Economic signs now are about as dismal as they've been in a decade and 2002 may turn out to be the calm of prosperity for many design firms before they have to weather the storm of market fallout and bad times. While the economy, the Iraq war and general capital spending uncertainty are bad omens for many of the ENR Top 500 Design Firms, the market may actually have hit bottom for others and could actually give way to pent-up demand this year or next.

Despite early signs of troubling times, The Top 500 had a pretty good year in 2002, with their combined $50.11 billion in design revenue up 3.8% from the $48.27 billion reported in 2001. Even with slowdowns in the U.S. market, firms recorded a 3.6% increase in domestic design revenue in 2002, from $39.61 billion to $41.02 billion. International work grew at an equal rate, rising 4.9%, from $8.66 billion to $9.09 billion.

But many in the industry know the worst is yet to come. "This is probably the worst combination of economic and business factors our industry has faced since I've been here," says Robert Prieto, chairman of Parsons Brinckerhoff. He notes that, overall, the international market remains sluggish and the domestic business recession continues without any significant uptick. Click here to view chart

Prieto says corporate governance scandals have taken their toll on clients' stock prices, cutting or delaying capital spending plans in favor of moves to bolster share value. "The only thing keeping the economy going was consumer spending here in the U.S. But now statistics show that it's slowing," he says. All this indicates the industry recession may be deeper than many expect, Prieto adds.

Some large firms are holding their own. "Our markets still are reasonable," says Noel Watson, CEO of Jacobs. Some company markets such as refining and pharmaceuticals are still strong, he says, but pulp and paper continues flat. "The war will come and go, but market strength will depend on how the economy responds," he says.

For two years, designers have been fretting about the general building market, the largest industry sector for Top 500 firms. In 2002, those concerns were borne out in the numbers. After years of steady growth, the general building market leveled off, growing only 0.6%, to $9.23 billion domestically. And 2003 promises to bring even worse news.

Nevertheless, some firms managed to make dramatic revenue gains, mostly through acquisition but also through organic growth in some cases. "We had good internal growth in 2002 and we expected the same for this year," says Henry Mann, CEO of Perkins & Will. "But even though our backlog is strong, we're not seeing work freeing up." He notes that the healthcare, science and technology and K-12 school markets remain stable, but worries about design prospects for colleges and universities. "With the soft financial markets, university endowments are down," Mann notes.

Many architects see the war in Iraq as a factor deterring the corporate building market. "One thing the capital markets hate is uncertainty," says Scott Wyatt, managing partner of NBBJ. He is finding corporate building projects being put on hold until the duration and impact of the Iraqi war is known.

Wyatt isn't alone. "The last few weeks have been tough," says Carl Roehling, president and CEO of SmithGroup. He says the firm has had four projects put on hold because corporate clients were hesitant to proceed amid cloudy political and economic signs. "We thought we could ride out the year, but probably revenue will be off a little this year," Roehling says.

However, not all is doom and gloom. "We have two markets that are holding up nicely– health care and research facilities," Roehling says. "Both markets are significantly funded and are looking to the long term."

For many firms, health care design is in the pink. "Our healthcare program grew by 8% last year driven by a variety of factors," says Richard Bell, CEO of HDR. He cites a variety of factors for the sector's strength, including demand from an aging generation of baby boomers, the need for replacement hospitals, and increasing medical reliance on high-tech equipment and robotics.

The trend of sustainable design is also breathing some life into building markets. "Sustainability is not there yet on a global scale, but it is beginning to make a significant impact in the U.S.," says Perkins & Will's Mann. "It's refreshing to see sustainable design being taken seriously not just by architects but from the whole industry," adds Wyatt. "We're now seeing both symbolic uses and cost-based uses."

Design firms are adapting to the new calling. "We have developed a sustainability practice within the firm," says Roehling "It's no longer just composting toilets. It's now becoming mainstream." He says sustainability is the culmination of many trends developed over the past 30 years that were designed to address specific issues or simply to be fashionable. "Today's architects have grown up with the idea that architecture can address societal concerns," Roehling contends. "They now take the idea of sustainability for granted."

Security design is another market springing from the times in which we live. "We have an in-house team of security experts and have been getting regular calls from clients about security consults," says Roehling. Requests run the gamut from threat assessments, ventilation protection, electronic security, and access and egress plans to a request for possible design and installation of a helicopter pad atop an office building, he says.

"Security is an issue" in architecture, says Wyatt. But he says it is not so much in terms of more brick and less glass than as a factor in overall structural design. "People are looking more seriously at how to manage the flow of traffic and how to protect equipment than how to protect against attacks," he says. However, some designers believe that the security market has not blossomed the way many anticipated. "We've found that homeland security hasn't provided as much of a boost to the engineering profession as we thought," says Prieto.

On the public-sector side, the country's economic slump has caused what many firms see as serious consequences. "State and local tax revenue is down, so many are pulling back on discretionary spending," says Prieto. "In fiscal 2003, we've already seen that in a couple states, particularly in California. But in fiscal 2004, you are liable to see that on a much broader scale."

