The threat of a recession, often heard during pre-pandemic months, is no longer a threat. It is real.
According to the National Bureau of Economic Research, the nation’s historic economic expansion—lasting 128 months—is now over after peaking in February. With double-digit unemployment and plunging economic output, the nation has been sliding into a pandemicdriven recession with an “unprecedented decline in employment and production, and its broad reach across the entire economy.â€
Recession is arguably one of the most frightening words any business leader can hear. When the economy turns down, stress levels go up. For engineers, project backlogs decrease or evaporate, client payments slow, and overhead may swell. The end result can be a heaping dose of anxiety, and, in a worst-case scenario, an engineering firm may find itself fighting to survive.
It is no secret that the United States has enjoyed the longest period of uninterrupted economic expansion in history. The last recession occurred more than a decade ago. Yet, warning signs began to appear and the question became not whether the economy will slow, but when.
The onset of the COVID-19 pandemic has further heightened concerns. A survey conducted by the National Association of Manufacturers (NAM) from Feb. 28 to March 9, 2020, found that 78 percent of respondents believe COVID-19 will have a negative financial impact on their businesses. NAM also found that challenging business conditions have led to a historic drop in optimism to 34 percent.
Says Terry Neimeyer, chairman of the board at KCI Technologies, “Firms must plan ahead and have a strategy in place to deal with a downturn when it happens.â€
How can engineering firms best prepare for a recession? What steps can they take to cushion the impact? And what are some of the lessons learned from the previous economic slowdown?
Although there is no one-size-fits-all approach for navigating a recession, there are ways to minimize the pain.
“The firms that engage in strategic planning will be better positioned to ride out the turbulence and build a stronger business over the long run,†says Rod Hoffman, CEO of management and leadership consulting firm S&H Consulting, LLC.
Sometimes the best way to prepare for the future is to look at the past. When the last major U.S. recession occurred—officially from December 2007 through June 2009—many firms were caught off guard as the overall GDP plummeted by 4.3 percent.
“They were sailing along and then, all of a sudden, the downturn hit,†says Steve Gido, principal at financial advisory firm ROG Partners. “The engineering industry essentially suffered a depression and shrunk by double digits over a few years. There were difficult times that included layoffs, office closings, and a dire outlook.â€
At the heart of the problem is basic human psychology—and hesitancy to make meaningful adjustments until it is too late.
“There is a tendency for people to think the good times will continue perpetually. Business leaders often ignore the warning signs when things are going well,†says Bill Siegel, former CEO of Kleinfelder and managing director at consulting firm McMahon|Siegel Group.
During pre-pandemic months, several economic signals were flashing yellow. In 2019, U.S. Treasury bonds displayed an inverted yield curve—meaning that interest rates for short-term bonds exceeded long-term bonds. This method has telegraphed virtually every past recession. Meanwhile, the American Recovery and Reinvestment Act, designed to jump-start the economy, largely failed to make an impact. In fact, the manufacturing sector in the U.S. officially entered a recession in September 2019.
According to Hoffman, changes in GDP activity over the last year correlated with a downturn. An economic study completed in the last recession shows a 0.96 r-squared correlation of engineering fees with GDP change, three times the effect, two years in advance. The GDP change from 2018 to 2019 was -0.4 percent. This predicts there will be a -1.2 percent change in net engineering fees in late 2021.
Since the pandemic appeared, the engineering and construction industry has taken notice. A PwC Pulse survey conducted in April 2020 found that 41 percent of respondents in the engineering and construction industry reported that COVID-19 will have an impact on their workforce and possibly reduce their productivity.
Meanwhile, 40 percent said they expect to see a decrease in demand, 23 percent expect supply chain disruptions, and 19 percent believe they will have difficulties with funding.
According to the survey, “The most immediate impacts are being felt at the subcontractor middle market of the industry, as the specter of potential widespread construction site shutdowns loom.â€
On the other hand, interest rates remain low and the stock market remains relatively strong. “The outlook is very nuanced,†Gido says.
“It is wise to be on the defensive and fully understand how your business and labor requirements change. It is very easy to go out and overhire during a boom.â€
TERRY NEIMEYER
CHAIRMAN OF THE BOARD
KCI TECHNOLOGIES
In December 2019, Bloomberg predicted that the probability of a recession within 12 months was 30 percent. Others, using different models, had tossed out odds of 70 percent or higher for the next year or two.
“There is a need to conduct overall strategic business planning but also engage in specific recession and scenario planning,†Siegel says. “The latter specifically looks at the extent of an economic downturn, how it will impact a business, and how to course correct based on different circumstances.â€
While no one can predict how broad and deep the recession might be, there is little doubt that the pain will be palpable for engineering firms. According to the U.S. Bureau of Labor Statistics, the A/E industry lost roughly 95,000 jobs during the 2008 and 2009 economic downturn. During the same period, the U.S. Department of Commerce reported that spending for private commercial construction dropped more than 20 percent.
