By Jay Landers

2022 is poised to be a good year for the North American architecture, engineering, and construction sector, thanks in part to the recent surge in U.S. federal infrastructure spending. However, several challenges threaten to impede prosperity within the industry, according to two recent reports evaluating the state of the AEC sector. Foremost among these challenges are staffing shortages, higher labor costs, and supply chain disruptions.

Strong revenue growth

Architecture and engineering firms are anticipating an increase in net revenues of 17.6% in 2022, according to a report released in May by the software provider Deltek Inc. Titled Clarity: Architecture and Engineering Industry Study, the report was prepared in partnership with CMG Partners LLC.

The report is based on a survey of more than 540 architecture and engineering firms of varying sizes and locations. Of the participants, 41% were small firms having 50 or fewer employees, 41% were medium firms having between 51 and 250 employees, and 18% were large firms having more than 250 employees. Ninety-four percent of the firms were in the United States, and 6% were based in Canada.

The nearly 18% increase in anticipated net revenues represents a jump of more than 13 percentage points year over year, according to the Deltek report. “The growth forecast this year is the highest in 10 years and greatly surpasses previous estimates in the two to six percent range,” the report states.

When asked in which markets they expected to see their positions grow, 60% of participating firms identified the combined category of water/wastewater/stormwater, while 59% said that they expected growth in the transportation market. Both markets are “expected to see an influx of funding from the Infrastructure Investment and Jobs Act,” the report notes. (The IIJA, also known as the bipartisan infrastructure law, is the $1.2 trillion spending bill that became law in the United States in November and includes $550 billion in new infrastructure spending over five years.)

Other top categories in which respondents expected their presence to grow included energy/power (57%), industrial (53%), and health care (52%).

A boost from the IIJA

With its promise of significant new funding for infrastructure, the IIJA “bodes well for (engineering and construction) firms,” according to the 2022 Engineering and Construction Industry Outlook from the professional services firm Deloitte. Released in November 2021, the report is based on survey results from more than 500 leaders of E&C companies.

The new law also is “likely to propel some growth in the nonresidential segment,” which has lagged behind the residential sector in recent years, the Deloitte report notes.

In addition to its increased federal funding for infrastructure, the IIJA “has other tax incentives to promote partnerships with cities and states and encourage private investments,” according to the Deloitte report. As an example of the types of opportunities afforded by the new law, the report notes that “E&C firms are likely to form public-private partnerships … with cities and states to capture opportunities from the recently approved IIJA.”

Given the relatively recent passage of the IIJA, new P3s have yet to form to take advantage of the law’s provisions. That said, the existing Transforming Rail in Virginia project offers an example of the type of P3s that can be expected to result from the IIJA, says Michelle Meisels, a principal at Deloitte Consulting and the leader of its engineering and construction practice.

Transforming Rail in Virginia is a partnership involving the commonwealth of Virginia, Amtrak, Virginia Railway Express, and private rail companies CSX Transportation and Norfolk Southern Railway that aims to increase rail capacity and service in the state.

Rising costs hurt profits

The optimistic revenue forecasts cited in the Deltek report are tempered somewhat by the likelihood that firms’ operating profit on net revenue will be lower than expected, as occurred in 2021. Last year, these profits dipped by slightly more than 6%, the first such decline in several years. “After years of upward trajectory, operating profit on net revenue dropped significantly to 12.8%, levels last seen in 2015, as firms experienced growing costs on a year-over-year basis,” according to Deltek’s report.

Higher labor expenses, especially, contributed to this dent in operating profit. “Increased labor costs were observed across all segments, pressuring profit margins especially in small and medium-sized firms,” the Deltek report notes.

The bump in labor costs is driven in no small degree by the difficulties faced by many firms in attracting and keeping talent. “Given the staffing challenges firms are facing, talent acquisition was reported to be the most expensive business process for A&E firms to support, growing nine percentage points year-over-year,” the Deltek report notes.

Employee turnover rose to 13.6% in 2021, and nearly half (44%) of participating firms listed finding and retaining qualified staff as their top financial challenge, well ahead of such other concerns as increasing profitability (19%) and managing growth (12%). Meanwhile, the increase in labor costs contributed to a rise by 14 percentage points in overhead costs for firms last year.

At the same time, the labor shortage offers a “tremendous opportunity” for companies “that are able to effectively position themselves as the workplace of choice for skilled and experienced employees,” the Deltek report notes. “Identifying creative ways to lower regrettable attrition — loyalty rewards for long-term contributors, extending part-time opportunities to valuable retirement-eligible assets and driving higher engagement rates for employees — will provide a valuable foothold to unlocking future revenue growth.”

Managing supply chain constraints

Supply chain disruptions, which began last year, will continue to hamper AEC firms for some time. Driven by the lack of materials and sharply increased costs for available materials, “supply chain disruptions and volatility are expected to be among the biggest challenges in 2022, and the firms that can navigate through them will likely emerge as winners,” the Deloitte report states.

Among the materials that have experienced sharp price rises is lumber, the cost of which went up by more than 40% between September 2021 and February 2022, Meisels says. Such price hikes “certainly (are) impacting margins on projects,” she says.

Higher material costs generally translate into higher project costs. “We’re going to see increases across the board, and that’s ultimately going to get delivered to the (project) owners,” Meisels says.

A potential “silver lining” amid the higher prices is the opportunity for AEC firms to lower their costs by investing in technology that enables them to “streamline and optimize” how they deliver construction projects, Meisels says.

In its report, Deloitte cites digital supply networks as an example of a technology that AEC firms can use to lower material costs. Such networks “can help contractors gain better visibility into the availability and movement of materials,” the report states. “Analytics performed on real-time data can help schedulers make better-informed decisions and develop alternate sourcing strategies and forward-looking insights to ensure minimum impact on projects.”

“Those companies that are going to invest and innovate are the ones that are going to perhaps weather the storm and come out ahead of this interesting time that we’re facing,” Meisels says.