An Engineering Consultancy Sector Update

November 2017

An Engineering Consultancy sector update. The Gentleman Engineer has found himself in the midst of disrup- tive change for centuries, from the steam engine to artificial intelligence. We believe that the industry now faces another period of change, and events embolden our predictions. 2 Roland Berger Spotlight – Topic here

Consolidation Engineering Consultants design In the Summer of 2015 the Engineering Consultancy the world's fixed assets, and are sector was still reeling from the merger of two of its top 10 players: AECOM and URS. Today it is reeling from the at the centre of a broader addres- merger of another two of its top 10 players: Jacobs and sable market for technical ser- CH2MHill, and another two of its top 10 players: SNC Lavalin and WS Atkins. vices worth USD 380 bn. The consolidation has continued apace, as we forecast it would, and the driver has continued to come from The top 150 of these consultancies have revenues aver- the supply side, not the demand side, that is to say am- aging USD 1 bn each, and are among the world's most bitious equity holders rather than customers. international professional service firms. The sector is We should not get too carried away with this theme. dynamic, harnessing global megatrends like urbaniza- The real uptick in global M&A occurred the decade be- tion, technology and environmental concern to draw in fore last, when it rose from 100 to 300 deals per year, and some of the brightest minds to a creative and lucrative the deal flow has merely continued at this level for the world profession. last ten years. The sense in which the consolidators have And yet all is not going smoothly for the Gentle- been public companies acquiring privateers is true, but man Engineer. The growth seen for many years is fal- again not overwhelming, with around half of the largest tering, and consolidation has unsettled suppliers and businesses remaining in private ownership. customers alike. But the element that makes this such a notable In Summer 2015 Roland Berger published a status "A+" prediction is the scale and conspicuous nature of report on the industry and its prospects, making predic- the mergers, and the role of the supply side. The role of tions for the five-year strategic time horizon to come. Now, an activist investor on the sell side of URS, and support- in Winter 2017, we offer a "mid-term report". 01 ing the buyside of WSP PB had already presaged this in

Figure 01: Progress on our predictions for the Summer of 2015, plus five transformational external factors

Consolidation would continue for supply side reasons A+

Advances in IT A-

Increased offshoring B+

Emergence of the Asian Tiger B

Increasing focus on climate change B+

Increasing convergence with other professional services like management consultancy A

"Overall this has been an excellent term for our predictions. While not quite straight A's, there is clear progress on each topic, and no residual chance of failure in any one of them. Keep it up. Two new topics for next term: IT disrupting the value chain, and When is big too big?" Topic here – Roland Berger Spotlight 3

2015, but this theme has continued and if anything past two years have marked many engineering consul- grown. CH2MHill's uncomfortable experiment with tants becoming more familiar with these rafts of soft- Private Equity and an employee-owned equity "grey ware possibilities. This has been in increasingly "tradi- market" may have hastened its exit. More particularly, tional" models like BIM, but also in newer fields like AI the emergence of "patient capital", pursuing reliable and "Big Data". Adoption of some IT approaches has returns at a time of historically low "risk-free" gilt become the norm in this period, for example 4 of 5 UK yields, has greatly influenced the market. Canadian companies in the construction sector have implemented pension funds' enthusiastic investments in WSP and BIM level 1 or 2. This represents huge progress for the SNC Lavalin remain the clearest case of this, but industry. As with all creative endeavour, it is only once Temasek's forays from Singapore into Australia show the expert users are familiar with the IT that they can that this has now emerged beyond Canada. define its true usefulness, and the implications of this At mid-term, our prediction could not have been creative process are becoming clear. more right. And with organic growth elusive for a de- One such implication is a value chain impact, intro- cade, it still has some distance to run. 02 duced as a new topic below.

Advances in IT A- Increased offshoring B+ This was in many ways our safest prediction; incremen- Our assertion from 2015 was that all engineering con- tal improvement of IT having been an influence on En- sultants could sensibly offshore a proportion of their gineering Consultancy every year since the advent of the work, viewed empirically to be 3-5% by value, to low computer. There has been no IT-induced hiatus, but the cost centres, typically in India. While we have not pur- ubiquity of C-suite discussions about design process in sued a statistically relevant sample, we have seen this 2017 vs. 2015 warrants an A grade. trend continuing. It is estimated that over USD 10 bn has been spent Some large companies have been edging their off- developing E&C-related software since 2010, and the shored workshare beyond 5%, particularly where they

Figure 02: Merged revenue in top 150 over time [USD bn]

