantageous contracts with suppliers.
Second, SMB construction companies desperately need easier and faster access to capital. Banks are looking to expand their construction portfolios as a high asset class. As a category, construction companies with annual revenues of $10 million to $12 million are severely underbanked. There is an excellent opportunity to bring these two together, while creating a more level playing field for SMB construction companies. But banks will need reliable insight into SMBs' financials — beyond just the owner's credit — in order to proceed with confidence, and that means having access to digitally accessible, well maintained books.
The construction industry is highly segmented and specialized, which means payments must often pass through a crazy maze before reaching their intended recipients. This is a primary reason this industry has long struggled with slow cash flows and continues to do so today. While the nature of the industry can't necessarily be changed, it can certainly be managed better.
This, combined with better banking access, will be the keys to SMB construction companies overcoming financial challenges and better managing risks, thus positioning them to capitalize on the current upswing.