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FMI Quarterly/December 2015/December 1, 2015

Navigating the Winds of Social Economic Changes

ThinkstockPhotos-455636265-445x298Understand the changing dynamics of social economic factors like income inequality to be proactive in shifting markets.

Sailing versus boating can be likened to how companies view their markets when planning for their futures. To a sailor, an open body of water represents freedom. It is open space, a time to apply the skills learned to achieve the goal. Captains set their destinations, trim the sails and plot their courses toward those destinations. Their routes rarely follow straight lines. Currents and wind directions determine their tacks. While their general direction is strategic, their interim steps are tactical in response to their environments.

Boaters, on the other hand, are propelled by mechanics and engines and think about their journeys a bit differently. Where sailors crisscross the winds to maintain forward momentum, boaters can take a straighter path from their point of launch to the destination. Sailors and boaters make adjustments based on current flow, but power boaters have less concern about current than do sailors. Both can decide to explore the backwaters, eddies and natural beauty along their routes. Sailors and boaters share many of the same planning elements that go into a successful day on the water; they simply have different ways to achieve their goals.

Companies chart their courses for the future like skippers. Some will choose to venture far, while others will stay on the shore or in the harbor. Some are more interested in the journey, and others are more fascinated by the destination. Some will be propelled on the mechanics of wind, while some use fossil fuels, electronics and gears to enable their journey. But both need to deal effectively with the wind and waters in order to be successful and safe. The water is the market that companies face in their journey toward their futures.

Your geographic market or market segment is your waterscape. You can choose to stay where you are, venture a little ways beyond the harbor, or set sail for distant shores. Just like sailors and boaters, you have to understand and interact effectively with the forces of nature to gain a safe passage across the water. After all, who would intentionally set sail in a small boat against gale-force winds when going a bit earlier or waiting an hour would dramatically change the height of the waves? If speed to destination were the intent, who would choose to sail versus powering up the engines?

Grab Hold of the Helm — Let’s Go
Skippers stand at the helm and guide their craft safely forward much like companies that use economic dashboards to help them judge the waters ahead and prepare for changing conditions. Many, if not most, successful industry firms use economic dashboards as early warning tools to changing markets, competitive positions and economic fluctuations. Like the label suggests, economic dashboards are heavily focused on the fiscal economics impacting markets — e.g., GDP growth, interest rates, employment/unemployment levels, per capita income, housing starts, etc.

Social economics are driving markets in increasingly obvious ways. They impact how markets grow and decline, the availability and quality of talent, and, in many cases, the severity of economic changes that will be felt in times of expansion and recession.

White Caps and Rogue Waves — Reading the Gauges
Those who track fiscal economic indicators attempt to predict the next recession or “rogue wave.” However, many tend to ignore the socioeconomic factors or “white caps” that affect their companies’ competitive positions on a day-to-day basis. Social economics impacts the way firms stay competitive and engage human capital.

Consider, for example, the socioeconomic metric of income disparity. Income disparity is a measure of the gap between the very rich and the very poor in a geography. A recent article by The Brookings Institution examined income disparity in 50 of the largest United States cities and found the disparity in many of the cities, like Atlanta, San Francisco and Miami, had a significant increase in income inequality from 2007-2012. Though these three cities had increasing levels of inequality, it occurred through different means. In San Francisco, for example, the wealthiest households saw an approximately $27,800 increase in income, while the poorest households had an approximately $4,300 decrease in household income. The rich got richer, and the poor became poorer there. The scenario was different in Miami and Atlanta, where the poor saw a decrease in household income, and the rich did as well, but to a lesser proportionate extent.

Income inequality is a broad look at the social economic environment within a specific geography. To create an actionable plan based upon fluctuation in this metric, one must look to the individual variables that show correlation to the broader metric. Individual variables such as education attainment, housing-to-income ratio, population density and commuting time all have statistically significant correlations to income inequality, and, as such, variations in income inequality can be explained to varying degrees by these individual metrics. For example, 32.5% of the variation in income inequality can be explained by variation in population density. What this suggests is that, as population density within a geography increases, a negative effect on income equality would likely result. This correlation coefficient may not seem high when comparing it to one expected in a laboratory environment; but when the subject matter involves the unpredictability of human behavior and outcomes, the correlation is high. When a metric, such as population density is observed to be increasing, a proactive firm may react by adjusting its compensation plan to retain existing talent or be more attentive to its pursuit of new talent.

The ability to track individual metrics, such as those listed above, provides the opportunity to focus efforts on one or more socioeconomic factors that is affecting the broader external environment. This allows the opportunity to react quicker and more efficiently to the changing dynamics at hand and ultimately create competitive advantages over competitors within your geography.

