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  June 20, 2017  
     
  Home Building's 'Elephant in the Room' ... a manifesto from operations guru George Casey.
Without innovation, today's home building business models risk extinction
 
     
 

by George Casey, CEO of Stockbridge Associates, LLC

Over the past several weeks, I have had the opportunity to attend a variety of fall industry conferences: the Urban Land Institute (ULI) fall meeting in Dallas, a Vistage Construction Network CEO Roundtable in Boston, and John Burns’ Fall Homebuilding Conference in New York.

The latter was held the day after Election Day about two blocks from the New York Hilton. An interesting time to be in New York, to say the least.

I enjoy the mix of the conferences, because of the variety of viewpoints they provide.

ULI gave the industry view from home builder, master planned community developer, financing and technology perspectives. Big picture and long-view stuff with a national and international perspective. The Vistage Network CEO Roundtable involved construction and construction service CEOs from New England and covered both commercial and residential, but Northeast focused. John Burn’s conference was expansive and deep on home building, residential community development, finance, and demographics on a national basis.

As I processed all of the information, a recurring theme kept coming back, kind of like that “It’s a Small World After All” song from Disney World. Once you get it in your head, it never leaves.

The theme was that many of the major players in the industry are not fully recognizing and attacking one of the core challenges for the industry: the inability to generate enough housing supply to meet the current and even-greater-tomorrow demand that is on the way. The focus of many in the industry is actually on yesterday problems and solutions.

An inability or unwillingness to see the issues that are new and with us today and which lack focus or solution seems to be a blind spot for many leaders.

At ULI, a panel of home builders and community developers on the developer/builder relationship in master planned communities spent the bulk of its effort talking about demographic trends, the need for more product segmentation to drive incremental velocity, and the rapid introduction of ever-more sophisticated technology tools to target buyers, to get to know more about them, to show them Virtual Reality model homes, and, generally, how to drive more sales to accommodate the coming millennial demand that is now, finally, upon us.

Yet, the reality is that in many markets in the country right now, builders cannot keep production up with the current sales level, forget one that is significantly stronger. More sales in this environment equals extended delivery times and eroding profits (just look at the recent batch of public builder operating metrics for case studies) and, most likely, really ticked-off customers.

There simply is not enough skilled labor to build what is being sold in many markets, and the prospect of more labor coming in time to make any kind of short- or medium-term difference is not very bright. Further back in the chain, the existing skilled labor pool for construction is relatively old and retiring out at rates that are becoming concerning.

The historical response to this issue has to bring in immigrant labor (both legal and illegal) to fill this gap. However, in the current political environment, this solution seems taboo.

The reality is that if any of the existing non-working population really wanted a pretty good paying job, the existing demand in construction would have been filled long before now. It seems that the truth is that the hard manual outdoor labor required for site-built construction in the current business model does not fit the fancy or inclination of the remaining unemployed.

The logical conclusion is that we are stuck, most likely, with a continuing and worsening labor shortage in all of construction, whether it is residential, commercial, or the services to the industry.

I asked the panel why they were focusing on the generation of even more demand when it appears that the real problem is how to generate more housing supply in a world where the labor supply to the industry is relatively fixed. Not surprisingly, no one had an answer or had thought much about it (other than to complain).

In fact, it is a relative new and vexing problem.

In the last housing cycle (1991-2008), we filled many construction jobs with baby boomers who didn’t mind working outside and immigrant labor from Central and South America, the former Communist Eastern Europe, and, particularly Mexico. Before that, the non-college-educated blue collar population of the country plus immigrants provided the labor in every cycle before.

The structural immigration changes we have made and the relative demonization of manual labor for millennials has left the cupboard bare.

The bottom line is that some of the smartest people in the industry were back focusing of the intellectually stimulating, tech and demographic fun stuff of marketing, sales, and demand generation, because that was the solution when production constraints were minor in the past.

The fact that the current problem (structural supply constraint instead of demand constraint) is not the past problem, but a new one, had not garnered much intellectual capital for solution.

Meaningful and permanent innovation in production was not on anyone’s radar.

At John Burns’ Homebuilder Conference, that perception was reinforced again through many of the presentations.

Great and thoughtfully analyzed demographic data from John’s team showed a surge of demand coming for both the millennials finally starting households and baby boomers needing retirement housing. A rosy demand picture for the foreseeable future.

A panel of Wall Street analysts and bankers, however, when questioned on why home builder stocks had not appreciated since 2012 in any meaningful way, despite a growth in orders, closings, and revenues, hit on a root problem. They noted that the builders continually overestimated their deliveries, and their margins are continuing to be under pressure and are declining.

These are not good stories to drive stock valuations higher.

