After the Global Financial Crisis: Growth and Ownership Transition Strategies for AE Firms

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1 After the Global Financial Crisis: Growth and Ownership Transition Strategies for No longer able to cut their way to profitability, experts point to project profitability and financial management controls Contents 1 Executive Summary 1 The Cost Cutting Party is Over 2 Top 5 Project Management Practices 3 Knowing Your Numbers 4 Ownership Transition 5 Summary Executive Summary With years of economic turmoil behind the AE industry, firms have taken numerous precautions to weather the storm. Understandably, slow industry growth and increased market competition has forced many firms to slash costs. The challenge moving forward, experts say, is that the cost cutting party is over. Simply put, the days of firms cutting their way to profitability are over. So how can AE firms position themselves for future growth and meet the challenges of potential ownership transitions? To help shed insight on this growing trend, this White Paper provides expert opinions from Deltek, Rusk O Brien Gido + Partners and DiCicco Gulman and Company (DCG). The overwhelming consensus amongst the these AE experts is that today s success-minded firms require a laser-like focus on strong project and financial management practices the kind that can carry their long-term growth goals to fruition. With the next decade posing as the most demographically challenging for firms looking at potential ownership transisitons, this advice becomes even more critical; putting strong financial controls in place now is an important ingredient to ensuring that your firm has a successful ownership transisition in the future. The Cost Cutting Party is Over Over the past 5 years, the trend within AE firms has been to cut the fat in order to match the high pressures of economic declines. While firms across the nation have been cutting their payroll and expenses, they have also competed with a higher emphasis on attractive price rather than increased value. Yet, as well intended as these strategies were, these initiatives have made it even more challenging for firms to deliver projects profitably. For many firms coming out of the recession, project management is not what it used to be, says David Sullivan, Partner at DGC. Put another way, Sullivan adds, Firms have gotten away from project management best practices. Now that growth is on the horizon, Sullivan continues, Project Managers are faced with not having access to the same level of resources and support that they are used to. Though firms should still take care to tighten their belts against the uncertain economy of the future, they need to begin reinvesting in their firms again. Coming out of the recession, every firm has focused on marketing and business development, which has put some significant downward pressure on pricing, Sullivan continues. Unfortunately, this has caused many firms to sell themselves short, and in some cases, pressured 1

2 experts emphatically point to the importance of every single project contributing to firm-wide profitability. firms to enter into long-term contracts that end up being loss contracts. This service model makes it almost impossible for Project Managers to turn around a profitable project. Top 5 Project Management Practices Following the Global Financial Crisis, experts emphatically point to the importance of every single project contributing to firm-wide profitability. To achieve that, they recommend the following 5 top Project Management practices. 1. Financial Oversight of Project Results Out of the top 5, I would say that financial oversight and project communication are the most important of all, says Sullivan. This doesn t mean having just a finance person looking at the project results, but making sure the Project Managers understand the financial status of the project and its impact on the company. When it comes to project communication, it means communicating the project status to the client, subcontractors and the entire project team that is involved. Ensuring that the Project Managers are knowledgeable about a project s finances can lead to a number of benefits across the enterprise, including: The ability to price jobs better Identification of the areas of business that need improvement and what types of projects the company generates the most profit from Stronger Project Manager contribution to the overall profitability of the firm 2. Regular Percent Complete Calculations This method of accounting is required for virtually all long-term contracts, and means that firms have to understand both what their project costs are at any given time, and what their total estimated costs are expected to be. Revenue and costs are then reported, based on how far along a firm is within their project. Often times, what you bill and how you bill does not always follow the percent complete, says Sullivan. Estimating your costs through to the end of a project requires having set budgets in place right from the beginning, and ensuring that the right data is available to all people on the team. 3. Out of Scope Management Also referred to as scope creep, out-of-scope management refers to the fact that projects can have many different phases, all of which are prone to widespread design changes. By setting expectations regarding the scope of the project up-front, Project Managers can effectively eliminate the potential for its firm to move into a grey area when changes arise wherein neither the firm nor the client is in agreement about strategy, timing or pricing. 4. Consistent Backlog, Reporting, Monitoring and Updating A well-managed firm is constantly looking at their backlog and monitoring project performance, Sullivan notes. These firms have a full picture of both their projects in process and what is in their pipeline that they need to be ready to manage. Executed correctly, Project Managers are involved in this process, and project performance is constantly evaluated to ensure maximized project profitability. Additionally, firms who are geared towards success in the upcoming years need to make it a priority to have a comprehensive staffing plan and strategy one that will ensure they not only have enough people to service the work, but also that they have the right people to help grow the firm and remain ahead of the competition. 2 deltek.com

