A Look Into Construction Tech
By Chelsea Zhang and Richard Kerby
The construction industry has had an interesting few years. Like with other major industries, COVID had a devastating impact on the sector and brought forth a myriad of problems, including project delays, labor shortages, higher material costs, tighter insurance markets, and more. While 70% of construction companies indicate that they were negatively affected by COVID, the sector remained on the frontline during the pandemic. Many projects were deemed “essential” and new developments for medical facilities and other infrastructure required companies to scramble to find innovative, and often digital solutions, to adapt to pandemic challenges.
A core focus for Equal Ventures has been technology deployment within legacy industries. Similar to our thesis within supply chain and logistics, we were intrigued by the potential that democratizing access to software could have within construction. Specifically, we had a hypothesis that construction could be a good fit for a model that we have seen to be very successful in other industries — leveraging counter positioning in legacy industries through giving away a freemium, core software product and monetizing on embedded financial services. But first, some market context.
Massive, fragmented, and cyclical
The construction industry is a critical component of the U.S. economy, with $1.8T in annual spend. Despite its sheer size, construction is actually extremely fragmented — per Census data, the average establishment has fewer than 10 employees. Companies with 100 or fewer employees hold more than half of the industry revenue, with that ratio going to two-thirds within specialty trade contractors specifically. Enterprises with 1,000 or more employees make up less than 20% of revenue, primarily driven by their strength within heavy & civil engineering. Within building construction and specialty trade contractors, enterprises hold less than 10% of industry revenue. This is an industry with a robust mid-market and a vast long tail — not surprising given the localized nature of construction.
The construction industry is typically segmented by public vs. private construction as well as by end markets. Within private construction, residential construction (single-family and multi-family housing) makes up over half of the segment, then followed by major end markets such as manufacturing and commercial (mostly retail). Public construction is primarily infrastructure such as highways and streets, schools and universities, transportation, and more.
While construction as a whole typically trends with the cyclical business cycle, the sub-sectors can move meaningfully differently in the short term. Within the private sector, residential starts trend with housing supply and demand, while the other sub-sectors trend with business confidence. Public construction spending is less susceptible to business cycles and is driven by major legislations such as the American Rescue Plan and the Build Back Better plan.
“Slowly at first, and then all at once”
Construction has long been one of the least digitized parts of the economy. A 2016 McKinsey survey ranked construction, second only to agriculture and hunting, as one of the least digitized industries globally, with less than 1% of revenues going to IT spend. While there were some signs of digital acceleration pre-COVID — global R&D spend among the top 2,000 construction companies increased by ~80% from 2013 to 2018 — the industry was not cracking the top five anytime soon.
The pandemic has undeniably accelerated technology adoption. The use of drones on job sites tripled in 2020 alone and other tools such as digital collaboration platforms, virtual scanning tools, and safety-focused wearables all shifted from “nice-to-haves” pre-COVID to lifelines for builders of all sizes to keep projects alive. Materials suppliers were forced to shift to a contactless model overnight to remain open — paper checks became ACH payments, in-person / quotes were submitted digitally.
COVID thrust the need for digital adoption to the forefront for many decision makers within construction and project owners that have embraced technology are already seeing the benefits. Dodge’s 2022 survey indicated that 66% of project owners using digital workflows are already seeing better-informed decision-making on their projects. KPMG’s 2017 Global Construction Survey saw fewer than half of respondents with a technology roadmap for improving project controls but 2021’s survey rated technology adoption as the second most important capability to deal with disruptive shocks like COVID, just behind company leadership.
Bumps on the road to recovery
There are a number of challenges as the sector looks to bounce back fully from COVID. Earlier this month, the Federal Reserve warned lawmakers that the chances of a U.S. recession in 2023 have risen to ~50% due to “slower consumer spending, global economic risks, and further interest-rate hikes.” Dodge forecasts a 2023 stagnation (dollar value to remain the same with a 3% dip in real dollars when adjusting for inflation) and declines in residential and commercial activity to be offset by growths in manufacturing and infrastructure. Sky-high lumber prices have eased but other building material prices have remained high, with materials in aggregate up 15% yoy. Supply chain issues are likely to push up prices next year, with a forecasted “escalation year-on-year of 7%.”
Higher material costs, labor shortages, and project delays have had a significant impact on casualty construction insurance, reflected in higher prices. Builders have already faced rising insurance premiums for the past four years to the tune of 5–15% per annum. COVID-related insured losses may approach $80B, likely pushing carriers to continue their harder positions. With the exception of workers comp, all other insurance lines are likely to experience higher rates in 2023. All in all, contractors believe their margins will continue to be pressured due to supply shocks and a weakening financial environment.