In some cases, stock prices are being buoyed by returning capital back to shareholders, rather than re-investing in the business. The stated culprit was that labor was in short supply, which drives up production costs faster than sales pricing and inhibits any reasonable ability to fully dictate deliveries.

Most of the home building participants in the room took this rationale as the non-adjustable norm. Same as it always was; same as it always will be.

When queried about innovation in the industry, new floorplans, the adoption of better CRM software, and better demographic targeting were cited. No one even tried to approach the issue of productivity, nor the possibility that the current business model for builders might be outdated. Not on anyone’s radar.

All I know is if I go into Delta’s faucet plant, Whirlpool’s stove plant, Ford’s F-150 plant, or Boeing’s airplane factory, that factories look significantly different than they did 40 years ago. Robotics, offsite sub-assemblies, lean manufacturing, just-in-time delivery, and other innovations have been brought into those industries in order to become more productive and profitable.

The businesses look much different in so many ways than a generation or two ago.

Yet, when I look at home building, the way the business is run and the way production is done have not changed markedly in that same 40-year period.

The house sales and production processes today are only marginally different than in 1960. Yes, the tools might be better (a pneumatic nail gun vs. the old 16 oz. “Thunderstick” hammer), but fundamental ways the business operates have not changed much.

Almost every builder uses exclusively sub-contract labor to site-build their homes. The training and management of those trades are left to others and most builders have little or no idea who will be showing up each day to advance the production of the homes they (the builder) have sold to a customer. Even worse, most builders do not even know whether the labor will show up.

Therein lies the risk and the opportunity.

If skilled trade labor is no longer as plentiful as it was in the past, yet demand looks like it will be considerably higher than our current and forecast ability to produce well into the future, perhaps someone should recognize the elephant in the room and be looking to fundamentally change the business model of the business.

Rather than buying back stock, shouldn’t the largest home builders reinvest in another way to create homes that involves less labor and more automation, and achieve higher productivity?

It would seem that the very existence of builders depends on how this question is answered and the value of their companies either ride higher or lower based on how they address the issue.

Shouldn’t Boards of Directors of home builders address this existential question before either the activists come in and turn the company upside down or market forces slowly eviscerate the franchise?

I wonder what the reaction in the marketplace would be to a builder CEO who, when asked the question regarding how they were innovating, had a response that sounded something like this:

“We recognize that this industry cannot operate any more like it has historically. The days of abundant and qualified sub-contract labor seem to be coming to an end.

We cannot afford to embrace a business model that thinks it is okay to deliver homes in 6-12 months and where we have little control over who builds our homes each day.

We have looked at other industries and see that, on our current track, we are destined to extinction in the face of a surging demand that our current business model does not permit us to meet at levels of margin and capital return that are acceptable and industry-leading.

We, instead have chosen to take a different path that will involve some short term pain, but will position us as a leader in the new housing economy.

We are going to take a meaningful portion of our cashflow and, rather than reinvest it back in land or stock buy-backs, we will invest in new methods of producing our homes, using a high degree of automation, new materials, and a dedicated workforce consisting of full-time team-members of our company.

We will use the best people and ideas from other manufacturers and home builders from around the world to help drive this innovation. Our belief is that we can deliver homes in under 60 days from the day the customer signs a contract with us, and at net margins and returns on assets of over twice what we achieve currently.

Even more, we are choosing to reorganize our company to continue to invest in the research and development needed to drive the continuous innovation and improvement that we see will be needed to keep us at the top of the competitive heap.

We will be innovative in our use of technology, materials, business systems, and people in this drive.

We know that, if we do not make these fundamental changes, we stand a high risk of extinction, and we will not ignore that fact.”

Wouldn’t that be interesting?

If our current crop of home builders cannot make that speech, my sense is there are others from outside of the industry or outside of the country who see this opportunity and will take it and run with it.

If this elephant of a question is not addressed, the current crop of builders risk a fate similar to those companies in other industries who failed to see the changes that drove new companies like Walmart, Amazon, and Apple to dominate spaces where more established companies had operated. Those companies that did not change with the times and environment ultimately became either extinct or food for the new.

So, if leaders and directors of current home builders continue to work in the old business model and on innovations with a small “i” and a 3-font, rather than innovations with a capital “I” and a 128-font, they will be truly picking up peanuts while the elephants run wild, and, (to mix metaphors) risk becoming the extinct dinosaurs more quickly than they realize.

Originally published in Builder Online on November 28, 2016 and can be found at http://www.builderonline.com/builder-100/strategy/home-buildings-elephant-in-the-room_o?utm_source=newsletter&utm_content=Article&utm_medium=email&utm_campaign=BB_112816%20(1)&he=acb26dfc22037f8627bb26d072d9871f0bba5969

"The Elephant in the Room 2.0" coming next week!