Are our industry's market leaders destroying our industry? The answer may very well be “yes.”
Conventional wisdom would have us believe there is no such a thing as a “good competitor.” Almost by definition all of your competitors are bad. But what about market leaders? Isn't any market leader other than you bad? Not necessarily. Good competitors and market leaders exist, and they are critical to an industry's health.
Many of the problems facing the home building industry today are a result of bad competitors leading the market. These competitors' actions have a significant negative impact on the health of the home building industry. Blame as you might our political leaders, mortgage lenders, or commercial lenders. The reality is our industry and our market leaders deserve more of the blame.
Michael Porter's Competitive Advantage describes the importance of “good competitors” and the role “good market leaders” play in the health of an industry. “A good competitor challenges the firm not to be complacent but is a competitor with which the firm can achieve a stable and profitable industry equilibrium without protracted warfare,” Porter writes.
“A good competitor has realistic assumptions about the industry. It does not overestimate industry growth potential and therefore overbuild capacity.” And very important, “A good competitor seeks to earn an attractive return on investment.”
Good competition is healthy. Push me to improve my performance. Demand returns commensurate with the risk. Don't underestimate risk and be willing to accept insufficient returns. Don't overbuild or overbuy, creating too much supply given realistic demand.
With this as the measuring stick, our industry's leaders—mostly our larger public competitors—have failed us.
Other than the cost of financing, public builders have a similar cost structure to private builders. The cost to construct a home and the cost to purchase and develop land are not significantly different. “A good competitor knows what its costs are and sets prices accordingly.” Yet, when the first quarter earnings were released, public company losses before impairments were, for the most part, staggering.
Ryland Homes reported a 5.9 percent gross margin for the quarter. No builder can earn a profit when less than 6 percent of every revenue dollar is available to cover overhead and generate a profit.
D.R. Horton offers sales incentives of 8 percent to 12 percent, plus Realtor commissions of 6 percent in San Antonio. Taking into account those costs, Horton's gross margin before that would need to be near 30 percent to generate a return after overhead.
Competing on price when your prices won't generate a reasonable risk-adjusted return isn't competition. If your strategy is to be a low-cost producer, that's fine, but you have to earn a profit.
Our industry would best be served if builders focused on how they could differentiate themselves from their competitors. Differentiation allows for premium pricing; premium pricing allows for higher returns. Innovation in product design, community design, the customer experience, supply chain management, or product delivery would create a meaningful competitive advantage. Selling homes and losing money doesn't.
Private builders are driving innovation today; they have to because they can't afford to lose money. Maybe our industry's market leaders should take a cue from their small private brethren.
Jamie M. Pirrello is CEO of Berkeley-Columbia Partners. He serves as CFO and San Antonio division president of Michael Sivage Homes and Communities. He may be reached via e-mail at email@example.com.