A starting point for coping with a recession is to operate as if a recession may be around the corner, says Bob Pence, chairman of the board at Freese and Nichols. Analysis and number crunching are critical.
“Review your efficiencies in operations and corporate support and make sure they are adequate but lean,†says Pence. “Revisit the initiatives the firm is engaged in and make sure they make sense and that the upside is commensurate with the risk. Review your corporate support ratios of staff supported per corporate staff and that they are aligned with industry. Take a hard look at your booking projections by client, and shore up any areas of concern. Balance your hiring with your backlog and maintain your backlog at least at 110 percent of staffing.â€
In fact, staffing is among the critical considerations during a recession.
“While ongoing shortages of skilled engineers are a problem for the industry, things can whipsaw quickly during a recession,†Neimeyer says. “It is wise to be on the defensive and fully understand how your business and labor requirements change. It is very easy to go out and overhire during a boom.â€
When the last major U.S. recession occurred—officially from December 2007 through June 2009—many firms, including engineering, were caught off guard as the overall GDP plummeted by 4.3 percent
One way to diminish the uncertainty is to establish a flexible workforce. This includes using independent contractors and flex employees for specific jobs, tapping retired engineers part time, and implementing voluntary job sharing. The least beneficial approach is laying off engineers and key staff.
“This impacts the future performance of the company,†Pence says.
During past recessions, firms with different geographic and greater sector exposure fared better than less diversified counterparts, according to Hoffman. However, diversification needs to be addressed well before a recession strikes.
“Right before a downturn is often the most expensive time to acquire a firm or talent. The market tends to be overvalued,†Hoffman says.
An advantage for firms equipped to deal with a recession is that they may be able to acquire other firms at a significant discount when prices drop.
“It takes a couple of years to build talent or integrate an acquisition. It must be part of a broader strategic arc,†Neimeyer says.
“Business leaders often ignore the warning signs when things are going well.â€
BILL SIEGEL
MANAGING DIRECTOR
MCMAHON|SIEGEL GROUP
When a recession strikes it is easy to get caught up in the carnage and allow fear to run rampant. Just as investors stubbornly cling to stocks in a bear market and then sell at the bottom of the market, engineering firms can slash costs too deeply, sell off assets below market value, and make myriad other bad decisions as things worsen. It is also easy to get sloppy about business processes, costs, collections, working capital, and more when times are good. Once a recession starts, it is tough to reel in the excesses.
For example, collecting on aging receivables can prove frustrating, if not impossible, when others are reeling from the downturn. The resulting cash crunch can magnify operational and staffing problems.
For engineering companies, a 10 percent drop in revenue typically results in a 50 percent decline in profits, according to Pence. The ripple effect quickly becomes obvious.
“This will impact the firm’s ability to reward staff. This can result in a further erosion of the quality of the staff. It can seed a concern among employees that the leadership is not on top of things, and all of this can erode confidence,†Pence says.
During a recession, focusing on employees and clients, as well as addressing cultural issues, is imperative, according to Hoffman. This includes communicating with people honestly. “Uncertainty breeds fear and it undermines performance,†Hoffman says.
In the end, the right blend of long-term strategic planning and specific scenario planning in advance can keep a firm on course—even under the most difficult conditions, such as the current pandemic. While there is no way to eliminate the anxiety and pain, minimizing them is possible.
“You have to understand how to adjust to a recession, plan for different scenarios, and understand how to react if and when they occur,†Siegel says. “If you have a plan in place, you will have the information you need to make the adjustments you require. You will be equipped to deal with whatever comes your way.â€
Samuel Greengard is a technology writer based in West Linn, Ore.
It is not enough to have a business plan; you need to develop a recession plan that specifically deals with a downturn. It should focus on key operational elements and risk factors.
Be careful not to overhire prior to the recession. Look for ways to create a more flexible workforce. This may include voluntary job sharing and incorporating part-time retirees and independent contractors.
Real estate is among the costliest items for a business. It is also tough to cut costs until a lease runs out—and subleasing space is tough in a recession. Examine your office space, especially during this time when working remotely is quickly becoming a component of the new business normal, to ensure you will not wind up with overcapacity. If space is tight, consider office sharing and increased telecommuting programs, at least over the short term.
It is easy to overlook information technology, but more efficient systems can squeeze out costs. This includes project management software, accounting systems, human resources, and emerging digital technology.
Don’t become lax about bills and collections. In some cases, it may be advantageous to push income into the next year. But during a recession, these bills may become impossible to collect on, thus leading to a cash crunch.
A good marketing pro-gram can pay enormous dividends during a down-turn. When a downturn takes place firms move into a market share fight. Those with a strong marketing focus are at an advantage.
Fear and uncertainty rule during a recession. Stay calm and avoid impulsive moves when problems occur. This sets a tone for the firm. Also, communicate with employees and provide honest appraisals of where the firm is at and where it is going.