How Business Cycles Affect Construction Firms

shutterstock_800415Small construction companies react differently to economic conditions than their larger counterparts, according to a study by the U.S. Small Business Administration. The study found that smaller construction firms experience a greater negative impact during recessions and a greater positive impact during expansions

The SBA looked at how different firms fared during the ups and downs of the economy in the past 50 years. Here are some of the details of the study, titled Small Business During the Business Cycle:

The entire construction industry grows more than other industries during periods of economic expansion and falls harder when the economy contracts.

However, small firms lose more in a slump, primarily because of their size and stability. Larger companies can usually manage by laying off employees, but small firms may be supplying the larger firms and are less able to downsize.

The construction industry is significantly affected by interest rates.


Obviously, when the economy is booming, consumers and businesses are more likely to add on, renovate or build new homes and buildings. But interest rates are an important factor. Residential construction boomed in the first few years of the millennium, even though the economy was slow, due largely to low interest rates.

Both large and small construction firms can quickly ramp up when the economy expands, but the smaller ones have an edge.
 
Bigger companies are easily able to give employees additional hours and higher overtime pay to meet additional business demands. They can also add employees and general contractors.

However, smaller firms can expand even more quickly because there are fewer decision makers involved in bidding on and accepting projects. Fewer people and a smaller infrastructure (such as workshops and tools) mean there are less changes necessary to take on new projects.


Another reason smaller firms show faster growth is purely mathematical: A $100,000 company that adds $10,000 grows 10 percent. That same total dollar growth for a $1 million company is 1 percent.

The ability of small firms to handle the economic cycle can depend on the larger companies.

Consumers and businesses control spending more tightly during a slump and resist major expenditures if their own incomes look shaky. As work dries up, the larger construction companies and general contractors don’t have jobs to outsource, leaving small companies that depend on subcontracting scrambling to find work. On the other hand, in an upturn, the larger companies can hire smaller companies as subcontractors on some of their lower-margin jobs.


Small firms have less pricing flexibility.


A large construction firm might be able to survive while losing a handful of accounts and might be able to cut prices to keep others. The small construction business doesn’t generally have this luxury. Without as many accounts, any losses are more noticeable, and there isn’t a lot of “wiggle room” in pricing.

 

Final Word: Wages and benefits rise and fall more rapidly in construction than in other industries as the economy goes up and down. Protect yourself by taking steps during the good times.

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