160

140 M&A within top 150 global 120 design firms

100

60 Organic

0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Source: Roland Berger 4 Roland Berger Spotlight – The Gentleman Engineer's mid-term report

have used it as a post-merger integration tool. Early Emergence of "the Asian Dragon" beyond China B adopters are enjoying improved efficiency with higher Of all our predictions, the one that has been least con- productivity, lower churn, and reduced commissioning spicuously right has perhaps been disruptions caused in costs for work as their processes have matured. It is not the non-Chinese market by Chinese consultants. surprising, therefore, that many smaller and non-An- It would not have surprised us by this time to have glo-Saxon practices are increasingly following their seen wholesale acquisitions of occidental consultants by larger Anglo competitors in this regard, with offshoring Chinese players seeking growth beyond domestic mar- now common in practices with as few as 1,500 employ- kets. For the most part, while the conditions endure, this ees. This has been reinforced by customers that are bet- has not been evident. ter educated in the benefits of offshoring, and expect it Chinese suppliers have indeed become dominant (and price it in) as the norm. in some sectors. For example, China now accounts for Against this, we have seen some drag on progress in 51% of the size and has accounted for 98% of the last 5 a period during which service industry offshoring has years' growth in the Power consultancy sector. Slowing dropped markedly. 03 Headwinds include protection- growth at home will undoubtedly lead to world class ism, demand market stagnation and adverse currency skills seeking opportunities abroad. Again in the power movements making offshoring less attractive, and increas- sector, the 22% growth rates seen annually in China ingly some of the detailed design disciplines typically off- since the first years of the millennium are forecast to shored coming into the range of design automation. fall to 7% for a supply chain now able to build some of We believe there is a logical and modest ceiling to the world's most advanced transmission grids, super- offshored design content. We just do not know what it is. critical boilers and nuclear reactors.

Figure 03: Global market of outsourced services, total contract value1) [USD bn]

105 -14% 99 29 95 91 93 37 88 25 29 89 83 25 81 76 77 28 77 70 76 24 Business process 65 68 60 66 63 64 52 55 53 IT 46

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Source: Roland Berger The Gentleman Engineer's mid-term report – Roland Berger Spotlight 5

The West has not seen M&A, or even much direct com- Figure 04: ENR export revenue of 225 top interna- petition from these players in its home markets in this tional design firms [USD bn] period. It has however been increasingly squeezed out of the Chinese market (where export revenues have fallen by c. 10% per annum during the last two years) and fron- tier markets like South East Asia and Africa where Chi- nese full-value-chain deals make sure that large seg- -4.9% ments of opportunity never become addressable. 04 70.9 0.3 This can hardly be a coincidence, and growth in such 4.4 markets is understandably more strategically attractive to a Chinese player than a frontal attack on incumbents 4.8 65.4 0.3 64.1 in low growth mature markets. 4.4 0.2 RoW -13.5% 2.9 Latin America -19.1% However, we continue to believe that Chinese com- 7.7 4.0 3.8 Africa -11.7% petition will now emerge conspicuously in the coming period, not least because we observe the increased so- 6.6 5.9 Canada -12.9% phistication of Chinese strategy functions, and the continued global allure of the best Western design. 10.7 Japan has demonstrated, for example through the 10.5 US -1.0% 10.9 UK acquisitions of Waterman and BDP, that M&A is a tool for oriental capital and know how, and we still doubt that China (or Korea) will resist the temptation to follow.

11.4 Increasing focus on Climate Change B+ 12.0 Middle East +2.8% So is Climate Change higher or lower on the corporate 12.0 agenda now than in 2015? Hard to know. In an Anglo-Saxon country, ravaged by an atavistic swing to the right in politics and the economic uncer- 15.1 tainty of the moment, the environment is probably something of a neglected intellectual luxury. This is per- 15.2 Europe +0.3% 13.3 haps even true in Saxon Germany, where the AfD has grown in strength and the Greens dwindle. This, plus climate change denial and withdrawal from the Paris Agreement in the US, must mean the high-water mark of climate concern has passed, right?

16.5 Well, no. Temperatures are rising, and while the OECD falters, commitment in the second world has 13.8 13.7 Asia & -8.8% grown. China, now the world's largest polluter, has re- Australia doubled its commitment to the Paris Agreement. The environment is no longer simply green-wash in the UAE, where record breaking PV installations and an ambi- tious 2050 low carbon target now reside. But most important of all, more important than the politics, are the technical advances, and growth in mit- 2015 2016 2017 igation of the practical effects now being ascribed to climate change. Source: Roland Berger 6 Roland Berger Spotlight – The Gentleman Engineer's mid-term report