Charting Your Course — Why Does It Matter?
So why should individuals or companies care about rising income inequality or other socioeconomic metrics, especially if it is an issue that might primarily be dealt with at agency levels (local, state and federal government)? Does it actually have a material impact on firms, and, if so, how can firms react? Leaders and managers should care and monitor these metrics within their individual geographies because they provide a strong measure of how they need to think about their talent pipeline. If you are located in a market with rising income inequality, you should expect to see increasing salary expectations coinciding with decreasing availability of talent. Companies should think harder about cultivating the talent they need internally rather than expecting to find it in the marketplace at a bargain price. Company “universities,” internships and apprenticeships through high schools, technical colleges and co-ops are several examples of how some firms are succeeding at the talent challenge.

As a socioeconomic metric, income inequality is simply a number that compares the spread between the highest- and lowest-earning households. When this ratio gets larger over time, several factors come into play, including decreased social mobility, high and persistent unemployment, and lower economic utility (the value of an additional unit of service or good). For example, with decreased social mobility, it becomes more difficult for someone to migrate from the lower to the middle class. Fallout from these issues can take the form of additional health and social challenges such as obesity, crime rates, substance abuse, unrest, waste of resources and so forth. When these factors persist over time, geographic regions begin to experience an erosion of the middle class as consumers struggle to afford essential goods and services.

Over time, income inequality dampens economic growth. This erosion presents a tremendous struggle for construction firms because most of the industry’s production and entry-level jobs exist within the middle market. This is one of several reasons why hiring staff has become so challenging over the last several years. Find a city in the U.S. where construction is happening at a torrid pace, and the talent supply-demand relationship will likely be heavily weighted in favor of the talent. Companies are running at capacity, have good backlog, enjoy healthy margins and cannot find enough people to fill their current staffing needs. Compounding this issue is the fact that many people left the construction industry as a result of the recession and housing market bust. If firms are unable to hire for open positions, then the discussion of talent development must be the next piece of the puzzle.

Connecting the dots, rising income inequality leads to a diminished middle class and ultimately a constrained talent pipeline for companies. Income inequality impacts education, commute times, availability of talent (and therefore the cost of talent) and so forth. It also has a dramatic impact on the attractiveness of the area, thus limiting the number of people from outside of the area who wish to move into the area and make it their home.

Given the context of a diminishing talent supply, a market that is unattractive to new recruits, and increasing project complexity, how will your company confront the challenge? Just as companies develop a strategy for market entry, companies also need to prepare a talent strategy for their own staff by assessing the external dynamics, taking stock of internal capacity and committing resources toward objectives. Proactive firms come up with creative solutions to these challenges, such as intern and co-op programs to cultivate younger staff. With the higher starting salaries expected in a geography with rising income inequality, allocating resources to develop the staff that is already a good cultural fit within your company may prove to be a better value compared to the costs associated with recruiting, interviewing and hiring new talent at competitive market salaries. Training and development yields the greatest dividend when it is tied to the company’s overall strategy.

The successful skipper ensures that his boat is seaworthy. He or she has the appropriate crew for the planned adventure and pursues an appropriate strategy with tactics that will achieve the destination. Successful leaders fill similar roles. As the skipper stands at the helm, the instruments provide signals for tactical shifts. Similarly, income inequality and other socioeconomic metrics, like GDP growth and unemployment levels, are the dashboard tools that help leaders understand what opportunities and dangers lie ahead.

Conclusion
The construction industry environment has changed significantly in many regions over the past five to seven years and should continue to change nationwide for the foreseeable future. The contractor selection process is changing from one based primarily on price — a residue of the recession — to a process that considers the total value that a contractor brings to the project. Though this trend is not consistent across the country, many cities and regions have already made the shift as the war for talent has allowed contractors to get more selective on the customers and projects they pursue.

This shift towards selection based on value creates an opportunity for contractors to leverage competitive advantages that are not cost-related. Competitive advantages in value selection projects stem from experience, unique systems, depth of process or client knowledge, and capabilities of staff and project teams. A contractor that is operating in these value-based procurement environments must act upon the external, socioeconomic metrics that directly influence its ability to retain and attract top-tiered talent.


Cynthia Paul is a managing director with FMI Corporation. She can be reached at 303.398.7206 or via email at cpaul@fminet.com.

Prentiss Douglass is a consultant with FMI Corporation. He can be reached at 919.785.9240 or via email at pdouglass@fminet.com.

Paul Giovannoni is a research analyst with FMI Corporation. He can be reached at 919.785.9216 or via email at pgiovannoni@fminet.com.

 

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