The Impact of High Borrowing Costs on Architecture, Engineering and Consulting Firms Despite Interest Rate Cut Forecasts

Caution is understandable around the world's economic prospects. After a time of turbulence and unpredictability in financial markets, it's no surprise that economic bright spots are becoming harder to find, presenting significant challenges for the professional services industry.

In the UK, for example, interest rates fell in August and November 2024, with further cuts predicted for 2025. Yet, despite this hopeful forecast, inflation and borrowing costs are still a concern for businesses. It can take time for financial institutions to pass on reduced costs to customers, which, in turn, impacts the cost of servicing current debt and delays making borrowing more affordable.

Couple this with changes to governmental policies, concerns about future economic conditions and geopolitical changes, and it's little wonder that leaders of professional services firms feel uncertain about what's to come. Historically, higher borrowing costs have put pressure on profit margins and overall financial health. Increased debt servicing costs have forced firms to scale back or delay new projects and investments, impacted cash flow and complicated day-to-day operations.

As part of our 5th Annual Deltek Clarity report, we asked architecture, engineering and consulting companies for their view of the economic landscape. 64% of respondents saw the impact of interest rate and inflation changes as their biggest threats in 2024. In fact, our research also shows that professional services firms see the unpredictable spending environment as a top challenge for finance leaders in the next three years.

In this article, Neil Davidson, Deltek's vice president of the professional services sector, examines the effects of persistently high borrowing costs on professional services firms, even as interest rates begin to normalize with further cuts anticipated. He also shares strategies to navigate these challenges.

How High Borrowing Costs Are Impacting Architecture, Engineering and Consulting Firms

#1 Delayed projects and investments

Despite the expectation that interest rates will fall, the reality is more complex. Financial institutions' delay in passing on interest rate reductions still makes it expensive to borrow money, making it difficult to invest in growth. This may cause professional services firms and their clients to scale back new projects and investments—or even delay them until the economic landscape feels more stable.

The benefits of lowering interest rates can also vary depending on other government policies and market uncertainty. For architecture and engineering firms, this can lead to increased expenses in construction projects and potential budget overruns that may lead to more reliance on lines of credit.

#2 Reduced profit margins

38% of professional services firms we surveyed listed increasing profitability as a top challenge. When borrowing costs remain high, even as interest rates are predicted to fall, traditionally profitable projects are more expensive to deliver, reducing their profitability. This impacts the bottom line and makes it harder for firms to secure new work.

#3 Cash flow challenges

In Deltek's Clarity survey, 31% of respondents said managing growth is a top challenge facing finance leaders over the next three years, and 30% said the same about managing cash flow.

Tighter financial constraints caused by costs that are still above their historic price trends can also limit a firm's ability to offer competitive salaries and benefits, impacting talent retention and recruitment. Over a quarter (27%) of architecture, engineering and consulting firms we surveyed for the 5th Annual Deltek Clarity report are concerned about their ability to attract and retain talent.

Unlocking Profit Potential in a Volatile Economy

Diversifying your revenue streams and seeking alternative strategies is a great way to maintain profitability should costs rise. You can explore new services or markets to reduce your dependency on debt-financed projects and give your firm an extra layer of economic security. In fact, 11% of professional services firms we surveyed for the 5th Annual Deltek Clarity report say breaking into new markets or segments is their biggest growth opportunity.

Improving operational efficiency can help lower day-to-day costs throughout your business. Some areas your firm could focus on include:

• Spending more time and effort on the right projects and clients. Make sure new projects you take on are for stable clients where you can deliver a big impact. And limit the time you spend on projects where profits and margins are consistently low.
• Focusing on operating cash flow to better understand where margins are suboptimal and what divisions and services can tie up an unfair share of working capital. You'll dramatically improve your financial outlook if you can focus on higher-margin work with the best working capital conversion to create value as economic conditions tighten.
• Continuously reviewing your accounts and key performance indicators (KPIs) and being flexible with your capital plans so you can pivot where necessary.

Leveraging technology to streamline processes and reduce costs can be a great long-term strategy, further boosting operational efficiency and streamlining your business. When we asked professional services firms about their biggest growth opportunity moving forward, 18% said it was investing more in their IT infrastructure.

Organizations that carefully align emerging technologies with business operations, such as utilizing AI to optimize the project lifecycle, will increasingly realize the value of these applications. Such organizations will see significant gains in the form of streamlined operations, optimized resources, and proactive risk mitigation.

Chart Your Course Through an Unstable Operating Environment

Despite the year beginning with mixed markets and political shifts, the drive for long-term stability remains essential to the Professional Services industry. By finding the right balance between careful planning, adaptability and leveraging the transformative power of emerging technologies, firms can continue to thrive.

Focusing on the right projects and making appropriate short—and long-term investments will go a long way toward protecting profitability and strengthening a firm's position. And should interest rates fall further in 2025, this will likely add some wind to the sails.

The full Deltek Clarity report provides more information about the current trends facing architecture, engineering and consulting firms.