Supply disruptions and inflation from COVID lockdowns, more disruptions and inflation from the war in Ukraine, high-priced gasoline, higher truck prices due to microchip shortages, and increased wages to cope with the higher prices resulting from all of the above are pieces of the economic storm we’re in. What’s a construction business to do?
We’re at a point when we have to pass along price increases for materials and consider higher wages for employees, knowing they’re paying more at the pump and the grocery store. The temptation is to raise our prices. By doing so, however, we enter the vicious spiral in which our response exacerbates the original problem. Raising prices excessively to combat inflation eventually reduces demand and exacerbates recessions. It’s possible the Federal Reserve can stem the effects of the recession by raising interest rates and tightening monetary supply, but don’t count on it—not because it’s the government, but because it’s a difficult task.
Even if the Fed can engineer a “soft landing”—avoiding the severe downturn and long-term recession—there may be serious consequences. Raising interest rates and reducing stimulus can decrease demand for goods and services and cause asset deflation. Higher rates discourage borrowing, which means fewer homes (new and old) and remodeling projects are sold. With asset deflation, the stock market and housing markets lose value, and spending is curbed because people feel like they have less money. We have seen stock prices plummet between 10% and 25%. Is housing next? The interest rate on a 30-year-fixed-rate mortgage is now 6.25% (as of this writing), not unreasonable historically but high when applied to all-time-high housing prices. The Mortgage Bankers Association reported in September that mortgage applications were down 14%. Housing prices may be coming down, but then longtime homeowners will feel they have less money, recent buyers may end up with homes worth less than the purchase price, and people looking to buy may not know what to do. Demand destruction in housing could be a kick in the teeth for the residential construction industry.
For those of us in construction and remodeling, with continued inflation, we get hurt; with reduced inflation (reduced demand) without a recession, we get hurt; and with reduced inflation with a recession, we get hurt. Employment is high, unemployment is low, and households have cash, so there is hope. But, even so, what do we do when we may get hurt no matter which scenario plays out?
Resist the Urge to Add to Inflation
On December 21 last year, I priced out a good-quality wood screen/glass combination storm door for a client. The estimate came in at $650, $693 with tax. The door was in stock. I added $500 labor to measure, order, pick up, deliver, demo, dump existing, and install. The estimate for the door and its installation came to $1,193, a pretty penny. Once the door was installed, in the spring, we would have the door painted. On March 15, I called to order the door. The supplier gave me a new estimate of $845, $901 with tax, a 30% increase. I wondered if the new quote was for the same in-stock door from December, and it had sat in the warehouse for two-plus months garnering an annualized return of more than 120% for the seller. I wondered if the distributor increased the price $195, or if the lumberyard tagged on some for themselves. My client expressed concern but gave the go ahead.
We had the door inside of a week, confirming my belief that the door had been in the warehouse for the winter. I checked the weather and coordinated the installation date with the painter, a gentleman we had worked with for years. We wanted the door painted immediately after installation and before the next rain. Because the door had no overhang, I requested the painter use an oil primer and two coats of oil paint. All went well until I received the painter’s invoice of $850. That was unexpected! My fault for not getting an estimate.
So, the distributor got 30% on a door that didn’t cost him 30% more, and the painter got more than twice as much as I expected. (He was one block away, so commuting to the site wasn’t a factor.) They entered the vicious spiral, a short-sighted approach to dealing with inflation. A wood screen/glass storm door cost a client $2,251. How many people are going to spend that to have a storm door installed? Economics 101 states that for each dollar increase in the price of a good or service, a group of people will postpone. A number of postponed storm doors is one less employee needed by the storm-door manufacturer, one less carpenter needed to install, one less painter to paint, one less lumberyard attendant, one less distributor employee, one less grocery store cashier, and so on. I am not suggesting that you eat the price increase, just control the greed. If a product price increases 10%, charge 10% more for it, but not more.
It appears some economic pain lies ahead. But if you can handle the pain in a rational and transparent way, your clients will remember. It’s hard, of course, when your suppliers and subs are like the door supplier and the painter who put me in an unfavorable position with my client—and I sure will remember.
Here are some strategies that may ease the pain:
Postpone large purchases. I hate to discuss postponing a purchase, because it reduces economic activity, thereby contributing to a recession. But if you think a business slowdown is on the horizon, it may be best to postpone buying the pickup truck, excavator, or roll-off truck. (Though, if the vehicle is leased and the buyout price was negotiated two or three years ago, it might be worth considering the purchase, depending on your cash on hand, work backlog, and loan rates. You might even be able to flip the vehicle and make a few bucks if the chip shortage remains an issue and vehicle prices remain high.) Even if you have the cash for a capital purchase, it might pay to wait. A slowdown may result in a better price, or supply disruptions may clear, increasing inventories and reducing prices.
