Over the past decade, the housing industry has enjoyed unprecedented growth and lower cyclicality than ever before. Builders have taken advantage of sustained above-trend demand to raise home prices, but opportunities to remove permanent costs through improved efficiencies have yet to be realized. Of the 13 builders we cover, there is a 1,000-basis point spread in profit margins, from 13 percent to 23 percent. This suggests that the average can continue to rise from 16 percent currently, particularly if a soft landing unfolds slowly, magnifying the opportunities for permanent cost reduction.

FACING FACTS A strategic advantage of the home building model is that the six- to nine-month window of order backlog provides short-term visibility. So, home builders have the luxury of not having to readjust their models in “real time” as demand shifts. In the event that consumers adjust to the higher rate and low affordability environment by buying smaller homes or taking fewer high-margin upgrades, home builders will have at least six months to address the potential for margin deterioration. The first step is likely to be slightly smaller homes, fewer standardized features, or higher density per acre, modifications typically slight enough to continue to deliver significant value to buyers.

Almost every builder is addressing the cost-cutting process. Opportunities have been identified on local, regional, and nationwide levels. Given the local nature of this business, it is unlikely that the entire 50 percent of cost of goods sold represented by sticks and bricks can be procured on a nationwide basis; however, builders do have concentrated market share positions in the top MSAs and are working to leverage their size in their biggest markets. National purchasing opportunities could be secured in products such as floor covering, bathroom fixtures and fittings, HVAC, and water heaters, although regional procurement of lumber, concrete, and drywall is unlikely to change. Locally, builders monitor competitive advantage by assessing the value per square foot of their product offering. As the top MSAs become more competitive, we expect effective cost management—which drives superior customer value—to be differentiate among the “haves” and “have-nots.”

HIGHER PROFITS To unlock the value tied up in the inefficient building system, large builders need to move upstream to improve the process by exploring procurement leverage. In a 100-day building cycle, up to 30 subcontractors are employed to complete the process. A common complaint among subs is that the process is wasteful, with costly manpower hours being tied up if or when an individual sub runs late. Builders essentially act as general contractors, overseeing the entire process, and as such, have the greatest opportunity to identify and drive changes.

It's likely that more builders will work backward toward an extremely efficient “everything's included” model and away from the proliferation of structural and cosmetic options that slow down the building process and create room for error. Repetition will drive cost savings. Because labor represents 25 percent of the home builders' cost of goods sold, margin expansion should follow quickly. Above all, standardization of the building process should make oversight of an increasing number of regional markets more manageable and highlight best practices.

FIVE TO-DOS Process simplification and standardization. Ranging from segmentation to design, simplify and standardize product and processes. Greater market intelligence lets you better align offerings with what consumers can afford, driving firmer pricing and faster asset turns.

National purchasing. Sourcing product from multiple vendors is inefficient and has capped incremental revenue returns. Turn greater attention toward national contracts with products companies. This facilitates negotiations for lower pricing on items such as plumbing products and appliances, while also placing primary builders at the top of the delivery chain.

Value engineering and quality control. This principle involves the efficient use of materials and labor and begins with land purchases. By choosing lots that fit home designs, architectural integrity is maintained, resulting in the highest quality product.

Improved supply chain management. The benefits of sourcing materials from fewer channels and standardizing construction methods is key. From the vendors' perspective, once national or larger scale contracts are established, there is an increased sense of security.

Vertical integration. This most likely appeals to large builders as it requires a sophisticated level of management.