3 It s important for goaloriented AE firms to recognize where they should be hitting when it comes to key metrics. 5. Project Management Training and Development While firms have cut costs, they have also deemphasized Project Management training. By getting back to developing a culture of Project Management, AE firms ensure that their most important assets their people resources understand the underlying purpose, skills and profit-increasing techniques associated with good Project Management. Unlike a lot of topical tips and tricks that industry experts focus on, investing in proper training and development is a method that guarantees better Project Management for the long-term, says Sullivan. By creating a culture of Discretionary Pre-Tax Profit (as a percentage of net service revenue) Project Management excellence, firms will be able to realize consistent, meaningful profitability for years, or even decades, to come. Knowing Your Numbers All Project Management best practices mean nothing without the strong financial control and understanding to keep your firm ahead of the competition. With this in mind, it s important for goal-oriented AE firms to recognize where they should be hitting when it comes to key metrics. Below, we demonstrate the measues and overhead cost rates that firms should attempt to meet, in order to achieve and sustain significant growth in 2013 and beyond. A typical level of discretionary profit ranges from 8-12% Well-managed firms target 15% or more Utilization Rate: equated as the chargeable labor costs divided by total labor cost Should be targeted for around 60% or higher Labor Multiplier: the net service revenue divided by chargeable labor costs Typical is between Revenue Factor: Net service revenue divided by total labor costs Typical is between 1.7 and 1.8 Overhead Rate: total overhead expenses divided by direct labor costs Typical is between 1.5 and 2.0 9or 150%-200%) Days Sales Outstanding(DSO): Accounts receivable divided by annual gross revenue, multiplied by 365 days Typical is between 50 and 70 days 3 deltek.com

4 Having solid, visibile historical performance information allows for more accurate project pricing and budgeting.»» Ian Rusk, Managing Principal, Rusk O Brien Gido +Partners Having solid, visibile historical performance information allows for more accurate project pricing and budgeting, says Ian Rusk, Managing Principal at Rusk O Brien Gido +Partners. What s more, it really has a positive domino effect. Project Management processes and controls that keep projects on budget allow firms to hit their target labor multiplier, and resource management and overheard management keep utilization rates and overhead costs on-track. When combined, these all assure strong and sustainable profitability across the firm. Predictive metrics are also critical to the health of AE firms. Specific data that Rusk advises firms to look for includes: Project backlog (net fee value of all projects under contract, less amounts already billed) New projects sold (net fee value of all projects added to backlog over a period of time) New project proposals (net fee value of all proposals made over a given period of time) New project inquiries (# and approximate net fee value of all inquiries for new projects over a given period of time) Strong financial controls are absolutely critical for long-term growth, says Rusk. With cost-cutting off the table and potential ownership transitions as a very possible challenge over the next ten years, your firm needs to be sure they have a solid understanding of both its historical and predictive performance data. Ownership Transition Besides the economic headwinds causing relatively slow growth and high competition within the industry, owners of today s AE firms are facing never-seen-before challenges of ownership and leadership succession. Rusk notes that this is partly due to the demographics of the next ten years, as more people will be within the age group range, and less in the age group. We re going to see a lot of personnel in the AE industry creep closer and closer to retiring age, without having a lot of other people who are going to be in a position to take over the reigns of a company, says Rusk. Basically, we re going to see more people trying to sell and less people trying to buy in. Without the surplus of buyers that the AE industry had before, it s going to be up to the firms themselves to make sure they are financially attractive enough to grab the attention of the few investors around. Whether your firm is positioning itself to attract internal or external investors, you can be sure that buyers are going to want a lot of confidence in their investment. Rusk explains further, stating, For owners, putting strong controls into place will improve the odds for a successful transition in the future. To be looked at more favorably by potential buyers, your firm needs to exhibit the attributes below. Strong and consistent profit margins Though strong profit margins goes without saying, most firms overlook how important it is to demonstrate consistency in their profitability. Not only will it increase the overall value of your firm, but it will show buyers that they can invest in your firm with less risk and better confidence for future cash flow. Strong and consistent cash flow also increases shareholders return on investment, making your firm s stock an attractive investment alternative to potential buyers, Rusk says. Investors will be more inclined to think that your stock is a good place to park their money compared to other investment choices, increasing your all-over attractiveness as a company for purchase. 4 deltek.com

5 AE firms need to move beyond trimming overhead costs to ensuring that projects are contributing positively to their overall profitability. Timely and detailed financial reporting Accurate, timely financial reporting and forecasting inspires investor both internal and external confidence, states Rusk. That s why it s so important that firms looking to transition internally practice Open Book Management, to give confidence and insight to those who may be rising up within the ranks of your firm. Good cash flow and a healthy balance sheet Demonstrating a healthy balance sheet, with very visible cash flow, increases credit-worthiness and debt capacity, Rusk continues. By managing and monitoring healthy balance sheets, your firm makes leveraged buy-outs more feasible, removing a lot of the challenges that might deter an external investor from moving forward with your firm. Summary The economic climate is going to remain challenging for the forseeable future, and will continue to impact firms expansion goals and successon planning for the next ten years. With a long, slow climb to industry-wide growth ahead, AE firms need to move beyond trimming overhead costs to ensuring that projects are contributing positively to their overall profitability. Equally as important, firms requre sound financial management and controls to help them maximize profit margins and stay attractive to potential investors. The party is really over when it comes to cost cutting, says Sullivan And the first step towards financial stability in the current landscape is to ensure that your firm is managing and executing profitable projects. By redirecting their focus to profitable projects and implementing Project Management best practices, firms will be equipped to succeed, despite the challenging AE landscape. Additionally, it s now more important than ever to ensure accurate financial reporting, as it facilitates good overall decision making and planning, Rusk continues. By effectively tracking project progress, backlog and other predicitive measures, firms guarantee better and more consistent profit margins attracting investors and guaranteeing your firm s long-term growth and success. 5 deltek.com

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