Road construction markets are influenced by what happened in the Heavy Equipment Rental market 2 years ago. This is what’s known as a leading indicator.
It makes sense.
Heavy equipment is used to build major infrastructure projects: mines, new industrial parks, new large commercial complexes, and increased harbor capacity. When these massive projects are complete, increased goods and people will start to move through the new area. Those goods and people need support infrastructure such as houses, gas stations, restaurants, and so on. All of that new or upgraded support infrastructure creates demand for roads.
Crazy Story: Market Size Limited Growth
I was working on a forecast for a road construction contractor. They specialize in fast delivery of barricades and safety products. Great company.
We were trying to figure out what their long-term growth forecast was going to be. But their market share was large enough that they were starting to hit “logistic turnover” in their market. That’s when they’re big enough that incremental market share against competitors was starting to have diminishing returns. This is a possibility for any company over 10-15% of the market. It’s almost certain for companies with over 40% market share. When companies get to this size, they can’t keep expecting growth in the future to look like the recent past that got them there.
In the data, often the historical growth looks exponential. It’s the classic “hockey stick” forecast that would be sexy, fun, and totally wrong. But the growth seemed to be missing the exponential part in the recent past. Growth started to look more like a straight line and was starting to miss that mark too.
I had already proven that their performance was highly influenced by total market size. We had created a market size indicator for the company based on publicly available road construction permit data. But that was only 1-3 months look ahead.
It would be a mistake to invest like our company was growing the same as before. We’d invest for capacity we didn’t need in a saturated market, and end up creating a price war to fulfill that capacity.
So, we knew we needed to see the size of the market a few years out.
Much of forecasting is guess and check. Find a list of possibilities, test all of them for statistical significance, and then ask an expert. There were a few industries with statistical correlations that didn’t make sense to experts. This is a great way to remove covariates (irrelevant and dangerous noise). Driveway paving, for instance, had a statistically significant correlation. But driveway paving wasn’t part of their customer market. In reality, driveway paving had very similar market-leading indicators, so it would look like it matters in the data, but it would be a mistake to use that if we could find an indicator that made sense.
I brought the list of potential leading indicators to the sales team and subject matter experts. Heavy Equipment Rental with a 2-year lead made sense, the experts could see and explain the link between that item and the reality of their market. So we kept it. We did this for several other leading indicators too. Keep or dump and so forth.
Market & Investment Opportunities
Knowing about the leading indicators and their scale gives us four things:
- Capacity Planning: If the overall market is making a move, and we know about it ahead of time, then we can invest and prepare capacity to match the market. That’ll include sales capacity, operations capacity, and capital expenditure.
- Avoid Price Wars: The worst thing that could happen is to invest in a market that doesn’t need capacity. Then we have to reduce the price to utilize that capacity. The investment would have been more profitable if we put it into a market that was going to have increased demand.
- Market Selection: Now we know to watch for major projects in our area. We know that we’re likely to see major opportunities when new contracts for dredging, high rises, or commercial parks. We know that we need some geographical investment in those areas.
- Performance Management: We can articulate whether sales are beating or losing to the market. If the market drops by 10% and sales only drop by 5%, the sales team are heroes. If the market increases by 20% and sales only increase by 5%, then we have a problem.