The fundamental understanding that emerges from the DuPont identity for Return on Assets: remove the financial leverage (equity multiplier) from the formula, and economic return becomes a function of profitability (Return on Sales) and operating efficiency (Asset Turnover). Economic return is margin x velocity; it is a co-equal dependency.
Is margin proficiency necessary? Yes. Is it sufficient? No.
To a home building company, does superior margin hold forth the possibility of ever achieving sustainable competitive separation? Absolutely not.
We’re not alone on this assessment:
“In fact, [asset] turnover is just as important as profit margin.” Barron’s Accounting Handbook (Siegel, Shim), 1990, 1997, p. 150.
“Build-to-order improves inventory turnover, which increases asset velocity, one of the most under-appreciated components of making money . . . higher velocity improves productivity and reduces working capital. It also improves cash flow, the life-blood of any business.”
--Execution: The Discipline of Getting Things Done (Bossidy, Charan, 2002, p. 17)
In case you missed it, home building is essentially build-to-order.
No matter. In the home building industry, action on the velocity side of Return on Assets inexplicably takes a back seat to action on the margin side. Pipeline workshops are aimed at changing that paradigm. However, the motivation and resolve to attend a Pipeline workshop starts with a willingness to acknowledge and remedy what is often a lack of knowledge regarding production principles and disciplines.
Really. Think you know this stuff? Really? There’s one way to find out. Take the test.
- An appropriate image of a home building production system is a pipeline. What are the measures of the pipeline’s capacity, length, and cost?
- True or False: Even-flow production is an outcome, not a mechanism.
- Which is the best measure of the size of a home building company? a. revenue b. number of full-time employees c. houses under construction d. annual closings
- From an operational perspective, there are three activities that describe “what happens to money?” The terms for those activities can be used to fully express--and, therefore, link--the formulas for productivity, cycle time, and inventory turn, to the equations for Net Income, and Return on Assets. What are the terms? What do they mean?
- True or False: A production system with balanced capacity across all resources will do a better job of optimizing the utilization of a system’s capacity than one where capacity is not balanced across all resources.
- In what three ways will a production system protectively react to variation?
- Which method of scheduling jobs considers both task dependency and resource contention, Critical Path or Critical Chain?
- Calculating the duration, or lead time, of a production process requires the knowledge of two operational measures. What are they?
- True or False: The phases in a job schedule should have enough safety built into their durations to insure a high certainty of on-time completion.
- Which measure of operating performance is the reciprocal of inventory turn?
- Lean Production views home building as a build-to-order process. Which resource does Lean recommend using to set the pace of production?
- True or False: CCPM (Critical Chain Project Management) does not adjust the job schedule according to when phases finish, whether early, on-time, or late.
- What three human behavioral tendencies consume the time safety built into a schedule?
- As a matter of standard deviation, increasing the probability that a task will finish on-time, from a 50% probability to a “highly certain” 95% probability, will cause the anticipated duration of the task to increase by a factor of how much?
- In a home building operation, which is more important, speed or velocity?
(the answers are at the bottom of the post)
It’s just a quiz. Like any quiz, the questions represent but a very small portion of the production and business knowledge required to effectively manage home building production, increase operating performance, generate higher Net Income, and improve Return on Assets.
Ultimately, every home building company has to determine how it will manage production within a specific context, within the parameters that comprise its market, its product mix, its choice of an information/management technology system, its financial situation.
But, the ability to manage production starts--it starts--with an understanding of the underlying principles and disciplines.
Answers: (1) capacity is the rate of output produced with a planned, finite, and controlled amount of work-in-process, length is cycle time, cost is all of the indirect, non-variable expenses associated with overhead; (2) True; (3) c: houses under construction; (4) money generated through sales is called Throughput, money invested in whatever will be turned into Throughput is known as Inventory or Investment, and money spent turning Inventory into Throughput is called Operating Expense; (5) False; (6) higher work-in-process, longer duration, or excess capacity; (7) Critical Chain; (8) work-in-process and throughput, expressed in units; (9) False; (10) cycle time; (11) the most capacity-constrained resource; (12) True; (13) Student Syndrome (wait to start until too late), Parkinson Law (expand to time allowed), and multi-tasking (dividing work between multiple jobs); (14) factor of 1.64, reciprocal of .61; four out of every 10 days in the schedule are safety to assure on-time completion; (15) velocity (a vector measure, velocity is speed in a specific direction, speed with a purpose).