Private equity groups are said to be looking to buy distressed building companies. Just as people bought houses two years ago, I am sure they're looking to flip these companies in two to three years for big profits. The question is: What would they buy?
Richard Hawkes For a company that's operating in the red, what are the odds that a financial acquirer could turn a profit in two or three years? Who knows? Historically, distressed industries snap back–with big profits in some cases. But with so many builders in the same sorry situation, what should private equity groups look for? Will size be important? Product types? If I managed an equity fund, I'd look for neither.

Experts forecast weak housing demand for the next five years, and profits will depend on operational efficiency. Today's biggest companies won't likely qualify as smart buys, simply because they haven't put a large enough emphasis on improved efficiency. Price increases fuelled market expansion and land appreciation, which ensured profitability. Overhead reduction was an afterthought. Even the cost of maintaining design centers received little scrutiny because buyers could finance upgrades of all kinds. Fact is, increasing profitability will never again come so easily.

And gross profits of 22-plus percent will be a thing of the past! Many would disagree, but the market is already dictating price. As competitive as many markets will be, you won't be in business long if you need to target gross profits greater than 20 percent, unless of course, you have a monopoly.

The next generation of builders will operate on a 15 to 18 percent gross profit margin. And as pricing continues to fall, profitability will depend on lower overhead.

Gross margins will be market driven. The chances of anyone achieving 25 percent gross margins in the future will be slim. Eighteen percent will be the norm and will require gross overhead below 8 percent.

Now, I know there are builders who believe that an 8 percent overhead factor is not possible, but it is! Operational efficiency is all about doing more with less. Among the companies I've run, none had overhead factors greater than 7 percent, and it's not all about volume. It's about what contributes to profits in relation to its cost–from knowing what revenues your Web site generates to understanding what your purchase order system costs versus savings. It all becomes important. Everything your company does needs to be questioned to ensure it has a positive contribution to your profitability.

Up until now, it didn't matter how much ads, Web sites, customer service programs, and computer systems cost because gross revenues were strong. Even if you have buckets full of money for all the bells and whistles in the future, you won't have the revenues to justify it all. You will need to know what is worth doing and what isn't. There are many past business processes that will no longer provide a benefit in relation to current or future revenue projections.

To be a player, gross overhead will need to be 8 percent or lower. This is where the rubber will meet the road. Leadership and managerial talent with clear thinking will be the key in making this happen. The results you are looking for will enable you to generate more sales with fewer employees, faster building times, superior customer service, less fixed overhead cost, and fewer mistakes than your competitors.

Now back to the private equity groups. Yes, there will be some buying opportunities soon, but fund groups must realize profitability will not just happen when the market recovers. They need to look for companies that have either proven their managerial ability or demonstrate the capacity to create operational efficiency to capture a good return on their investment. Leadership and management talent will be the key to success, and companies that master operational efficiencies could be the next national players.

–Richard Hawkes, former CEO of Holiday Builders, currently heads his own consultancy. He may be reached via e-mail at