Being in the home building business is not the same as being in the business of home building. In the business of home building, it is not enough to have revenues that exceed costs, or to have a positive cash flow; a home building enterprise must also generate an acceptable economic return from its home building operation.
Because it has an operational (as opposed to investment) focus, the most appropriate measure of economic return is Return on Assets; the best expression of ROA is the DuPont identity, which separates economic return into two components: Return on Sales is the margin side of ROA; Asset Turn is the velocity side.
For some unexplainable reason, home building is not an industry that has ever given these two components of economic return the same standing. There has always been an unequal attraction. In good times or bad times, the emphasis--the priority--has been on improving margin; the effort to increase velocity is brought--kicking and screaming--to the table.
That emphasis and priority is heightened coming out of a downturn. Emerging from the most recent downturn, it was assured that builders would instinctively move first to repair margins. And--it can be predicted that it will be another two to three years before most builders start any effort to become more productive and do more with the production capacity they pay to have at their disposal.
Assured. Predictable. Dangerous.
During the home building collapse, constrained capacity wasn’t an issue; the industry bled-off capacity it was unable to utilize. Now, it is an issue. Even at a relatively low rate of new home sales, there is now insufficient production capacity to meet current demand. What will the situation turn into, in the next several years, when – as Calculated Risk’s Bill McBride predicts--the level of annual new home sales rises 60% from current levels, to a modest level of 750,000 to 800,000?
Replacing lost capacity without any increase in productivity has two negative effects: First--it is more difficult, because it requires finding even more of what there currently isn’t (more resources). Second--it becomes just another more-for-more proposition, an offer of more capacity at a higher cost; not higher productivity; not additional throughput achieved with the same capacity.
Will higher direct labor cost result in the availability of additional capacity? Can the additional direct labor cost associated with securing more capacity be automatically passed through in the form of higher sales prices? Can higher overhead cost automatically be recovered?
Margin is perhaps the correct initial focus coming out of a recession, but continuing to work only to improve margin without also working to increase velocity is fighting the battle with one arm tied behind your back.
Why do we argue so forcefully for the drivers of higher velocity? Why do we argue so relentlessly for better processes, for shorter cycle times, for faster inventory turns, for higher productivity, for a managerial accounting approach that provides visibility into operations, for better-managed production systems, for team-based performance compensation based improvement to a single business outcome that is impacted by every position in the enterprise and reflects both components of economic return? Why do we advocate so strongly for adoption of an urgent, rapid-results process of continuous improvement that focuses on whatever currently constrains an enterprise’s ability to generate more of that single business outcome?
Why was a book like The Pipeline: A Picture of Homebuilding Production written? Why is there a Pipeline workshop on the principles and disciplines of home building production?
This is why.