2010 State of the industry report

December 2010 » Exclusive
An analysis of civil engineering performance through the recession, plus predictions for 2011.
Christopher Frangione

Every industry has been affected in one way or another by the economy in the last few years. So when it comes to the civil engineering industry and all the sectors it encompasses — including transportation, power, environmental remediation, and water infrastructure — it’s important to take a close look at how it’s changed in recent years. In this article, Farkas Berkowitz & Co., a management consulting firm serving companies that provide design, construction, and operational services for government and industry, details the current state of the civil engineering industry, and its future.

Design market overview
Design and construction markets related to environment, infrastructure, and facilities contracted in 2009; however, these markets will bottom out in 2010 and enjoy at least modest growth in 2011, according to data compiled by Farkas Berkowitz & Co.

Designers for transportation, power, water infrastructure, environmental remediation, and facilities saw their U.S. billings plummet 12 percent in 2009; construction firms serving these same markets saw their markets fall roughly 7 percent.

Ninety-one percent of design and construction companies took special measures in 2009 to maintain profitability in the face of declining revenues, according to Farkas Berkowitz & Co.’s proprietary online survey of 85 CEOs and other executives serving the design and construction industries. Eighty-four percent laid off professional staff; 57 percent made marketing more productive; 50 percent closed marginal offices; 45 percent exited marginal businesses; 40 percent “fired” unprofitable clients; and 32 percent reduced fringe benefits. In 2010, these firms also undertook initiatives designed to position them for the recovery, with 84 percent intent on further improvements in sales and marketing. More than 50 percent of surveyed firms intended to make organizational changes, conduct strategic planning, provide leadership development training, and make at least one acquisition before the end of the year.

Improved backlogs suggest that many firms started seeing signs of recovery in late 2009. Fifty-five percent of surveyed firms saw increases in backlog during 2009 versus 42 percent who saw increased backlog in 2008. Conversely, only 17 percent reported a decrease in backlog in 2009, while 39 percent reported lower backlogs in 2008.

In spite of improved backlogs last year, only 19 percent saw an upturn in their principal markets in the first half of 2010; 38 percent were expecting improvement in the second half of the year; and 43 percent do not expect to see their markets improve until 2011 (see Figure 1).

Figure 1: Forecast of timing of upturn in principal markets
Source: Farkas Berkowitz & Co. CEO Survey, 2010

Transportation engineering and construction
The transportation engineering market contracted by 2 percent to $10.7 billion in 2009 (see Figure 2). Farkas Berkowitz & Co. expects the overall transportation market to edge slightly lower in 2010 due to continued weak state and local government spending. As state and local budgets begin to recover in 2011, the company expects to see the market grow again. A reauthorization of the federal surface transportation law in 2011 would have the impact of generating strong growth by the second half of 2012.

Figure 2: U.S. transportation engineering market
Actuals based on ENR Top 500 Design Firm Survey for 2009; forecasts by Farkas Berkowitz & Co.

Highway and bridge — The highway/bridge engineering market shrank by about 4 percent in 2009 due to depressed state and local spending. This is the first time the engineering market for highways and bridges contracted in 10 years. Highway construction, however, increased 3 percent, according to U.S. Department of Commerce statistics on construction put in place. The construction increase was due to the American Recovery and Reinvestment Act (ARRA). Without stimulus spending, according to the American Road and Transportation Builders Association, there would have been a decline in highway construction of 5 to 7 percent.

According to the Congressional Budget Office, roughly 40 percent of the nearly $27 billion in stimulus funding will be spent in 2010. This should have enabled highway/bridge construction to climb further this year. Engineers saw modest stimulus dollars, but the stimulus dollars that engineers did see were related to construction only. Although contractors are the principal beneficiaries of stimulus spending, the invasion into this market sector by refugees from weak facilities markets is generating cut-throat price competition — projects are often being let 10 to 30 percent below the engineers’ estimates according to the American Association of State Highway and Transportation Officials.

The near-term future of the highway/bridge market depends greatly on whether Congress is determined to see the federal government continue to shoulder major financial responsibility for surface transportation. Currently, federal grants are flatlined until reauthorization because the federal law expired on Sept. 30, 2009. While Congress has passed numerous short-term extensions to keep the funding in fiscal year (FY) 2010 at the same level as FY 2009, participants should not expect to see a windfall in 2011. Obama’s 2011 budget proposes keeping the funding essentially flat by increasing the funding by a mere 0.6 percent. The prospects for seeing a significant increase in federal highway grants to states anytime soon is bleak. The one shining light is that the president made infrastructure a top priority in a speech on Labor Day in Milwaukee.

