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FMI Quarterly/September 2014/September 1, 2014

Geographic Expansion as a Market Strategy

getty_navigate_imageProvide your key employees transparency around your strategic and financial intentions to avoid costly distractions.

Are you over the “defensive mode” of 2008–2012? You are not alone. In fact, improved optimism in the building markets, plus several macroforces that point to smoother sailing in the years ahead (“cautious optimism” still relevant), have pushed many contractors out of the defensive mode and into offensive or strategic mode.

Those that fit the latter description are seeking ventures to capitalize on growth prospects, and many of them are seeking opportunities to allow the next generation of leaders to have their chance to build the businesses. After all, even though we often talk about all of that midcareer talent that exited the workforce during the Great Recession, there is more talent waiting patiently in the wings.

For contractors, growth can come in several ways. Some companies decide to expand into new market segments and serve new customers; some decide to offer existing customers new services; and some — more so now than in recent years — are attempting to enter new geographic markets. In late 2013 FMI conducted a review of approximately 200 strategic plans of clients during the prior five years. It turned out that in the midst of the recession (2008–2009) about half of our reviewed clients had plans to expand geographically in some form or fashion. In 2013 that number jumped to about 90%. We were intrigued to dig a little deeper into this trend and capture some “best practices” in market penetration — many of these lessons learned prior to and during the recession.

Geographic expansion is undoubtedly one of the most costly and often least successful strategic options that a contractor can employ. However, since almost every contractor of decent size attempts geographic expansion sometime in its life, we would be remiss as an advisor to the construction industry not to talk about it and update the construction community on best practices and lessons learned on this subject.

We also want to point out, in the hyperconnected environment that we live in, geographic expansion does not just mean opening an office in City X. In fact, it can come in plenty of different ways other than permanent expansion, such as traveling with a customer for a one-off project or series of projects; sending business development professionals to seek out new opportunities in a market; or simply joint-venturing in a new market to deliver a project right in your  wheelhouse. The point is, geographical expansion in many cases does not require a permanent presence. Plenty of successful contractors realize this and maintain most project and corporate services back at headquarters.

The Cash Siphon

By definition, a cash siphon is the drainpipe injected into your balance sheet, discharging all available cash and working capital so desperately needed to run your business. An imprudent venture into a new market is one example of a cash siphon. Used in a sentence, “I can’t believe we ever tried opening that office in (enter warm-weather, snowbird city such as Phoenix or Orlando) — with low-bid work, too much competition and a poorly led group of staff; we wasted tons of money — man, that was a cash siphon.”

As unsuccessful as many geographic expansion ventures are, FMI has worked with many contractors that have been successful with geographic expansion. A few tried-and-true lessons when avoiding the “cash siphon” include:

Look before you leap
Research is challenging, expensive and time-consuming, but guess what? The other option — expansion into new markets with only one eye open — is even more challenging, expensive and time-consuming. A little over a year ago, one of FMI’s electrical contractor clients was expanding into a new market and sending some of its best people to that market. They were confident that they had a handful of existing customers that they could service based on existing relationships, although they realized that over time they would need to pick up additional clients. During a conversation at the time, FMI asked the vice president charged with the effort how business development efforts were progressing in the new city. The VP replied, “We should get the keys to the new office next week and then we can start calling on clients.” This was a red flag, of course. Fast-forward to one year later, and we probably do not need to tell you how the rest goes. Needless to say, that office is a cash siphon with an unknown time horizon in place on when it will begin breaking even. And it’s not because there was no work for the electrical contractor; but the client simply did not understand the buying habits of customers, competitive forces, workforce dynamics and major economic trends that were driving work in the new city.

Mind the gap
The dual strain of managing a workload in your existing geography, coupled with starting up business development and operations in a new geography, is one of the hardest transitions any company can make. To keep employees engaged during this transition, you will need to overcommunicate and establish strategies that keep the team united. Celebrate successes, even when small, and recognize and reward field and back-office employees who are working double shifts to keep the wheels on. You should also avoid “cutting special deals” (compensation, living arrangements, per diem, etc.) with employees who need to travel temporarily or indefinitely to new regions or project sites. Every new lucrative “deal” that you cut will become the standard for all employees (face it, they talk to each other), and you will continue to increase your fixed costs to a point of unsustainability. Instead of deal-cutting, use a standard “mobility policy” that states upfront what adjustments to compensation and fringe benefits will look like, and make exceptions on as few occasions as possible. When you are forced into making an exception for an employee, he or she will be less likely to talk about it since any “hearsay” of the exception can easily be traced back to him or her. Also, the mobility policy will allow you to revert to standard pay if and when that employee returns to the home market.

Make your intentions clear
Ambiguity of strategy and direction is one of the biggest drains on any organization. Without making your intentions clear to the organization (i.e., a short-term geographic transition to travel to a customer’s location or a permanent move to a new market), your employees will make up their own versions of the story. That perception will become reality. This may seem trivial, and you may be saying, “I’ll only tell them what they need to know, and they should focus on their jobs.” But the fact of the matter is that your employees will need to pick up the brunt of the extra work it takes to maintain existing operations and start up new operations elsewhere. They need to know that all of that extra work and effort is supporting a long-term strategy and vision with reasoning behind it. Without this information, they will quickly become disenfranchised to the point of disturbing your home business.

Have an exit strategy
Let’s face it, even with proper due diligence and a sound strategy in place, geographic expansion is risky and can result in failure. Many of the reasons contractors fail when tackling new markets are outside of anyone’s control and due simply to market dynamics of supply and demand. Regardless, you are still going to send some of your best people to that new market, and you need to retain them whether or not the market entry is successful. Our hubris often prevents us from asking, “What are we going to do if this strategy fails?” So instead, ask yourself, “What defines success — in terms of expected profitability, return on investment and time frame — and what will we do if we do not achieve success?”

As you may have already noticed, one of the themes of this article is transparency. By providing your key employees transparency around your strategic and financial intentions, as well as a comfort level that they still have a job if the market entry does not work out, you can avoid costly distractions. Your employees will be able to focus on their jobs, feel comfortable that they can be open about risks and issues, and not stay awake at night worrying about what happens if this market does not work out.

If you are reading this article, there is a good chance that you are thinking of growing your company, possibly via geographic expansion. As you likely suspected, and as we have reinforced in the preceding discussion, this is one of the most difficult and investment-intensive opportunities that a construction firm can embark upon. If, after reading this article, you are still considering this move, please take the four key pieces of advice to avoid the cash siphon, and, of course, be sure to engage outside counsel from others that have experience in this area.


Jeremy Brown is a consultant with FMI Corporation. He can be reached at 303.398.7205 or via email at jbrown@fminet.com.

 

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