Five ways that inflation could be eating away at your firm’s growth and what you can do about it.
Now that Fed Chair Jerome Powell has officially retired the word “transitory” from describing the current inflation situation we have going on, principals in the AEC industry need to take a step back and decide what this really means for their firms. Being in the professional services industry leaves us in a strange predicament where we can’t just raise our rates the way companies in the consumer market can. Simultaneously, our firms are made up of people who do feel the effects of inflation and need raises to combat it. At the same time, rent, fleet/crew vehicles, gasoline, and powerful computers are getting more expensive. The latest number I’m sure we’ve all heard is 6.8 percent inflation for goods and services on the Consumer Price Index.
While a principal might be inclined to argue that their customers aren’t “consumers” for the most part, inflation can most definitely affect your firm in other ways, such as:
- Service rates. A good portion of the AEC industry works on fixed hourly rates or a lump project cost. Think about how you come to these rates and when the last time they were increased was. While it isn’t ideal to get a client to agree to a rate increase halfway through their project, you can set the expectation that you will have to increase your rates to keep up with market forces prior to the next time they do business with you. If you do a good job and they like your firm, they’ll likely be fine with this.
- Staff salaries. While your firm’s clients may not be consumers, your staff most definitely are, and you can bet they’re feeling the effects (especially if your firm is based in a major metropolitan area). If you’re not proactive, this is one of those things that can sow real distrust between your staff and management. It’s all over the news and they can see it the same way you can. Don’t ignore this and try to stay on top of yearly cost of living raises at the very least. Being proactive about this will likely earn you major points with your employees from a recruiting and retention standpoint as well. At this point you will likely need to consider raising your rates on new projects, which should be fine, as your clients are people who are almost definitely feeling the same pressures you are. As I outline below, there are also ways to protect against inflation during a contract as well.
- Growth rate. In order for your firm to not eat into its working capital more and more every year, you need to keep an eye on the growth rate of your firm. If you aren’t growing at least as fast as the core inflation rate, you’ll likely start seeing more decreases than increases in your month-to-month working capital.
- Fixed cash payments over time as part of M&A deals. While getting to the end of an M&A deal is exciting and the rewards are often bountiful, don’t let yourself forget about money you could be potentially losing through a fixed cash payment scheduled for a few years down the line. If this earn-out is not adjusted for inflation then you’re quite simply not getting the full value you agreed on. It could very realistically mean the difference between the base model C8 Corvette or that shiny new Z06 Corvette. It’s your choice!
- Lump sum/guaranteed max price contracts. After the crazy fluctuations in building material prices this past year I’m sure this one is near and dear to many hearts. With inflation expected to continue climbing, along with continued supply chain shortages, make sure you are protecting yourself in your contracts with verbiage that is inclusive to nonstandard inflation and materials rates. While a court will likely side with you most of the time if it gets to that point, who has time to go to court? Something worth noting however, is that while those in lump sum contracts may feel pressure during this time, those on percentage of construction cost contracts will automatically earn more. This may be worth looking into for future projects and discussing with your development partners.
These are just a few of the ways that inflation could be eating away at your firm’s growth in the background. Luckily though, we’re faced with this problem in a historic bull market for our industry as a whole. Use this time of record backlog and infrastructure bill work to get your firm inflation proofed. Those who are proactive on this issue will likely come out the other side (when inflation slows down) able to charge higher rates, with less employee turnover, and with better margins. The tides are high in the AEC industry right now but they likely won’t be forever. Don’t let your firm get left high and dry once tides return to more normal levels!
Will Anderson is a mergers and acquisitions analyst at Zweig Group. Contact him at wanderson@zweiggroup.com.
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