Farkas Berkowitz & Co. expects the highway/bridge market to be flat through 2010 and then have modest growth of around 2 percent in 2011.

Design-build continues to gain in popularity and has become the project delivery method of choice, particularly for large projects, wherever it is permitted. Meanwhile, Farkas Berkowitz & Co. continues to be pessimistic regarding the prospect that public-private partnerships will have a significant impact on the market during the next five years.

Rail and transit — Transit design and construction were by far the strongest transportation segments in 2009. Farkas Berkowitz & Co. estimates that the transit design market grew by about 5 percent in 2009, while the construction market jumped by 24 percent, according the U.S. Department of Commerce. Heavy rail design and construction was flat in 2009 after enjoying strong growth in 2008. Farkas Berkowitz & Co. predicts the railroad market will recover in 2011 thanks to the increases being seen in freight rail and to the $2.3 billion in grants to be provided by the Federal Railroad Administration.

The Obama administration embraced high-speed rail in 2009. Not only did the administration include $8 billion in grant funds under the ARRA, but it also promised continued support in the form of $1 billion in grants for each of the next five years. While most participants in the rail market question how much high-speed rail the public will actually see, engineering firms are moving at lightning speed to cash in on this bonanza with glossy high-speed rail brochures and newly minted corporate officers with “high-speed” in their titles.

Airport — The airport design market was flat in 2009 after growing at about 5 percent annually during the three prior years. There were a paucity of attractive opportunities in 2009, and those that did come up for bid were often delayed. International markets have friendlier skies, with the Middle East offering the most attractive foreign market. Farkas Berkowitz & Co. expects the U.S. market to be depressed for the next two years.

Port and harbor — Engineers serving the ports and harbors market saw the flow of opportunities slow in 2009 after enjoying six consecutive years of double-digit growth. With U.S. imports down 26 percent in 2009, port operators tended to slow down ongoing expansion efforts and delay those that had not yet been initiated. In the first quarter of 2010, there was not a significant uptick in opportunities in this segment; but increasing container traffic should quickly return this market to strong growth.

Figure 3: U.S. power engineering market
Actuals based on ENR Top 500 Design Firm Survey for 2009; forecasts by Farkas Berkowitz & Co.

Power engineering and construction
The U.S. power engineering market decreased 18 percent in 2009 to $5.4 billion (see Figure 3). Power engineering is a two-tier market, with engineer-procure-construct firms in the top tier and everyone else in the bottom tier. The top-tier companies participate in the design of base load capacity, while the bottom tier design peaking plants, substations, transmission and distribution systems, and assist with environmental permitting and assessment of new energy facilities. These two tiers fared very differently in 2009. The top 15 firms in power engineering design saw revenues recede by more than 20 percent, while all others enjoyed an average revenue increase of 14 percent. Overall, Farkas Berkowitz & Co. forecasts that the power engineering market will plateau at $5.4 billion this year and enjoy a 15 percent growth rate in 2011.

The power construction market grew 11 percent to $89 billion thanks to the momentum of the coal-fired power plant build-out. That build-out accounted for a 78-percent surge in construction put in place during 2007 and 2008. With that momentum now abating, Farkas Berkowitz & Co. projects a shrinking power construction market during the next two to three years.

The decline in power engineering revenues was due, in part, to a weakening of electricity demand. The U.S. Energy Information Administration (EIA) reports that electricity output dropped 3.7 percent in 2009 — the steepest drop since 1938 — after sliding nearly 1 percent in 2008. Some utilities reported demand was down as much as 15 to 20 percent in 2009 due to both a decline in manufacturing and a milder-than-normal summer.

The huge expansion in the estimate of natural gas reserves in North America will change energy calculus for years to come. The estimate for natural gas reserves in the United States has doubled during the last three years thanks to the growing recognition that it is now feasible to drill for natural gas in shale deposits. The return of natural gas as the ”fuel du jour” will further dim coal’s near-term future and also limit the recovery of the power engineering and construction markets. Capital expenditures per kilowatt hour for natural gas are three to four times less than that of coal and the lead times required are half as long, enabling utilities to delay capacity expansion. If these shale gas discoveries stabilize the price of natural gas at $5 to $8 per million BTUs, as forecasted by the EIA, natural gas could also limit the future use of renewable energy and nuclear energy.

