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Big Builders Improve Operations and Reap Big Profits
While they credit market fundamentals, land assembly strategies and customer satisfaction for their unmatched financial performance in recent years, the nation’s big home builders have been steadily implementing innovative operating practices that have worked to their advantage by increasing their home building efficiencies, according to a new study by the Joint Center for Housing Studies of Harvard University.
Between 1999 and 2004, companies building 500 units or more realized inflation-adjusted revenue growth of 135%, according to “The Evolving Home Building Industry – Implications for Consumers.” In addition, they increased their gross margins on homes sold and net income by about 4.5 percentage points each. Gross margins rose from 19.6% to 24.0% and net income grew from 8.0% to 12.6%.
To examine some of the implications of changes in builder operations and the emergence of large national production builders, the Harvard study drew on recent survey results of U.S. home builders conducted with the Harvard Center for Textile and Apparel Research through its Sloan Foundation activities. The research, known as the Harvard Distribution Study, was supported by Masco Corporation, which is a member of the National Council of the Housing Industry — The Supplier 100 of NAHB.
The survey focused on builders reporting closings of 500 or more single-family homes in 2004, including “national producers” building 2,500 homes or more a year and “regional” companies building in the 500-2,500 range. The survey respondents accounted for more than 60% of homes constructed by large builders and almost one-quarter of all new single-family homes sold in 2004.
When asked to name the single most important reason for their recent financial performance:
- More than half of the survey respondents attributed their success to strong housing market conditions.
- Nearly one-third cited their land assembly strategies.
- Another 13% considered improved customer satisfaction the key to profitability. (According to a J.D. Power and Associates index that rates home builders and their operations in selected markets on such factors as customer service, home readiness and the company’s sales staff and construction manager, customer satisfaction with builders has improved markedly since 2001.)
- Few respondents attributed their success to shorter construction cycles, savings on product purchases and on-site construction costs, and other operational efficiencies.
However, the study notes evidence of operational improvements, particularly within the divisions of national builders. Less success was seen among local divisions of regional builders. “Although their homes have become bigger and have incorporated higher-quality materials in recent years, national builders have been able to shave almost five days off their construction cycle time, keep cost increases at modest levels and significantly improve customer satisfaction scores,” the study reported.
The Harvard Distribution Study identified four general practices that larger builders have been using to their advantage:
- Coordination with subcontractors. Innovations in this area include making scheduling information easily accessible to subs, automatically notifying subs of schedule changes and frequently updating the job site production schedule.
- Component preassembly. “Preassembling major components such as roof trusses allows greater precision in manufacturing and often provides cost savings by substituting semi-skilled off-site labor for skilled on site-labor,” the study says. “The preassembly process is also more efficient when done off-site, thereby creating the potential for shorter construction cycle time.”
- Supplier installation. For many products, builders have begun to purchase installation services from the manufacturers or distributors, helping to limit disputes over problems with products and helping to reduce construction labor needs.
- Supply chain management. This is the area where larger builders can use economies of scale to gain a competitive edge over small builders in practices ranging from price negotiations for products and value-added services to the implementation of information systems to support purchasing and inventory management.
The study notes that builders have been doing a better job of managing risks, for example, by controlling more land through options, joint ventures and other approaches that keep land costs off their books until they buy the entitled lots.
But the study says that their ability to reduce the share of homes they build on a speculative basis is even more important. Among the builders surveyed, 73% of the homes closed in 2004 were sold before construction began, up from 70% in 1999, and “national builders pre-sold over three-quarters of homes closed in 2004, while regional builders pre-sold about two-thirds.”
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