The 2017 hurricane season, and its attendant (and tem- The challenges of such changes in business model are porary?) depopulation of the Virgin Islands and Puerto not trivial, and have been accompanied by the creation Rico lead to civil works and a newfound respect for plan- of arms-length entities and brands like Advisian (Worley ning and design in Houston and Miami. The "new" Parsons) and Acuity (Atkins). With these clearer brands Chek Lap Kok airport, an enterprise that cemented comes clearer recognition from clients of the breadth of many of the engineering reputations of Hong Kong, is services the sector has to offer, particularly in regions now tabled for flood defences or even ultimate reloca- like the Middle East where the Gentleman Engineer has tion as storm surges rise. retained prestige as a trusted advisor. First mover clients like the Norwegian government Commensurate takeovers of engineering and cost are demanding credentials at the tender stage which are consultancies by accountants have not transpired, but leading to major players like Spain's Acciona scrapping rumours have been rife and occasionally credible. We for the title of "zero Carbon contractor". expect this convergence to continue. Most encouragingly of all, there is a sense that the Power sector has crossed a Rubicon in the past two years, with renewables now the least cost non-firm generator in most geographies, and the electrification of transport next on the agenda. 05 In general, then, our mid-term As ever, then, the environmental movement makes report shows good progress by two steps forward and one step back, but it maintains forward momentum. the Gentleman Engineer in all the areas that we predicted. We Convergence A Encouragingly for the Gentleman Engineer, there ap- will continue to monitor each of pear over the past two years to have been growing for- these trends for the coming ays into novel professional services arenas more typi- term, along with two new and cally populated by bulge-bracket advisors like the accounting Big Four. interrelated topics.

Figure 05: Illustrative factored cost, by source [EUR per kWh]

Nuclear 0.09 Gas 0.05 steady steady

Clean coal 0.07 Onshore wind 0.05 steady falling

Offshore wind 0.07 Solar 0.03 falling falling The Gentleman Engineer's mid-term report – Roland Berger Spotlight 7

IT disrupting the value chain this more devolved approach. We have seen this playing As previously discussed, we see IT developments across out through our project work in several environments, the new "E&C 4.0" value chain. Relationship manage- including BIM object libraries and energy management ment is democratized by social media like Linked In. systems. A useful side effect is that cloud-hosted soft- Contract assessment is an early target for AI, as are some ware-as-a-service pricing models are the norm, making elements of detailed design. BIM-related suites of soft- the software accessible to all customers, be they large ware provide transparency to the full lifecycle of many or small. assets from concept design to asset management. And In this model, then, communities of small expert sup- of course, there are myriad new products focusing on the pliers may grow up serving common customers and asset on-site efficiency of contractors and O&M providers. types collaboratively. A small agile consultancy could play Much of this IT is focused upon process efficiency its part in the biggest and most complex projects, offshor- within a company. However, we believe that this IT inno- ing to external partners in India and exchanging real time vation shares characteristics which will boost efficiencies information with build partners. Importantly for the lead- between companies. These characteristics stem from the ers of these businesses, such a vision would preclude the nature of the developer companies themselves. complication of multiple business models, geographies Most developer companies at this time are start-ups, or post-merger integration under one roof, and allow fo- over 1,000 of which can be observed in the E&C domain. cus on the excellence and innovation with which the sec- Start-ups in 2017 almost always harness the ubiquity of tor has always been tasked. the internet and cloud computing to reduce their cost of Of course, we could be very wrong, and the advances entry. Inter-operability is vital for these new applica- in proprietary BIM packages could serve to weld the tions, as they cannot rely upon the incumbency offered value chain together. In either case, IT solutions now in by Microsoft or SAP, but instead knit together an ecosys- development could break or link the elements of today's tem of applications to tailor a software suite. And it is value chain in ways previously inconceivable. this interoperability which means that, in our opinion, existing value chains may be disrupted. When is big too big? In the future some value chain roles will merge; With consolidation have emerged several consultancies why separate cost consultancy from design when BIM with tens of thousands of consultants. objects have cost attributes? A large vertically inte- There is some evidence that big can be beautiful. grated contractor employing for example every aspect Large projects like green field airports need many hands, of an advanced ERP-integrated BIM package from con- and suppliers must be able to deploy large teams with- cept to FM may have a material cost advantage vs. a out failure, an imperative recognized by the UK govern- more traditional specialist supply chain. We know of ment when it closed its HS2 tendering process to suppli- some contractors and consultants that are developing ers with revenue < GBP 600 m. If large consultancies can in-house software teams and bolt-on acquisitions with secure the best projects, they will attract the best engi- exactly this in mind. neers in a virtuous circle. Consolidation remains very But conversely an object-oriented information flow low vs other markets, it still being rare for players to have with best-in-class software modules each sharing open more than 10% share of any national market, so there architecture data could serve the same purpose. If the are few anti-competitive concerns. functionality of such individual software applications Against these positives, there are many desirable outstrips the progress of the more integrated mono- qualities that the largest companies have not universally lithic model, then their users will benefit. And in any demonstrated. 06 case, Level 3 BIM is open to third party information Such large companies are not easy to run, and a lot of transfer by nature. our time as advisers is consumed with helping the leader- To our mind the more flexible model is in the as- ship of such companies. Controls can be difficult, with cendant, and the prevalence and creativity of IT start- transfer pricing across multiple business cultures leading ups means that the best performance will come from to unintended consequences. Where different business 8 Roland Berger Spotlight – The Gentleman Engineer's mid-term report