Nevertheless, green energy is continuing to advance. Although there was a lull in new wind and solar starts in most of 2009, engineers are now enjoying growing wind and solar markets. Additionally, there was no pause in the growth rate of transmission line work. Farkas Berkowitz & Co. estimates that double-digit growth continued unabated in 2009.

Nuclear power also continues to advance. President Obama has clearly embraced nuclear power by proposing an additional $36 billion in loan guarantees as part of his FY 2011 budget. The Shaw-Westinghouse joint venture is expected to begin construction in the fall of 2011 on two nuclear power projects. By 2012, nuclear power will provide a significant boost to the power construction market.

Figure 4: U.S. environmental remediation consulting market
Actuals based on ENR Top 500 Design Firm Survey for 2009; forecasts by Farkas Berkowitz & Co.

Environmental remediation consulting and engineering
The overall environmental remediation consulting and engineering market fell 13 percent to $5 billion in 2009, after climbing 12 percent in 2008 (see Figure 4). The top five firms in this market fared much better than their smaller competitors. The top five firms saw their aggregate revenues ebb just 2 percent, while all others saw revenues sink by 17 percent. There has been significant consolidation in this market segment. Three years ago, the top five firms represented just 35 percent of the market. Today, they represent 47 percent. Farkas Berkowitz & Co. believes that the recession will further this consolidation trend as smaller firms are acquired by larger ones or close their doors.

Reviewing the industrial remediation and environmental compliance market, Farkas Berkowitz & Co. estimates that both industrial remediation and environmental consulting contracted last year by roughly 10 percent. The conditions worsened throughout 2009 and bottomed out in the first quarter of 2010. Two of the principal drivers of remediation spending — mergers and acquisitions and brownfield development — were absent in 2009. Fewer mergers and acquisitions resulted in fewer transactional cleanups. Brownfield development ended as a result of the real estate crisis. In addition, the recession slowed discretionary cleanups. Only the fourth driver, enforcement-driven cleanups, continued in 2009 and the beginning of 2010. Fortunately, the mergers and acquisitions market is roaring back with an aggregate of $130 billion in deals completed in 2010 through mid-April. This augers well for the industrial remediation market.

Major industrial firms took advantage of the buyers’ market last year by re-competing their master services agreements, and in the process of doing so, extracted concessions on price and terms. Owners forced rate cuts of as much as 5 percent, resulting in multipliers dipping below 3.0. These re-competitions also reduced the number of suppliers supporting each firm, resulting in a two-tier structure with a premium being placed on geographic reach. The top tier requires international scope. Farkas Berkowitz & Co. predicts a flat industrial remediation market in 2010, but a return to solid growth of approximately 5 percent in 2011. The company looks to the oil and gas industry to lead the recovery. And long term, stronger environmental regulation and enforcement should bode well for the broad remediation and environmental consulting market.

Department of Defense (DOD) spending did little to offset weak industrial spending even though environmental budgets were up considerably in both federal FY 2009 and 2010. Farkas Berkowitz & Co. estimates that the DOD remediation market declined by 15 percent in 2009. Only participants in the Environmental Protection Agency (EPA) Superfund program saw increased spending in 2009 thanks to an additional $600 million made available by ARRA.

DOD remediation contractors find the current procurement environment at the DOD to be very frustrating. One of the principal reasons for the slowdown in spending is that contracting officers are running scared as a result of reports of alleged irregularities in contracting in Iraq and in response to Hurricane Katrina. The DOD now often rewards firms protesting contract decisions by including them in the winners’ circle. Today, winning a DOD contract is simply a license to bid on task orders. More winners mean more bidders for each task order, and the need to evaluate each and every proposal further slows down the contracting process. Only the Navy has managed to avoid bureaucratic gridlock. In addition, the DOD continues to favor lump-sum performance contracts and pushing greater risk to contractors including being responsible for ultimate regulatory closure of the site. Farkas Berkowitz & Co. finds that “best value” is now always low price and that sole-source awards have disappeared.

The company forecasts a flat 2010 and 2011, mostly as a result of a flurry of FY-end 2010 task orders. In the out years, it looks for a slowly declining DOD market, but expects that the unexploded ordnance/munitions segment will grow.

