All Business Myth Stories
From customer care and human resources to land strategiesand purchasing, misconceptions abound about how to operatea building business...
Customer care myth: Home buyer satisfaction increases in an up market.
Finance myth: Every dollar of revenue should generate the same return.
Service myth: The customer is always right.
Purchasing myth: Price and cost are the same thing.
Hiring myth: It's all about money.
Operations myth: Bigger is always better.
Land strategy myth: Builders need to pay more for land than developers.
Operations myth: Land is the answer to all problems.
Labor myth: Talent lost during the recession is easily replaced.
It is no longer enough to possess strong capabilities in sales and construction for growing home builders. In today’s complex and competitive environment, builders must have world-class financial expertise as well, industry expert Jamie Pirrello tells BIG BUILDER.
What’s the No. 1 misconception builders have about financial issues?
The No. 1 misconception that many builders have when it comes to financial issues is believing that every dollar of revenue should generate the same return. Too many builders today ignore the importance of risk-adjusted returns paying attention only to the number of dollars to be earned. In its simplest form, higher risk investments require higher rates of return to compensate for the greater level of risk.
Investments made by production home builders run the gamut as far as risk. To start, home building is a design and manufacturing business that relies upon land as a critical inventory component. Many builders seek to control land through vertical integration by controlling through ownership the critical inventory component of land. The business of acquiring land, entitling land, and developing land is a highly speculative business, and as such requires higher risk-adjusted returns.
It is as if a jeweler decides to control a key inventory component such as diamonds by acquiring land and developing a mining operation. While both components are viable businesses one has a lower risk profile designing and manufacturing jewelry than the other business of identifying, acquiring, entitling, and developing a mining operation. It would be foolish to expect that returns associated with the design and manufacturing operation would adequately compensate for the risk associated with acquiring and operating a mining operation.
What else do builders need to know?
Related to this topic is that the majority of private builders do not match the duration of their assets with the duration of their liabilities, a principal tenant found in finance. Public builders, as a result of their access to long-term debt, have a significant advantage over private builders who traditionally finance long-term assets (e.g. land and development costs) with short-term commercial bank debt. It is the mismatch of asset and liability durations that caused many private builders to close, while public builders who had properly matched durations survived.
The key takeaway is that builders who are designers and manufacturers can accept lower returns and shorter liability durations then builders that actively acquire, entitle, and develop land. The mistake is not taking this reality into consideration when builders make investment decisions.
What does the future look like?
In the past, home building was about taking advantage of opportunities. This is no longer the case. Today, the key to above-average performance is about being strategic. Homebuilders need to conduct significant research to identify underserved segments in the market, develop strategies to capture the segment and a financial plan the properly capitalized the company, including the ability to generate acceptable risk adjusted returns. Homebuilder can no longer afford to be reactive; to succeed today builders must be proactive. It’s a level of expertise and business acumen that has not been found in homebuilding heretofore.