To diversify or not? The pros and cons for construction firms

In recent years the practice of diversifying into new services and or markets, within the construction sector, has been encouraged by business analysts, in part as a response to the global pandemic. Indeed, it’s clear that having a diverse spread of services has proved profitable for some construction companies. Towards the end of last year, tier one contractor Morgan Sindall Group reported profit growth ahead of expectations, thanks to its fit-out division; at the end of September profits rose by 15% to £1.3bn, from 2023’s figure. McLaren Construction Group, another tier one contractor, launched its construction management wing last year, which contributed to pre-tax profits nearly doubling last year to £11.9 million, from 2023’s £6.3 million.

However, the collapse of ISG in September last year, the biggest construction failure since Carillion in 2018 (another tier one main contractor) has been blamed, in part, by some commentators on its strategy of growing through acquisitions; allowing it to expand into broader construction markets distinct from the original core service.

As figures continue to show, the construction sector remains particularly vulnerable to the risk of insolvency – construction firms accounted for 15% of all insolvencies in England and Wales in November 2024, with 316 registered construction businesses becoming insolvent. Of all the industrial sectors, construction experienced the highest number of insolvencies in the year to November 2024.

Some companies may view the strategy of diversifying their offering as a way to bolster their resilience, while others could see this as a potential threat to their stability, preferring to stick to one or two specialist areas to mitigate risk. What are the arguments for and against? Here we explore the pros and cons of construction companies diversifying their service offer.

Reputation, reputation, reputation

Diversification can be an effective way for a company to grow but requires careful consideration of the company’s existing strengths, resources, and its position in the market. Ideally, construction companies should aim to diversify in a way that builds on their existing expertise and brand, minimises risk, and maintains standards.

Dr David Crosthwaite, Chief Economist at BCIS, says: ‘Smaller, or niche companies may benefit from staying focused on their specialty. By honing a strong reputation in one area, they can build a loyal client base that values their expertise and avoid the pitfalls of overstretching resources.’

This has worked well for BW Interiors, a leading fit-out and refurbishment contractor that specialises in this currently booming sector. The decision to focus primarily on commercial office space appears to have fared well for the company; its September pre-tax profit was £3m, up 38% on the previous year.

Dr Crosthwaite cautions: ‘On the flip side, diversifying services can sometimes impact quality if resources are overstretched or if the company doesn’t have sufficient knowledge or experience in the new area. Further, as new entrants to a market firms will be at a significant disadvantage to established businesses in that market and will likely only be able to compete on price rather than reputation. This is not a long-term sustainable business strategy. Indeed, they could risk damaging their reputation across all areas of the business.’

Some commentators have argued the roots of ISG’s demise began when it diversified from its core fit-out business. It had built a strong reputation as a market leader in office fit-outs, particularly in high-end corporate spaces; the acronym itself stood for Interior Services Group. The company branched out into multiple contracting sectors, including retail, technology, healthcare, and new-build construction. While this brought growth and global expansion, it’s been suggested ISG overextended itself across multiple sectors and locations and lacked the capacity to deliver efficiently. This was also one of the criticisms levelled at Carillion, the UK’s second-largest construction company when it collapsed in 2018.

Creating stability

One of the main draws for diversifying services is the promise of creating multiple revenue streams. This can be especially helpful in the cyclical construction industry, where demand for large projects may fluctuate; not least in an era where uncertainty over large infrastructure projects continues to reign, and competition for these contracts remains fierce.

Branching into other areas, such as residential, commercial, or fit-outs, can help companies tap into new client bases and respond to market demand, especially when certain sectors – such as fit-outs – go through more robust periods than others.

One relatively successful example comes from Laing O’Rourke originally a specialist concrete sub-contractor. The company went from high-end building construction into engineering, digital construction, off-site manufacturing, and infrastructure projects, securing high-profile projects that included Crossrail.

And of course, relying on one sector can become problematic, not least in the face of an unprecedented global crisis; the most obvious in recent years being the pandemic, during and after which the commercial office sector has been significantly impacted.

Some companies could be tempted to branch into housebuilding, as Angela Rayner continues to reiterate the government’s determination to reach its target of 1.5 million homes in this Parliament. However, it could prove fruitless to pursue this avenue, as industry experts continue to highlight the damaging ramifications of labour shortages across the industry, which could certainly scupper any plans for companies to diversify. Although the government has made some progress in aiming to address this through increasing the number of apprenticeships, Dr Crosthwaite warns that if Labour’s plans are to be realised, it will need to rely on ‘migrant labour to satisfy peaks in demand’.

In addition to this, companies set on entering new sectors also tend to rely on finance to get started. This may be sustainable when the economic landscape is strong but inflation, high interest rates and supply and demand issues can send finance costs rocketing. This increased burden can lead to delays in payment. As a consequence, suppliers may file winding-up orders when payment delays raise concerns about insolvency – this was understood to have happened in the ISG case, when a logistics firm filed a winding-up petition against ISG Engineering for an alleged unpaid debt.

All things to all people

The ambition to become a one-stop shop provider is understandably enticing for companies because it’s a big draw for clients who prefer dealing with fewer contractors. It can also help to reduce delay and streamline projects. For example, after a new build, a company could offer interior fit-out services, securing a larger share of a project and creating ongoing client relationships.

However, cross-selling or ‘vertical integration’, as it’s also known, could be problematic due to supply chain issues that make it harder to source a different set of materials or relevant skills, especially if they don’t have an established reputation in the field.

AECOM, for example, entered the main contracting market in the UK in the mid 2010s but withdrew after just four years following a ‘strategic review’.

In addition to this, new entrants often rely on underbidding established players, which can erode profit margins and destabilise the broader sector.

Growing through acquisitions

Companies listed on exchange markets can come under pressure to show rapid growth to satisfy shareholders. If organic growth is slow, firms may turn to acquisitions as a strategy for growth. Although it’s possible for this to work out well it’s not always sustainable, as teething problems can occur as the new company is integrated – this can be especially true when due diligence is undertaken by non-financial experts, who might miss critical red flags concerning the company’s finances.

Conclusion

There is, perhaps, no definitive answer on whether a company should diversify its offering or stick to one specialism, as several macro and micro factors can impact financial success – from supply chain challenges, caused by economic shockwaves, to how financially robust a company is, in the face of ever-tightening profit margins and cash flow pressures.

On the one hand, broadening a company’s service offering can provide resilience by tapping into multiple revenue streams, reducing dependence on a single sector, and enabling firms to adapt.

However, diversification into unfamiliar markets can also put a strain on resources, increase exposure to financial and operational complexities and have a negative impact on reputation. Ultimately, the decision must align with a company’s capabilities, risk tolerance, and long-term goals. Firms that can maintain high standards, build on existing strengths, and manage financial pressures effectively are more likely to turn diversification into a competitive advantage. For others, remaining focused on a niche market may prove to be more sustainable.

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