Your Innovation Currency: Merge With Yourself

A Leader’s Guide to Helping E/C Firms Combat Commoditization and Win

The market for engineering design and construction (E/C) firms may be the best it has ever been. Virtually all market sectors, especially in areas like water and transportation, are seeing solid gains with double-digit growth. Project backlogs and gross revenues are reaching new highs. And the economic outlook remains strong. Yet while these firms have much to celebrate, they are finding themselves facing increasingly complex project needs in an increasingly competitive and cutthroat marketplace — one with tighter margins and escalating construction and project pursuit costs. These challenges are magnified by clients who don’t always recognize (or want to recognize) differing values in products and services, making it harder for even acknowledged industry leaders to sustain meaningful inter-brand differentiation. Value-based procurements are the exception, not the norm. Procurement strategies and selection processes focus heavily on lowest-cost providers. The rationale in board rooms and executive suites remains the long-standing commodification of design. And most firms don’t recognize this as a strategic problem. The power of precedent is so great that it leads to some strange organizational anomalies.

The first instinct for some is to turn to acquisitions (buying as opposed to creating market share). The logic here is to grow scale and geographical footprint or expand services — achieving efficiencies of cost, scale, or scope. The underlying premise is that greater market share equals greater profitability because companies benefit from the realization of these efficiencies. Others turn to overhead cost reduction programs or opt for reorganizations, which often improve short-term results. Acquisitions can yield synergy and reengineering can streamline operations and finances. The insidious thing is that such results convince these firms that their current business model is right – making them focus deeper inwards rather than outwards, where the real problem lies, and blinding them to the need for strategic change. It may work for a while, but overheads soon grow back while net labor multipliers and project gross margins remain flat or even decrease. Meanwhile, the underlying problem gets worse.

Many E/C firms are now recognizing that growth through innovation is their best strategy for competing and winning in a commoditized market. Virtually any industry can be improved — no matter how long it’s been done the same old way. And it can be remarkably profitable. Earthbound Farm reshaped a commodity like lettuce into a high-margin product (prewashed, packaged salad greens) that customers love. Starbucks transformed coffee from a commodity into a $5 splurge. Whole Foods transformed the natural and organic foods industry into something special, selling healthy products with a healthy profit — while changing the way we eat in the process. Ask Apple, which moved into one new adjacency after another (iPod to iPad to iPhone to Apple Watch) and profitably redefined entire product categories, or Netflix, or Intuit, or Fujifilm, or Southwest Airlines, or Google, or Accenture, or Ikea, or many other companies that shook loose from the ordinary and realized extraordinary returns. Companies like CEMEX in cement, Nucor in steel, and Dow Corning (Xiameter) in silicones have shown how innovation can thrive in mature businesses. The wild success of MWH Global with MWH Soft (a.k.a. Innovyze) proved that serving the most conservative water and wastewater utility market could be highly profitable with record-breaking margins. Look no further than the plethora of companies successfully selling bottled water, mostly pre-packaged purified municipal tap water (some even vitamin-enhanced) that costs 2000x more. If a basic commodity like municipal tap water can be transformed into a high-value, high-margin business, anything can.

Most CEOs of failed E/C firms floundered because they were always fighting the last war and living on their past successes. They had risen to higher positions on the basis of their popularity and operational success with the technologies and tactics of the last war, and had great difficulty letting go of those approaches when conditions and problems changed. They learned how to do things a certain way and grew committed to their choices and their actions. Good men and women they were. Change agents? They weren’t. They were in strategic denial. They all saw the need for strategic change, but some, like the proverbial ostrich, ignored it in the hope that it would go away. Others were frozen like rabbits in the headlights, seeing the danger but not doing anything about it; some distracted themselves with tactical moves to combat commoditization, like a hamster on a wheel running ever harder just to stand still. Their firms’ failure may have been unique in its details but the same in that it represented a failure in leadership. Their leaders failed to confront reality, the fact that their strategies no longer worked. They remained locked in the past. The way they thought was reactive and incremental. They all wanted better results, but were unwilling to change and pay the personal price of unpopular bias. It’s a challenging task, considering the incessant drumbeat of quarterly performance. They are also rarely blamed for doing again and again what they have done in the past. Instead, they became expert at gaming the internal game. Their first line of defense in their board rooms and executive suites was, “Our industry is different. It is traditional, conservative and risk averse. What worked in other industries will not work for us, period.” They had fallen into the familiar trap of thinking there was no room left for change in their businesses — to the clear detriment of their stakeholders. Opportunities were lost because circumstances were more changeable than they thought...often more changeable than those leaders are. They became victims of their own success. When your headlights aren’t on, even the best rearview mirror isn’t likely to guide you to your destination.

But what exactly does commoditization mean? Simply that your clients just don’t value further improvements along particular lines, making you unable to charge more for what you have to offer. That doesn’t mean there are no improvements your clients would value. Looking for dimensions others have overlooked can differentiate your firm in the eyes of your clients. The next big breakthrough is not likely to come from asking clients what needs fine-tuning; this only leads to incremental improvements, not radical innovations. Clients are better at assessing the present than foreseeing the future. They are not well-equipped to help you plan for new products and services that would change their lives and yours, reinvent your offerings, or create new business models. They cannot tell you about a future that doesn’t exist yet. They cannot tell you what they don’t know and haven’t experienced (unarticulated needs). Most are pretty good at comparing your current services with their current needs and those of your competitors, and will most likely encourage you to do more for them for less — further reducing your competitive positioning and pricing power. Escalation occurs when larger competitors begin offering more benefits at a lower price, squeezing everyone in the marketplace and dooming your company to ever-shrinking profits. Worse still, economic downturns can accelerate commoditization and make the resulting challenges much more difficult to overcome.