One firm hit by pullbacks is David Evans and Associates. "The California Dept. of Transportation used to be our biggest client, but it's virtually stopped all work," says David Evans, CEO. "But we've won a lot of light- rail work [in the Pacific Northwest] and are doing well."

Evans believes the funding concern is temporary. "There's still a lot of pent-up demand," he says. "The turnaround may come in the next few months, or it may take another year, but the needs are there so we're confident that it will come soon."

Evans isn't the only one seeing a slowdown in public infrastructure work. "In the U.S., every tax-based [publicly funded] business is down," says Diane Creel, president of Earth Tech. The existing TEA-21 federal highway funding program requires states to come up with matching funds for projects, and some are struggling. "On three jobs in Texas and five in Virginia we got stop-work orders last fall in the middle of the projects," she says. "They are still halted, although we are beginning to see a little movement."

Stagnation in public funding has taken its toll. "For the first time in my 11 years as Earth Tech CEO, we will have a down year from an earnings standpoint in 2003," says Creel. "We've been burning backlog this year and haven't been building it as fast."

Not everyone is pessimistic. "Most firms I've talked to remain fairly busy with some growth," says William Howard, executive vice president of CDM and incoming chairman-elect of the American Council of Engineering Companies. "For the second year now, people are saying ‘the market is OK, but what will next year bring?'" Howard is concerned about government funding of public infrastructure. "States, municipalities and now the federal government are running deficits," he says. "And now there's a potential for federal tax cuts. We have to ask in such a climate: How are we going to make infrastructure investments?"

Jacobs also sees a slowdown in civil works, but some bright spots elsewhere. "The federal government market is still strong," says Watson. "We are chasing programs with the military and NASA. We're still selling more work than we're working off. It's not doomsday."

The water market seems to be resisting market troubles. "We are actually finding a larger volume of work in the West, particularly the Southwest," says Steve Hough, regional managing partner for Carollo Engineers. "It's mostly driven by population growth and clean water regulations." Some are region-specific. "There are new issues arising out of the allocation of Colorado River water," he says, noting more work on water containment and surface water recovery.

Not all firms are confident of continued Sunbelt growth. "I think we are beginning to see a slowdown in migration patterns," says Robert Uhler, CEO of MWH. "We saw a lot of work as high-tech firms began to flee the high-cost California market for lower-cost areas like Denver or Salt Lake City or even Madison, Wis.," he says. Uhler adds that regional migration patterns seem more focused on people trying to find jobs, rather than on wholesale company migration.

But some Top 500 firms are seeing some economic impacts, even in the water supply market. "We're seeing active, aggressive project selection processes, with teams bidding on jobs," says Bell of HDR. "And, once the team is selected, we are seeing some projects being downsized in scale."

If there is a major concern among the designers working in the public infrastructure market, it is the siphoning of earmarked funds for other purposes. "As state and local governments run into budget shortfalls, there is going to be increased pressure to get at dedicated funds," says CDM's Howard. Most funds, such as those from bond issues or highway monies, "are pretty well protected," he claims. "But governments will have to be careful about the future when they try to tap into these funds for immediate needs."

Another major concern is whether public money is going to continue to flow. "Usually, when there's a recession, the federal government can be counted [on] to pick up the spending to pump up the economy," says Uhler. "But with the cost of the war [in Iraq], no one is certain that there will be money coming out of Washington for projects."

SLOW FLOWING
Uncertainty also surrounds the petroleum and petrochemical markets. "Right now, the major drivers on the refining side are regulatory," says Khalid Farid, executive vice president of ABB Lummus. Clean fuels technologies and refits are the major source of work in the market in the U.S. and Europe, he says.

The prospects are not much better on the petrochemical side. "The petrochemical cycle from the viewpoint of the owners has been strung out a bit longer than most anticipated," says Farid. Most experts in the industry believed that 2003 would be the turnaround year for the industry. He notes that the volatility of oil prices as feedstock has had a negative impact on petrochemical companies, affecting their cash flow and putting a stopper on major projects.

Prospects in other industrial markets are equally somber. "Industrial process and manufacturing markets have not been doing well since 2001," says Yorgos Papatheodorou, manager of strategic and market development for Lockwood Greene. "Just when things began to look like they were recovering, clients began to pull back in anticipation of war." He notes that capacity utilization among chemical plants is actually dropping, another bad sign that even an economic turnaround may not spark a new round of work.

"We're still seeing a depressed market in chemicals, power and telecommunications," says Robert Giorgio, CEO of CDI Engineering. The firm has been shifting its emphasis over the past few years to concentrate on customer alliances with some of its primary clients, he says. "We've restructured our business to provide the highest utilization of personnel and are now no longer strictly project oriented," he says. The problem with being project driven "is that you're constantly going out of business and have to procure more work to stay in business," Georgio points out. "With long-term alliances, the cost of capture can be amortized over the longer term."