Rethink energy. Energy prices also complicate decisions. Diesel prices are through the roof. Can we expect energy prices to drop again, or are those days gone forever? The writing on the wall says that EV will take more market share, fossil fuel’s days are numbered, oil and gas exploration will receive less public and private funding, and alternative energy sources will receive more. It’s going to take a decade or two to transition energy sources significantly. For now, maybe gas is a better option than diesel. An electric pickup—or even an electric concrete mixer—might be in your future.
Avoid debt. The economy and business cycle are outside our control, but the amount of debt our business carries is not. Debt is risk. Postponing a large purchase helps to limit risk if the economy slows. Reducing balances on lines of credit and credit cards is another way to reduce risk and be prepared.
Inflationary price increases. Price increases aren’t usually a problem during a recession; in fact, they should come down. But, during an inflationary period like the one we’re in, prices are difficult to predict. The construction trades are particularly vulnerable because we provide estimates to clients for projects that often start weeks or months after agreements are made.
One way to protect your company from having to absorb unexpected price increases is to insert a “material price increase clause” in your contracts and estimates to pass material price increases to your customers. Without one, you may get stuck during fast-moving inflationary periods, and what should have been a profitable job might become a disaster. Keep the clause simple: If prices increase more than a certain percentage from when the estimate was presented or the contract signed, the customer is responsible for the increase. Apply this to a list of materials “including but not limited to” lumber, plywood, siding, steel, flooring, appliances, and so on. Be prepared to show price increases through quotes and material lists accumulated during estimate and contract preparation. Allowances in an estimate or contract may also provide protection. An allowance for doors, windows, hardware, and appliances, priced months before project startup, provides a benchmark for future price increases. A little price protection may help your business survive during a difficult time. Just be sure you openly discuss the clause with clients so there are no surprises.
Flexible employee inflation assistance. As David Gerstel has stated in a number of his books, you take care of your employees. If you do, you will enter any period of inflation with your employees fairly compensated by a combination of wages and benefits. However, even with fair compensation, employees may need, and you as an employer may want to offer, additional assistance during this period of high inflation.
Our present economic situation is multilayered and makes knowing exactly how to provide assistance difficult. Not knowing if 8% inflation is headed to 12% or 4%, or not knowing if credit tightening will curb inflation or create a recession, I suggest you provide flexible or temporary assistance that can be easily changed as conditions change. It would be untimely to raise wages as inflation peaks in the third quarter of 2022 or a recession begins and construction projects disappear. An increase in payroll while there is a decrease in revenues helps no one. Permanent increases in company overhead during times of uncertainty only make it harder to weather the storm. A changeable or temporary benefit, on the other hand, will help employees through an inflationary period and help the company weather a recessionary time. While inflation persists, an employee gets assistance. If a recession occurs, assistance is stopped and hopefully jobs are preserved.
Consider offering a weekly or monthly stipend for gas. While prices have come down, gasoline prices saw an increase of 55% over the last 12 months, and we may similar increases later this year. A gas stipend may ease the pain of an employee’s commuting expense. Their monthly savings can then be applied to other household basics, like food and shelter. The stipend can stay in effect as long as high inflation persists and company revenues continue unabated. Note that I’m suggesting an equal stipend for each employee’s commute and not a gas card. A gas card for commuting might be abused or benefit the owner of an inefficient guzzler over more conscientious employees, and might be harder to take away. A gas stipend is only one way of providing assistance; you may decide to use other methods that are more appropriate for your employees or business.
Don’t ignore retirement accounts. If demand destruction ends up reducing asset values, it might be a good time to start a retirement account or increase contributions to an existing retirement account. It’s only a good idea if your job is secure, your business is healthy, you have the money, and a recession isn’t on the horizon. Buying lower is always a good long-term strategy.
Profit is Critical
The economy is likely to get worse before it gets better. If your business has built a war chest from a portion of its profit over several years, you stand a good chance of having your own soft landing. If you haven’t created a war chest, now’s the time to start, but it may be difficult to do so quickly.
Dealing with increased costs and reduced margins, and resisting the urge to raise prices to cover it all, will be difficult if not fatal to a company that hasn’t earned a good profit over the years and stashed some away. Having a general idea of what direction the economy is headed will aid your decision making. Gather information from more than one source, and stay away from talking heads that are preoccupied with stirring up emotions. Above all else, remember that it’s in your family’s best interest if you don’t overextend yourself at the wrong time.