The biggest opportunities for innovation and profitable growth are probably things your clients haven’t even thought of, things that would prompt them to say, “I can’t imagine what we did before we hired you.” There is so much more to the pursuit of competitive advantage than fulfilling needs articulated by your clients. Steve Jobs is often quoted as saying, “It’s not the customer’s job to know what they want.” Henry Ford once acidly noted, “If I had listened to my customers, I would have given them a faster horse.” Don’t expect customers to help you envision the future. Make that mistake and you’re likely to get lots of suggestions for “faster horses.” At the end of the day, it is all about your leadership.

Navigating an increasingly challenging business environment and conquering commoditization require new thinking, a more strategic business framework, and tapping into your most valuable assets: your people. Specifically, your too-often-overlooked project engineers and project managers — the unusual suspects. They are hidden in plain sight, often residing near the bottom of your firm’s totem pole. Yet, they ride daily with your clients, watching them struggle and stumble, discover their pain, and convert it to solutions. They mostly innovate. They rarely imitate. They see unresolved problems and anticipate critical needs. They have their feet on the ground, pairing ideas with actions. They make use of technology in new ways. They understand how your clients are changing and where they’re heading, and foresee what they’ll need before they do. In this way, they’re able to identify windows of opportunity that can be exploited and monetized. For them, risk is about innovation and success. The cost to your company will be negligible, and the upside may be more than just increased profitability. It will be the opportunity to advance the engineering profession and shape industry practices, to create, to rewrite, to nudge history in a different direction. As the adage goes: take care of your people and they'll take care of you. And give them a stake in the business and release trapped value. They will go the extra mile for your company, for your clients, and for fellow employees.

Simply put, merge with yourself.

The fact is, commoditization is not going away soon. It is no accident that the ranking of top 100 ENR Design Firms keeps changing, but their profitability remains largely the same. Fostering a culture of innovation is the lifeblood of all E/C firms, as important as mapping out competitive strategies or maintaining good backlog and billable utilization margins. Rather than benchmark competitors within your industry, go against the mainstream and question some long-held but outdated assumptions. Ignore industry boundaries and mine other industries for breakthrough ideas. Above all, open your mind and tap your project engineers and project managers to unearth new value for your company and for your industry. They can detect connections where none seem to exist. Such bold thinking will enable you to change the marketplace to create new opportunities and new value. Of course, you’ll still make a habit of listening to your clients. They are always the top priority. No clients, no revenues, no companies. Just don’t confuse this proven business practice with how you go about hunting up the next big breakthrough. It would be helpful if engineering magazines (e.g., ENR) ranked companies not just by sales (gross revenues) but on their innovation track records. The approach also applies to your board. Boards can shift the balance of power in a firm and temper CEO hubris. They add value when they are vigilant. Leadership starts with the board.

Innovation requires leadership, not just great operators. It almost invariably threatens the status quo. It cannot succeed with a culture of risk aversion and a focus on short-term results. The siren song of quarterly earnings reports may seem irresistible. Manage it. Aim for lasting impact. Alter the nature of competition. Break down the traditional silos and thinking, encourage and lead bottom-up innovation, and drive organic growth. Create new business models, disruptive technologies, and products and services that change the way your clients do their work and wow them. Your industry will no longer be the same. And your company will be the place for the best talent to work. 

E/C executives love to say that their companies innovate. But don’t just say it. Do it, and do it right. And let the results speak for themselves. You either perform or you don’t; you are paid for solutions and rewarded for results, not effort.

Is denial a problem for you? When your firm is at the top of its industry it’s the best time to ask whether you are on the right path. You may be riding the express train to oblivion. History has lessons to teach about the role of denial in the decline of companies. The stubborn refusal of the Ford Motor Company under Henry Ford (one model, one color) to admit the changeability of consumer demand is a good example. What about Kodak, which focused on its core film developing business all the way to bankruptcy, or Xerox which missed exploiting the personal computer technology it had invented? Or Western Union, which passed on the telephone, and Intel, which passed on the smartphone market? What about word processing pioneer Wang Laboratories, instant photography king Polaroid, electronics and communications giant RCA, and minicomputer pioneer DEC? Sears, Polaroid, Firestone, AOL, Bethlehem Steel, Smith Corona, RIM/BlackBerry, Circuit City, Blockbuster, Pan Am, Woolworth, Siebel Systems, Sharper Image, and Radio Shack were companies that led their industries. Yet they had either failed or had a near-death experience.

Make no mistake: E/C firms are not immune. Many once-leading engineering design firms have been relegated to history. Just check the ENR Top 10 Design Firms of 2019 versus 2014 (last five years). Some paid a terrible price for denial. Don’t let it destroy your company, too.

Your actions and inactions define the future. You can turn the trap of commoditization to your advantage. Or you can choose the path of least resistance and get trapped. It’s your choice.