Case study

Superior Engineering in Texas: Stay or Go?

Thad Lepp, chief operating officer at Superior Engineering Services (SES), thumbed through the regional sales report for 2013. On the whole, it looked as though the worst was over. Sales were up in every region except for the Midwest, but the Texas figures were troubling. Despite the Lone Star State’s potential, Superior had been unable to penetrate the market there in any meaningful way. Texas was contributing only 2 percent of company revenues. It had been almost 10 years since Superior opened offices in San Antonio and Fort Worth. How much longer should the company work to cultivate this market? Was there enough of an upside to warrant staying the course? Should Superior jettison this market to focus on areas closer to its base of operations in North Carolina? These were questions that would certainly come up when Superior’s executive team held its regular quarterly meeting.

The Engineering Services Industry

The engineering services industry provides studies, design, construction management, and consulting for facilities in support of all sectors of the economy (e.g., residential, commercial, government, transportation, health care, education). The industry was active in all developed (and some undeveloped) portions of the United States.

The engineering services industry consists of many small companies that typically restrict their activities to regional markets, while larger firms have a global presence. The industry was fragmented with the four largest firms controlling less than 14 percent of the industry sales. Despite the low concentration, the 50 largest firms generated approximately 40 percent of industry sales. As the recession deepened and construction projects plunged, many small firms were forced to cease operations. The industry was further fragmented by over 90,000 self-employed professionals; however, they constituted only a very small proportion of industry sales.

The industry was highly dependent on the real estate and government sectors of the U.S. economy. Construction activity and sales declined during the recession beginning in 2007 and continued through 2013 largely due to cuts implemented in a government sequestration. Since 2011, the industry had shown signs of recovery as businesses began to invest in new facilities. However, the federal government scaled back spending on capital projects. Competition was high due to the large number of competitors within the industry. Clients typically made their purchase decisions for engineering services based on reputation for service and quality, experience on previous projects, and price. The demand for engineering services in the United States consisted of industrial and manufacturing projects, transportation, commercial, federal, government, residential, project management, and municipal utilities.

The Texas market had added 24,000 construction jobs as of August 2013, roughly 14 percent of the 168,000 added nationwide. Job growth in Dallas, Houston, and Austin was twice the national average. Furthermore, in 2013, three of the top 10 U.S. metro markets with the highest number of housing starts were in Texas.

Superior Engineering Services

Superior Engineering Services’ (SES) headquarters was in Holly Springs, North Carolina, just outside Raleigh. The employee-owned company, founded in 1987, grew to include 45 locations with just over 1,100 employees by 2014. The offices were primarily along the Eastern Seaboard (Florida to Pennsylvania), but it also had offices in Indiana, Ohio, and Texas.

The company services spanned geotechnical, environmental, and facilities engineering and construction materials testing. For example, in widening one city’s beltway, Superior provided geotechnical engineering and inspection for drilled shafts and retaining walls. For the reconstruction of a fire-damaged building, the company provided petrographic analysis of concrete columns and load testing of existing pile foundations. Services it provided to a metro rail project included construction materials testing and quality control of drilled shafts. The company’s clients included architects and engineers, facility owners, and general contractors, as well as state, local, and federal government.

Thad knew that the “Texas question” was not as straightforward as the numbers might indicate. Superior’s recent executive meeting illustrated the complexities of the situation. One of the standing agenda items was a report from each business unit on its financial and nonfinancial status. After Barney Williams, regional manager of the Texas operation, gave yet another report laced with more red than black ink, the room grew silent. Was someone going to comment, or would they be able to avoid unpleasantness? Not surprisingly, the Mid-Atlantic manager, Mike Mangione, asked “How much more money de we need to lose before we cut our losses?” He grabbed a copy of the Texas balance sheet and pointed to the negative shareholders equity. “After all these years, we’re still running a $1 million deficit in retained earnings, and that doesn’t even include the personal injury litigation we settled for $3 million,” he continued. Seeing his chance, Phil Collins, the Florida regional manager, said, “Texas is too far from any of our other operations, making the span of control difficult. Furthermore, we can’t seem to convince any of our most experienced managers to take on the challenge of turning it around.”

It went downhill from there. The CEO, Mike Matthews, launched into his defense of the Texas operation with a lecture on the great potential offered by the state, an apology for some early tactical errors, and an affirmation of his commitment to stick it out in Texas. All the regional managers looked relieved when Mike’s executive assistant announced that lunch had arrived. The call to lunch had broken the tension, but managers continued the discussion in small groups around the restrooms and in the buffet line. Thad made a mental note that this scene was like the 1993 movie Groundhog Day all over again, except that at Superior, the situation never improved—the Texas question came up again and again.

Before the afternoon session began, Thad scanned Superior’s rather erratic sales growth (see Figure 1).

Growth percentages for Texas varied, with some higher and some lower than those at other offices over the same time period but on a much smaller dollar sales volume. Superior’s total sales for 2013 were over $119 million, but the Texas operation had never contributed more than $3.1 million to company sales. Furthermore, profits were nonexistent for the Texas operation with the average net profit margin being a negative 16 percent from 2007 to 2013. Losses since 2010 had been getting smaller with the net profit margin reaching a high of −1.5 percent for 2013. Figures 2 and 3 show the contributions to sales by the various sales offices in both 2008 and 2013. The basic contributions provided by each office had remained relatively consistent over the time period.

Figure 2 Regional Offices’ Percentage Contribution to Superior Sales, 2008

 Figure 3 Regional Offices’ Percentage Contribution to Superior Sales, 2013

Thad scanned Superior’s selected financials (see Table 1) hoping to gain further insight into the Texas question. As he glanced at the figures, he wondered how much would actually be saved by eliminating the Texas operation. For example, it wasn’t clear to Thad whether the Texas branch managers would be reassigned or terminated. His best guess, based on the CEO’s comments in defense of the Texas operation, was that only one manager would be retained, at a cost of about $140,000. The equipment used in Texas was getting older, and the cost of transporting it to a new location would probably be more than it was worth. Thad thought it could be disposed of at its book value. Thad seemed to recall that this was the last year of the lease and that negotiations to extend it would occur next quarter. Since each branch operated essentially as a strategic business unit (SBU) Thad knew that Superior would not need to reabsorb any of the overhead costs or business development (BD) and marketing attributed to the Texas branch. Likewise, the other income associated with Texas would be eliminated.

As Thad made his way back into the conference room, he seemed to have more questions than when the day began. Texas might be a huge contributor to Superior’s bottom line one day, but when? Were the losses incurred over the 10-year effort in Texas relevant to going forward? What other numbers might help Thad and the other Superior executives make a decision on resolving the Texas question?

Discussion Questions

1. Reconcile the executive team’s lamentations regarding Texas’s poor performance with Figures 1–3 in the case.

2. Why has Texas struggled to be profitable? What does a vertical analysis of Superior’s financials suggest about the Texas operation versus Superior as a whole?

3. What would the Texas branch’s financials look like if it maintained Superior’s overall gross margin?

4. What would the Texas financials look like if its pricing was similar to the company’s as a whole?

5. What should Superior’s executive team focus on to answer the Texas question? What additional information might they need?