We've raised the question of vertical integration as one possible way of dealing with what has become a chronic, some believe permanent, shortage of skilled construction labor.
As we said then, reflecting upon every Pipeline workshop™ we have ever done, one of the most important takeaways, one realized by virtually every home building company executive in attendance, is this: if they are going to have any hope of managing production as a system, something has to be done about the fragmented value stream that defines this industry.
In their landmark 1996 book, Lean Thinking, Jim Womack and Dan Jones defined a value stream as “the set of all the specific actions required to bring a specific product through the three critical management tasks of any business.”
Womack and Jones went on to describe a set of processes: a problem-solving task, an information management task, and a physical transformation task.
By definition, a value stream does not belong to an industry; it is enterprise-specific; each value stream belongs to its enterprise; thus, every home building company has its own specific set of actions.
Nevertheless, it would be a challenge to cite any other industry, in which the sequence of tasks in the most common versions of that industry’s core-critical process (start-to-completion, i.e., the physical transformation task) is performed entirely by separate entities, as is the case with home building.
Look at the value stream of almost any home building enterprise, and you will find a combination of independent, separately-owned, non-proprietary, non-exclusive, unaffiliated businesses, with their own overhead, each having their own goals, that are often at-odds with each other.
We have a descriptive phrase for what amounts to a completely outsourced building model like this, a building model in which the builder settles for a residual as low as five percent of the price for which he sells the product.
We call it “strip-mining the value stream.”
This type of outsourced building model is at the opposite end of the spectrum, light-years away from what would be termed a vertically-integrated building model, in which a builder acquires or starts business operations, all of which are within the same industry vertical (residential construction), at different points of the value stream.
A vertically-integrated building model is also very different than what would be termed a horizontally-integrated building model, in which a builder might acquire or start business operations at the same level of the value stream of a single industry vertical (again, residential construction).
And, when you get right down to it, horizontal integration–whether it occurs within an industry vertical, a value stream, or a production process–is nothing more than a M&A strategy designed to achieve economies of scale. And, it would be no different if that horizontal integration occurred as a result of starting business operations, or as a result of buying them or merging with them. It would be the same strategy.
Whether it is an outsourced building model or (to a lesser degree) a horizontally integrated building model, they have the same mental models regarding size, growth, capacity, inventory, capital, risk management. These models are “more-for-more” propositions.
They have the same wide and shallow strategic footprints.
They are strip-mining operations.
A vertically-integrated building model is profoundly different. It has very different--often the very opposite, diametrically opposed–mental models, compared with an outsourced or horizontally-integrated building model. (see notes below).
This model is, at a minimum, a “more-without-more” proposition, if not a “more-for-less” proposition.
It has a narrow and deep strategic footprint.
It mines deeply for a greater share of the value produced on every house.
At the beginning of this series, we said this:
“The best way to describe this dilemma is that we have to deal with it. We have to deal with a chronic skilled construction labor shortage, whatever that is, for a yet-to-be-determined period of time. And, we have to deal with the demand for that skilled construction labor relative to its limited supply.
“It is about the shortness of supply, but it is also about the burden of demand. And–it is about utilization. This requires some combination of the following: Increasing the supply; reducing the dependence; making better use of what is required.
“One thing is certain. If we don’t change the way we do business, if we don’t take action–proactively, resolutely–on an ordered set of steps to deal with this situation, it will remain a chronic skilled labor shortage.”
At the beginning of this series, we said the linked span of solutions available to builders for dealing with this dilemma was wide-ranging.
Yes–addressing the “why” and the “want-to” are just as important as answering the “what” and the “how-to.” By all means do it, build a company of business-people, a savvy, motivated, mutually-accountable home building team, one in which everyone has a financial stake in the outcome. But–adopting Open-Book Management and team-based performance compensation doesn’t change the strategic footprint.
Yes–getting back to elegant architectural design will make homes more desirable and easier, faster to build. By all means, do it. But–elegant design doesn’t change the outsourced nature of the building model.
Yes–getting more out of the cost of direct labor, by understanding how those costs behave in relation to why they were incurred is important. Do it. But–in and of itself–it doesn’t change the fragmented nature of the value stream produced by an outsourced building model.
Yes, technology–specifically, offsite manufacturing processes–will improve quality, reduce waste and variation, reduce cycle times, increase productivity. By all means, consider doing it. But, by definition, manufacturing off-site doesn’t unify the value stream, unless you own or joint venture the facility.
Yes–eliminating all of the non-value-adding work from your own business processes will increase the number of houses that can be built and delivered with the same inventory and capacity (the Gross Income from which drops straight to your bottom-line as Net Income). BPI is worth the investment, so, by all means, do it, get your own house in order. But–BPI is about internal processes; it doesn’t change the strategic footprint, from one that is wide and shallow to one that is deep and narrow.