Labor shortages are expected to persist
Labor productivity is often cited as construction’s biggest problem. An aging construction workforce has resulted in a shortfall of 8.2M workers between 2017–27 and in April of this year, the U.S. construction and manufacturing industry had ~440k and ~1M job openings, respectively, the highest levels recorded since the data were first recorded. ~80% of contractors are having difficulties filling skilled positions as recruitment costs continue to rise, but the pain is not only being felt there. ~40% of the labor shortage will actually be within the materials sector, spanning across manufacturing, distribution and warehousing. To increase efficiency, 30% of firms are adopting technologies and labor-saving processes like lean construction and BIM and almost 50% are increasing IT spend, especially for project management software, but that will not be enough. In 2023, the industry needs to bring in almost 600k new workers on top of normal hiring to meet industry demand. There is an urgent need for construction to attract more new and / or younger people into the labor force in the very short term. We are particularly interested in two potential models:
1. An employer of record (EOR) model — a third-party organization that manages employees’ payroll, taxation, compliance, onboarding, etc. We have seen this model work extremely well in the entertainment industry in our portfolio company Wrapbook
2. A tech-enabled platform to find and build talent, especially in high-demand segments like skilled specialty trades.
Permitting & insurance remains a big issue
Legacy processes are tedious, complicated, and still very manual. Codes are constantly changing and any mistakes with formatting or filing can result in denials and project delays. The permitting process also varies significantly by state and even locality. California is notorious for its strict building codes and development regulations and New York requires interaction with 30 different government organizations. While there are select exceptions like Rhode Island, where most municipalities have adopted a software product called Viewpoint that enables contractors to easily upload documents for approval, the vast majority of permitting processes require a convoluted paper & pen process. Solutions like PermitHub, PermitFlow and Pulley are helping to shorten the permitting process but more work needs to be done.
A September 2022 NMHC survey of multifamily developers indicates that 78% of respondents reported delays in permitting and the number of respondents seeing permitting take 9 months or longer, doubling to 20% from June to September, which can add significant costs and time. In addition to making the permitting process more efficient, there is a large data play within permitting as well, given where permitting sits in the value chain. Permitting is at the top of the funnel of construction and is a leading indicator of where real estate demand lies. We have yet to find a solution that can demonstrate tech leverage without relying too heavily on services but we continue to believe that permitting remains a massive untapped opportunity and are actively looking for more solutions in the space.
We can’t talk about permitting without talking about insurance. A huge part of construction permitting is making sure the right insurance products are in place and getting construction insurance products is a doozy. From general liability to workers comp, to surety bonds, commercial auto, and builder’s risk — all stakeholders within the construction value chain require insurance. Today, critical data is largely collected manually and stored in separate and distinct silos and underwriters do not have great visibility into risk profiles, especially for the mid-to-long tail of projects and contractors. In an environment where carrier margins are under pressure, underwriters are naturally becoming more selective as they face higher pressure from management and reinsurers and will prefer to work with brokers that they have a history with. In the past year, developers have put projects on hold due to sky-high premiums. There is a huge opportunity to improve data connectivity and visibility to 1. improve access to high-fidelity financial and operational information for carriers and brokers in order to improve underwriting, which 2. has the potential to reduce premiums for all stakeholders in the value chain.
Let’s talk about payments
The problem of slow payments within construction can not be understated. Per the Rabbet 2021 Construction Payments Report, delayed payments to general contractors and sub-contractors created $136B in additional costs in 2021, 36% higher than in 2020. We have heard anecdotally through industry discovery calls that contractors screen their customers by their willingness to pay upfront and the data proves it — 67% of sub-contractors did not bid on a project due to a general contractor’s or owner’s reputation of slow payments.
Any delay in payment from the project owner to the contractor has a knock-on effect down the chain. A 2019 survey of contractors indicated that floating payments for wages and invoices added on average more than 5% to total project costs. Materials were cited as the biggest factor impacting cash flow in 2021, with 74% of respondents citing higher cost of materials and 47% citing longer material lead time. 86% of general contractors report that payment delays extend project deadlines — adding “unnecessary risks in the forms of liens, project delays, and unforeseen costs.” In addition to slow payments, construction payments are just still extremely manual. We have heard horror stories about paper checks taking too long, getting lost in the mail, check fraud, and even instances of check-washing. Many local and regional materials distributors and suppliers do not offer a digital payment portal today and only deal in checks — contractors sometimes have to call in and give their card number over the phone if they want to use a card.
As we have seen in other industries, a payments problem creates a credit opportunity. Per Rabbet again, 2021 saw a 76% increase in general contractors using lines of credit and credit cards to float payments when payments are delayed and 72% of subs would offer a discount in exchange for payments within 30 days. In 2019 Q1, 3.3% of total project costs are finance expenses from floating capital alone but credit products are often not available to the long tail of general contractors and subcontractors.
The vertical SaaS + fintech opportunity
A legacy industry that is on the precipice of technology adoption? Check. A fragmented mid-to-long tail that struggles with cash flow? Check. Sounds eerily similar to other legacy industries we have looked at previously where the model has been successful. We are already seeing great verticalized software and fintech startups building in this space but construction remains an under-invested part of the venture ecosystem. Despite a sharp uptick since the beginning of 2021, construction tech received a relatively measly $2.2B in 2021 vs. $12B in funding for JUST Amazon aggregators over the same time period. While Amazon’s revenue totaled an impressive $470B in 2021, construction spend toppled $1.7T in 2021. It is clear that the opportunity set for construction is wide open.
We at Equal Ventures believe there is still a tremendous opportunity for a counter-positioning software play that improves workflow efficiency and monetizes through alternative methods. In GlobalData’s 2021 construction study, 45% of respondents identified limited financial gain in the short term as a barrier to investment in new technology and 36% cited a lack of financial resources allotted for technology innovation. Even without SaaS revenue, there is more than enough payment volume (and credit and insurance opportunities) flowing through the construction sector for a business of immense scale to be built. If there are any founders building in these spaces, please reach out to Rich and Chelsea — we would love to learn more!