Figure 06: There are many desirable qualities that the largest companies have not universally demonstrated

A reputation for excellence amongst their peers Compelling scale economies in overheads Reputation for excellence amongst peers vs. size [# mentions] Growth in revenues vs. SGA, 2012-16

Firms [#] SG&A CAGR, 2012-16 4 9 18 40 93 30% 45° line 71 25%

20% 55 Line of 15% best fit

10%

26 5% 20 0%

-5% 2 -10% 1 2 3 4 5 Quintile -10% -5% 0% 5% 10% 15% 20% 25% 30% [by revenue] Gross revenue CAGR, 2012-16

Class-leading shareholder value creation Growth beyond their domestic markets Total Return Index, three largest listed E&C consultancies Top 150 engineering consulting firms revenue by end market [USD bn]

550 WSP 150 140 500 130 450 120 400 110 100 Domestic 350 90 300 80 250 70 60 200 Average 50 150 40 AECOM International 30 100 Jacobs (export) 20 50 10 0 0 2007 2008 2009 2010 201 1 2012 2013 2014 2015 2016 2017 2018 2002 2003 2004 2005 2006 2007 2008 2009 2010 201 1 2012 2013 2014 2015 2016

Source: Roland Berger The Gentleman Engineer's mid-term report – Roland Berger Spotlight 9

models exist, for example developers, designers and con- "We don't work with [Large tractors, so very different metrics and incentive structures must coexist. As mergers become larger the prevalence of Engineer] any more "complementary" deals recedes; it is no longer sufficient to "park alongside", but rather an "integration" period because they're now must ensue. This is a nature-different acquisition environment, with higher risks of failure, particularly in a competitors. We've heard good market where no one wants to become a "synergy", that some contractors think and disaffected assets can walk. Fundamentally, the stem of our scale question of them the same way." comes back to the observation that supply, and not demand, has driven consolidation. Recently interviewed Principal at Unblemished customer satisfaction is an impossible leading Architecture practice dream for any company, and a more conspicuous chal- lenge for large-and-conspicuous players, but it does seem to us from our work that there is disquiet from some of the customers and employees of the largest players The risk of relying on the primal ambitions of activist investors to drive growth and consolidation is that their timeframes are difficult to tame. Engineering consultancy has been a patient game, with long asset cycles, a reliance on trust, and low risk or balance sheet require- ments. It has thus favoured employee-owned models, in it for the long haul. For the most part these conditions have not changed Where capital can drive superior performance it will do so, but this logic can just as easily drive demergers as consolidation, as adjacent sectors like Pharmaceuticals and Chemicals will testify. A scenario can be painted where activist investors in public companies lose patience with the introspection and loss of customer focus in their creations and demand a reversion to specialist monocul- tures, supported by the new collaborative IT environment. We doubt that such a wave of demergers is upon us soon, but we at least observe the possibility.

Summary The two and a half years that have elapsed since our first treatise on the Gentleman Engineer have seen many of our predictions borne out. Cycles continue on a sectoral and country level, some of them, like the deep recession in Oil & Gas, felt more keenly than others. But the versa- tility and intellect of the technical services sector pro- tects it from the worst eventualities, and we believe that megatrends and openness to continued change will see such businesses prosper. WE WELCOME YOUR QUESTIONS, COMMENTS AND SUGGESTIONS

AUTHORS PUBLISHER

Tim Longstaff, Partner, UK Roland Berger Ltd [email protected] 55 Baker Street London W1U 8EW Tijo Collot d'Escury, Partner, Netherlands United Kingdom [email protected] +44 3075-1100 www.rolandberger.com Gillian Morris, Partner, USA [email protected]

Dereck Ji, Partner, China [email protected]

Alexis Gardy, Partner, Canada [email protected]

Julia Fagerberg, Consultant, UK [email protected]

More information to find here: www.rolandberger.com

Disclaimer This publication has been prepared for general guidance only. The reader should not act according to any information provided in this publication without receiving specific professional advice. Roland Berger GmbH shall not be liable for any damages resulting from any use of the information contained in the publication.