Does Superior fit the definition of a small business or an entrepreneurial venture? Please explain. Reconcile the executive team’s concerns regarding Texas’s poor ?performance with Figu

Superior Engineering in Texas: Stay or Go?

Author: Woody D. Richardson, Kenneth D. Machande, Peter W. O'Hara

Pub. Date: 2016

Product: SAGE Business Cases

DOI: https://dx.doi.org/10.4135/9781473980839

Keywords: Texas, engineering services, engineering, engineering industry, sales, income statement, costing

Disciplines: Business & Management, Strategic Management, Management Accounting, Accounting,

Decision-Making

Access Date: January 12, 2023

Publishing Company: SAGE Publications: SAGE Business Cases Originals

City: London

Online ISBN: 9781473980839

© 2016 SAGE Publications: SAGE Business Cases Originals All Rights Reserved.

Abstract

The case describes a decision facing an engineering services firm regarding the continuation of

its Texas branch. The $120 million company operates over 40 offices in several states, primarily

along the Eastern seaboard of the United States. Its Texas offices have underachieved since

their inception. The executive team grapples with the question of whether to continue the Texas

operation. The case provides cost data as well as dialogue among the executives regarding the

search for an answer to the Texas question.

Case

Learning Objectives

After reading and studying this case, students should be able to:

• Apply the concepts of vertical (common-sized) and differential analysis to managerial decision-mak-

ing.

• Develop and interpret pro forma analysis to assist in managerial decision-making.

• Identify costs relevant for managerial decision-making including the distinction between avoidable

and unavoidable costs.

Introduction

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, Supe-

rior had been unable to penetrate the market there in any meaningful way. Texas was contributing only 2%

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 in areas closer to its base of op-

erations in North Carolina? These were questions that would certainly come up when Superior's executive

team held its regular quarterly meeting.

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Page 2 of 9 Superior Engineering in Texas: Stay or Go?

The Engineering Services Industry

The engineering services industry provided studies, design, construction management, and consulting for

facilities in support of all sectors of the economy (e.g., residential, commercial, government, transportation,

healthcare, education). The industry was active within all developed (and some undeveloped) portions of the

United States.

The engineering services industry consisted of many small companies that typically restricted their activities to

regional markets, while larger firms had a global presence. The industry was fragmented with the four largest

firms controlling less than 14% of the industry sales. Despite the low concentration, the 50 largest firms gen-

erated approximately 40% 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 segments of the U.S. economy. Con-

struction activity and sales declined during the recession beginning in 2007 and continued through 2013

largely due to cuts implemented due to 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 decision 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, residen-

tial, project management, and municipal utilities (Edwards, 2015).

The Texas market had added 24,000 construction jobs as of August 2013, roughly 14% 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 (Avila, 2013).

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

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Page 3 of 9 Superior Engineering in Texas: Stay or Go?

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 ma-

terials 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 compa-

ny 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

the state, local, and the 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 non-financial status. After Barney Williams, regional man-

ager 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 loss-

es?” 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 contin-

ued 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).

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Page 4 of 9 Superior Engineering in Texas: Stay or Go?

Figure 1. Sales Office Growth 2008–2013 showing the trends of the year over

year sales growth of the various regional offices of Superior Engineering Ser-

vices.

Source: Adapted from information provided by the company.

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% from

2007–2013. Losses since 2010 had been getting smaller with the net profit margin reaching a high of −1.5%

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. 2008 Sales Office Percent Contribution to Superior Sales showing

the percentage contribution of Superior's regional offices to the company's to-

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Page 5 of 9 Superior Engineering in Texas: Stay or Go?

tal sales. Texas contributed only 2.7 % in 2008, while the Carolina office con-

tributed 52.9 %.

Source: Adapted from information provided by the company.

Figure 3. 2013 Sales Office Percent Contribution to Superior Sales.

Source: Adapted from information provided by the company.

Note: Figure 3 shows the contributions by each office for the 2013 year. Texas contributed 2.6% and the Car-

olina office 53.8%.

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Page 6 of 9 Superior Engineering in Texas: Stay or Go?

Thad scanned Superior's selected financials (see Table 1) hoping to gain further insight into the Texas ques-

tion. 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 busi-

ness 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.

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Page 7 of 9 Superior Engineering in Texas: Stay or Go?

Table 1. Superior Engineering Services: 2013 Selected Financials, showing the income statement for Supe-

rior as a whole and the income statement for Texas only.

Superior Consolidated Superior Texas Only

Sales (net of bad debt) $119,893,314 $3,175,025

Cost of services $70,004,181 $2,290,204

Gross margin $49,889,133 $884,821

Expenses

General overheads $30,080,474 $1,089,424

Branch managers $8,267,966 $240,390

Depreciation $1,495,266 $35,972

Rent $5,306,605 $210,619

BD & marketing $1,293,453 $34,208

Total expenses $46,443,764 $1,610,613

Net income from operations $3,445,369 $(725,792)

Other income $(1,672,465) $(93,203)

Net income before taxes $1,772,904 $(818,995)

Taxes $655,977 $(303,028)

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Page 8 of 9 Superior Engineering in Texas: Stay or Go?

1.

2.

3.

4.

5.

Source: Adapted from information provided by the company.

Note: Superior's sales totaled $119.8M with just over $1M net income. Texas generated just over $3M in sales

producing a loss of $515,967.

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 the10-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

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

the case.

Why has Texas struggled to be profitable? What does a vertical analysis of Superior's financials sug-

gest about the Texas operation versus Superior as a whole?

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

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

What should Superior's executive team focus on to answer the Texas question? What additional in-

formation might they need?

References

Alva, M. (2013, November 5). Texas construction booming on broad economic strength. Investor Business

Daily

Edwards, J. (2015). Engineering Services in the U.S. IBIS World Industry Report 54133, p. 4. Retrieved from:

http://clients1.ibisworld.com.ezproxy.umw.edu/reports/us/industry/ataglance.aspx?entid=1403

https://dx.doi.org/10.4135/9781473980839

Net income $1,116,927 $(515,967)

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Page 9 of 9 Superior Engineering in Texas: Stay or Go?