Yes–Epic Partnering™ is a means of fostering strong relationships of shared, mutual interest with building partners and supply partners; it is both a process and a program for progressively transforming suppliers and subcontractors into true partners, into trusted allies. By all means, do it. But–effective trade partnering is not the same as vertical integration.
Yes–moving to Critical Chain Project Management from a 1950s-era algorithm (Critical Path Method) that was not designed for managing a portfolio of projects, nor was it designed to function in environments where velocity is important, where faster cycle time and higher inventory turns are critical drivers of business outcomes, where reducing cycle time while preserving the reliability of the job schedule is important; CCPM will enable skilled construction labor that is in short supply to do “more-without-more.” By all means, insist on it; do it. But, the building model will still be akin to a strip-mining operation.
Builders attending Pipeline workshops™ consistently emphasize the need for stronger trade-partnering, better coordination, more cohesiveness, a more unified approach to managing the trade side of production.
They acknowledge the obvious: they do not have the internal resources necessary to perform “the set of all specific actions” required to bring houses through the start-to-completion process, and they are completely dependent and reliant on skilled construction resources that are in short supply.
Is a vertically-integrated building model right, or even possible, for every home building enterprise? Likely not. Is vertical integration part of the answer? Yes, for a few. We have been suggesting, for almost 20 years, that builders at least consider that possibility, that they find a way to shut-down the strip-mining operation.
Opportunity always lies in radical, undoable notions; true, sustainable competitive separation comes from the innovators and disrupters, from doing what average, typical builders will not do.
The extent of the strategic role vertical integration has to play in the home building industry will eventually emerge. Meanwhile, at each Pipeline workshop™, the contrast between outsourced and integrated building models is now being portrayed in one of the Pipeline games™, covered in the Lessons from the Pipeline© business case. It was added as its own section in the second edition of The Pipeline: A Picture of Homebuilding Production© (released for publication in 2016).
This is the final installment of a nine-part series on BUILDER over the past 18 months, on getting home builders to address–to deal with–the skilled labor shortage in residential building, by changing the way they do business.
Part I looked at building the internal understanding, desire, and resolve to deal with what is an external problem; it looked at Open-Book Management and Team-Based Performance Compensation, and how to build the type of savvy, motivated, mutually-accountable home building team required to address the skilled construction labor shortage.
Part II looked at restoring elegance and allusion to architectural design, in order to make homes faster, easier, and less expensive to build, while making them more livable, more distinctive, more storied, and more desirable; it looked at what happens to productivity when builders waste time, energy, and money building senseless, overdone, exaggerated illusions of architectural style.
Part III looked at how costs behave in relationship to what caused them to be incurred, and how to manage those costs in a way that diminishes the conflict that exacerbates the shortage of skilled construction labor.
Part IV looked--through the eyes, and in the words, of six industry experts--at how the process of planning, designing, fabricating, and assembling components at a location other than their final assembly-installation point partially answers the shortage of skilled construction labor.
Part V was skipped, because Jennifer Castenson's builderonline.com article about Building Information Modeling (BIM) said everything that needed to be said.
Part VI looked at why Business Process Improvement is central to how builders create more value – benefit in excess of cost – for their stakeholders, first among which are their buyers.
Part VII looked at Epic Partnering™, the program and process of creating and building strong trade partnerships.
Part VIII looked at the ability of Critical Chain Project Management to reduce cycle time, ensure on-time completions, and make schedules more manageable and dependable.
Integration is a strategy used by businesses in the same industry or production process; integration can be horizontal or vertical.
In a horizontal integration, one company takes over another company that operates at the same level of the value chain [value stream] in an industry. Companies use horizontal integration to increase their size, diversify offerings, achieve economies of scale, reduce competition, or gain access to new customers or markets.
In a vertical integration, a company acquires business operations within the same production vertical; the company acquires another business that operates in the production process of the same industry. Companies use vertical integration to strengthen their supply chain, reduce production costs, capture upstream or downstream profits, and access new distribution channels.
There are several reasons why this [vertical integration] strategy can be important: improving the efficiency of the production process; eliminating overhead; shortening cycle time.
[investopedia.com was a source for a portion of this information]
Within most value streams, there are two ways vertical integration can occur: backward [upstream] integration occurs when a company decides to buy another company that makes an input product for the acquiring company's product, usually to ensure a steady supply; forward [downstream] integration occurs when a company decides to take control of its post-production process. Since builders would almost surely start the vertical integration process from a completely outsourced building model, direction would only matter as the integration process moved forward.