If the DOD market turned ugly last year and the first part of this year, the Department of Energy (DOE) market is clearly looking good. The environmental management program at the DOE benefited from an infusion of more than $6 billion in ARRA funds, boosting program spending by 50 percent compared with FY 2010 and FY 2011. Major contractor beneficiaries have been CH2M HILL, Fluor, and URS. Contractors at the DOE are benefiting greatly from stimulus spending. However, Farkas Berkowitz & Co. does see the market discriminating against mid-size firms. Large firms have scale and scope advantages and can afford the high bidding costs at the DOE, while small and other special category firms enjoy set-asides.

For the remediation engineering market as a whole, Farkas Berkowitz & Co. forecasts a 5 percent growth rate in 2010 and a 10 percent growth rate in 2011. The company believes that stimulus spending for the environmental management program at the DOE and the Superfund program at the EPA should be hitting the streets now, which will bolster revenues of those fortunate enough to have DOE and EPA contracts. With a recovering mergers and acquisitions market and a strong oil and gas industry, Farkas Berkowitz & Co. expects the industrial market to show growth in the last quarter of 2010, which should continue into next year. Finally, the company is betting that the procurement bottleneck at the DOD will be broken and this will benefit the 2011 market.

Figure 5: U.S. water engineering market
Actuals based on ENR Top 500 Design Firm Survey for 2009; forecasts by Farkas Berkowitz & Co.

Water infrastructure engineering and construction
The water and wastewater design market shrank by 2 percent in 2009. At the same time, the value of construction put in place for water and wastewater decreased by 3 percent, according to Commerce Department statistics. This market fared better in 2009 than any of the other markets Farkas Berkowitz & Co. covers. The company predicts modest growth of 3 percent in 2010, with stronger recovery in 2011. It forecasts a 6-percent growth rate in 2011 for engineers (see Figure 5).

The company also expects that 2010 will be a mirror image of 2009. Engineers enjoyed a decent market in the first half of 2009, but in the second half, the market sunk. Those that participated in the Sun Belt states were hit the hardest with some firms reporting revenue decreases of greater than 10 percent. Relationships are becoming more important than ever, and local offices are becoming a prerequisite for winning work again. In these austere times, clients like to know that the money they spend will be reinvested in the community in the form of sales taxes, income taxes, or property taxes.

Participants have hope that the Obama administration will help the market during the mid-term. The EPA has already begun to develop stricter regulations for coastal waters that will impact dischargers in Florida and has announced that it wants to update the Clean Water Act. Participants also expect to see opportunities at DOD installations.

Engineering-led design-build projects reversed flow in 2009. The engineer-led design-build market shrunk by more than 10 percent in 2009. Every participant could point to cancelled or delayed projects and the once rapidly growing markets in Arizona and Florida screeched to a halt. Farkas Berkowitz & Co. expects that the market will recover in 2011. Once municipalities manage their financial situations, the design-build market will grow rapidly. A lot of pent-up demand exists, and design-build is a delivery method that has the potential to reduce schedules.

In some areas of the country, design-build projects morphed into design-bid-build projects. Some municipalities wanted to reap the benefits of the competitive construction bidding environment. In addition, by going design-bid-build, the municipality can include more local contractors and engineers. This trend is not expected to continue.

Water public-private partnerships — Based on a survey recently reported in Public Works Financing magazine, the water public-private partnership market has remained essentially constant since 2005, at just under $1.3 billion.

Inquiries seem to have increased significantly in 2010, with many of these being design-build-operate. In addition, participants are adapting to the stagnated market by expanding the range of services they provide. Participants are offering other municipal services, doing tank maintenance, and entering new geographies.

In addition to adaptation by market participants, the report noted two potential game changers in the market. First, the city of Winnipeg is trying to create its own corporation with the city as the only shareholder to manage operations and maintenance of its water facilities. This corporation will then be able to compete for the operations and maintenance contracts of other municipalities. Second, the city of Indianapolis signed a memorandum of understanding to sell its water utility to the non-profit that runs its gas utility. The city chose Citizens Gas out of the 24 proposals because it was a non-profit. This decision was easier politically and also allowed the water utility to transfer ownership without calling into question its use of tax-exempt financing. The question is: Will other municipalities follow suit, and are these potential game changers opportunities or threats to current market participants?

Chris Frangione, managing associate, and Alan Farkas, managing director, work at Farkas Berkowitz & Co. (www.farkasberkowitz.com) — a management consulting firm serving companies that provide design, construction, and operational services for government and industry. Frangione can be contacted at frangione@farkasberkowitz.com.


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