The second half of 2006 was brutal for home builders in a slew of markets. Faced with ballooning inventories and slowing sales, most resorted to special incentives to move homes, hold the line on prices, and avoid fire sales. But as concessions moved from upgrades to paying for closing costs and mortgage points to giving away even more creative items—vacations, cars … you name it—the inevitable happened. Some early movers started dropping prices, figuring their first loss is their best loss.

Dropping prices is a blunt instrument. It puts pressures on others to follow suit lest they be the last builder holding the bag. As prices start to fall, order cancellations begin to skyrocket—discounts offered to newcomers are greater than the deposits tethering buyers to sales contracts. As cancellations soar, further panic sets in. All of a sudden, offering discounts to your customers in backlog starts looking more appealing.

Overheated markets seldom move back into equilibrium gracefully. Think back to Economics 101. What brings supply and demand back into balance when markets are oversupplied? Here's a hint. Prices!

Gimmicks work when markets are not badly overbuilt. But at some point, buyers recognize that prices are effectively falling. Some get timid and stay on the sidelines, while others get aggressive and pick up the phone to see what they can get. Either way, prices fall.

So what can you do in this difficult environment other than trim prices? There are several things, but I am not going to stand by any one of them. But, given the ugly consequences of slashing prices, they are worth a go. And more importantly, they will make your company all the better for it, even if you also decide to cut prices.

RECOURSE, OF COURSE You may have to cut prices in some communities and on some models, but it's a huge and costly mistake to think that you have to offer the same price cuts across the board at the division level. House prices are astonishingly local. History shows that even in areas undergoing steep price declines, some neighborhoods and towns hold up quite well while others will underperform. Invest in really good market intelligence. Not only will it keep you from giving away more than you must, it will help you sort out which land to shed and which places to slow build-outs to a crawl, if not a standstill.

When markets cool, your salesforce has to gin up its pitch. Marketing your special features is the only possible way to justify a premium over your competitor next door that just sold the farm for five chickens. Even if your salespeople are transformed overnight into the best marketers in town, they have to have real differences to market if you want that premium.

Differentiating your product doesn't have to cost more. To hold the line on costs, your organization has to do three things. First, drive operating efficiencies. Second, find out what your marketing folks have wanted to do but didn't because they were too busy taking orders. Third, get design, marketing, and production pulling on the same oar.

GET BUYERS IN THE HOUSE When prices are soft, every day that passes between when an order is taken and fulfilled exposes you to cancellation risk—and the risk of repricing to a lower price point. Keep the time between the order and the closing short. Related to this, when you sell a home that was canceled, push for buyers ready to close fast.

Lower monthly payments may be as appealing to a buyer as a lower sales price. While reducing monthly payments amounts to an effective price reduction, it does not count as one.

When—not if—you start to lose your nerve and are ready to cave and cut your prices, estimate the damage it may do to your brand. Do you want to be known as the builder that slashed prices and left previous customers in the dust?

Let me end on a more hopeful note. Although prices bring oversupplied markets back into equilibrium, the best way to ease the pain is to swiftly bring supply back in line by not adding to the supply.

Eric Belsky is the executive director of the Joint Center for Housing Studies at Harvard University.

Rule of Eight How to weather the next stage of the downturn

  • Be discerning in pricing strategy.
  • Help buyers sell existing homes.
  • Get out of sales mode and into marketing mode.
  • Differentiate your product with a vengeance.
  • Spend time with marketing, production, and design teams.
  • Reduce cycle times with new-found vigor.
  • Reduce buyer's monthly payments not your prices.
  • Estimate the damage of price cuts to your brand.