Giorgio notes an ominous sign in the industrial market: increased use of online reverse auctions for services. "Staff augmentation was where it started on the service side," he says. However, Giorgio does not dismiss online reverse auctions. "We've streamlined our operations, so we are very competitive. But it's a trend that's going to be a big shock to a lot of big E&C firms with bloated cost structures," he says. "Taking part in reverse auctions gave us a very clear picture of the cost structures in the industry."

But most engineers find the notion of reverse auctions as one more sign that design is being considered a commodity. "We've taken a look at a couple of these reverse auctions," says Howard of CDM. "In one, we withdrew rather than participated, but we ended up being approached by the client afterward and were awarded the contract anyway."

Howard advises customers to sit back and think twice about reverse auctions. "Once price becomes a factor in the selection process, it soon becomes the only factor," he says. He warns that clients using reverse auctions are just sacrificing any kind of innovative approaches to the design. "This industry never ceases to amaze me on how it keeps being its own worst enemy," says Howard.

The power market is in a long tunnel and there's no light ahead. "I don't see it getting any worse, but it's not getting any better," says Bob Battenhouse, business development manager at CH2M Hill. "Competition is really keen." He says 16 competitors recently applied for qualification for a $25,000 first phase of an owner's engineer contract. "We're seeing a little more than the usual suspects showing up," he adds. CH2M Hill has found itself competing with equipment makers such as General Electric and private-power developers such as Calpine Corp.

The market won't pick up before mid-2004 or 2005, says Bob Milhiser, senior vice president for power and energy at Burns & Roe Enterprises Inc. He sees some strength in California and the New York City area, but says the market is "spotty" between those points. There is a lot of development work going on, but the gestation for projects is long, he notes. "We're starting to see some activity in [circulating fluidized-bed boiler] projects," and also some in renewable energy," says Milhiser. "Wind power is also more attractive right now." He is also seeing renewed interest in waste-to-energy projects.

R.W. Beck has accepted the prospect of a flat power market for the next four to five years and is focusing on its consulting for lenders and developers, says Victor Derks, principal and senior director of Beck's Energy Consulting Group. "There are distressed assets" due to developer defaults, he notes. The banks require engineering consultants to advise them as they take over or refinance the projects.

Hard times for generation usually have meant better times for transmission and distribution, says Everett Chartier, national director of technical energy services at Beck. But both of those markets are down, he says. The long-running uncertainty surrounding the energy market's redesign is the main culprit there. But transmission and distribution has been stronger in a few isolated areas, including Texas, Arizona, Nevada, the Pacific Northwest, Maine and Vermont, he notes.

In 2002, the design industry saw the end of the boom and the beginning of a recession. Now, firms will be faced with one final concern about the down market. "There are many first-tier managers who have never really seen this kind of down market before," says Prieto. "They have shown the ability to be flexible in managing in good times. Now we'll find out if they can manage through a recession."

THE 2003 TOP 500 AT A GLANCE*
VOLUME
	DOMESTIC		INTERNATIONAL		TOTAL
	$BIL.	% CHG.	$BIL.	% CHG.	$BIL.	% CHG.
REVENUE	41	3.5	9.1	4.6	50.1	3.7
PROFITABILITY
	NUMBER OF FIRMS REPORTING		AVERAGE % OF
	PROFIT	LOSS	PROFIT	LOSS
DOMESTIC	447	20	6.7	NA
INTERNATIONAL	129	34	4.5	NA
PROFESSIONAL STAFF
	NUMBER OF FIRMS REPORTING		AVERAGE % OF
	DOMESTIC OFFICES	INT'L OFFICES	DOMESTIC	INT'L
INCREASE	197	39	9.8	52.1
DECREASE	149	23	9.4	26.4
SAME	144	97	NA	NA
BACKLOG
	NUMBER OF FIRMS REPORTING	AVERAGE %
HIGHER	180	16.2
LOWER	120	11
SAME	154	NA

MARKET ANALYSIS
TYPE OF WORK	REVENUE $MIL.	PERCENT OF TOTAL
BUILDING	10,239.6	20.44
MANUFACTURING	1,268.4	2.53
INDUSTRIAL	3,072.4	6.13
PETROLEUM	6,192.3	12.36
WATER	2,967.9	5.92
SEWER/WASTE	3,668.7	7.32
TRANSPORTATION	9,848.7	19.65
HAZARDOUS WASTE	5,060.0	10.1
POWER	4,942.9	9.86
TELECOMMUNICATIONS	925.7	1.85

INTERNATIONAL REGIONS
	NUMBER OF FIRMS	REVENUE $MIL.	PERCENT OF TOTAL
CANADA	89	975.1	10.73
LATIN AMERICA	116	706.0	7.77
CARIBBEAN ISLANDS	84	284.0	3.13
EUROPE	129	3,124.0	34.38
MIDDLE EAST	80	558.6	6.15
ASIA/AUSTRALIA	130	2,266.0	24.93
AFRICA	59	443.3	4.88
OTHER/UNALLOCATED	—	730.9	8.04
* Ranked according to design revenue obtained in 2002; NA= Not available

 

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