Opportunity Lost

Posted May 26, 2019 By Fletcher Groves

(first posted on Escape from Averageness® in October 2010;  reposted here, unchanged from ten years earlier, as perspective on matters of collaboration, franchising, mergers and acquisition, systems, and return on technology investment)

About a year ago, I commented to two homebuilding clients – somewhat offhandedly, first to one, then to the other – that they ought to find a way to collaborate with one another.

At the time, that recommendation was not the intended outcome of any of the work I was doing.  It just seemed to be a suggestion that made sense, particularly under the circumstances, and with the two companies involved.

They are both strong companies, with good business models, well-versed in starting and supporting geographically-dispersed homebuilding operations.  The principals are respectful friends.  The two enterprises share some geography, but do not directly compete.  They are very different, but that was what made it work.

Their attributes complemented one another – remarkably so, really – and those attributes offset whatever deficiencies there were.  In collaborating, neither enterprise had to give up anything that was worth keeping.

The two operating systems were a reflection of the business models and temperaments of the two enterprises, a reflection of the different natures of the homebuilding the two enterprises did, and a reflection of the differences inherent between the long-time licensed use of third-party software, and the long-term development of proprietary software.

In that last regard, it was a revealing comparison between a system that made very effective use of purchased components, and a system that was purpose-built.  It was a picture of functional, workable-but-forced integration versus elegance-at-a-cost.

The systems comparison is almost a story, in and to itself.

The larger story is about two homebuilding companies, so complementary in their attributes, that, in my estimation, they could not possibly have been better served maintaining separate platforms at the expense of remaining smaller, more vulnerable enterprises.  Two completely compatible companies, confronting realities that this arrangement would have addressed, with no discernable negative consequences.

Two companies that, nonetheless, chose not to move on the opportunity.

Opportunity Lost.

Not for lack of thought or consideration.  There were meetings.  There were systems overviews. There was a recommendation.  There were broader discussions.  It just never went anywhere.  That, however, does not change the validity of the thinking behind what would have made it work so well, which went as follows:

In helping them with the systems analysis, I was struck by the amount of resources these two separate systems consumed, and the amount of energy required to run them.  I wondered whether either company was getting out of their systems anything close to the benefit they should have been getting.

I wondered what the “energy/benefit ratio” was, wondered about the relationship between the amount of energy expended on a system, versus the benefit derived from having expended it.

Energy Expended v. Benefit Derived.

I wondered about the resulting Return on Investment.

I wondered about scale.

Neither of these systems was being leveraged to the extent they could or should have been.  The economic conditions and state of the housing market that had atrophied these two companies clearly had a lot to do with the extent to which the systems were being under-leveraged.  Those conditions have not abated [remember, this was in 2009].  But – it is also fair to say that, historically, the respective investments have never, ever been exploited the way that they could have been.

These systems were capable of supporting more users, more building operations, more business.  The systems had unused capacity.  Since they both had unused capacity, it was also pointlessly redundant.  The unused and redundant capacity was muda.  It was pure waste.  In a way, it characterizes the waste and redundancy associated with working within the fragmented value stream and supply chain that is the homebuilding industry.  More than anything else, unused, redundant, unmanageable capacity distinguishes this value stream.

The waste – the muda – existed in both companies, but consider just one example:

The licensed use of third-party software incurred fees.  Not an issue with a proprietary system, but the fee-only cost to the client with the non-proprietary system amounted to about $250,000 per year, despite the fact that the fees had been cut to the bone, in terms of extra seats, etc.  That cost would certainly increase in future years.  At a three percent (3%) franchise fee, that $250,000 in fixed overhead cost represented more than $8.3 million in franchisee sales revenue that had to be generated, just to pay the licensing fees.

All systems require attention.  At some point, that attention becomes a distraction.  At some point, attention and effort is distracted from other areas.  The under-utilization of the system is waste that creates the added waste of being distracted from other, more important areas.  My two clients – my two friends – needed to be asking themselves how much this distraction was worth, and whether it would have been a better decision to leverage the burden between their two enterprises.

I pointed out, as emphatically as I was allowed to, that both of these enterprises should have been looking for opportunities to leverage the investment they had in their systems, and that they could certainly have done with utilizing a single platform, in terms of an operating and information/technology system that would have met both their needs.

But – it was more important than that.  My contention was that these two enterprises would actually have been far better operations for having done so.

I made a business point to my two clients – my two friends – whom I have always held in deep respect, for their business judgment.

I pointed out, as significant as it was, that leverage was about more than the investment of capital or the expenditure of overhead.  It was also about the aggregate distraction caused by the attention to two separate, under-utilized systems that impacted both companies, and that kept them from getting to where they both wanted their enterprises to go.

I pointed out, that what was at stake was the far greater opportunity to create and benefit from a larger, stronger, heavier footprint.

Opportunity Lost.

 

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It is time to wake up.  It is time to change – time to reform and re-form – your thinking regarding the type of workflow that homebuilding is and how it can be best managed with the technology you provide.



In the lead-up to every open, sponsored Pipeline workshop®, we make the same point to builders, for the purpose of explaining the production principles and disciplines the workshop espouses.

We state it in these terms:

The nature of the workflow in homebuilding production is project portfolio management, managing what can be large amounts of work-in-process, managing what can be a large number of construction jobs, which clearly meet the definition of projects.

Yes, there is workflow performed in processes, but those processes are a different type of workflow, and they are generally embedded in, and enabling and supporting of, the larger, more primary scheme of managing a project portfolio.

The process of building a home – what we call Start-to-Completion – is actually the management of multiple projects that share resources.  It is the structuring and the management of a portfolio of job schedules, with interdependencies and interactions of tasks and resources.

At its core, homebuilding is multi-project management.

The current, accepted method of project scheduling is the Critical Path Method (CPM), which evolved from the Program Evaluation and Review Technique (PERT) in the 1950s;  CPM has been in existence for almost 70 years, and it is the method used in every homebuilding ERP.

PERT and CPM were designed for one-off programs with large, complex structures (Polaris weapons system, the Manhattan Project), but the Critical Path Method has become the de facto standard for scheduling all types of projects:  aerospace/defense, software development, product development, research, and – yes – construction.

The problem with CPM is that it was not designed for managing a portfolio of projects, and it was not designed to function in environments where velocity is important, where faster cycle time and higher inventory turns are critical drivers of business outcomes.

Where it must contend with variation and uncertainty, CPM offers only a buffer of additional time – individual task durations lengthened to protect the completion date of each task, not the completion date of the project.

And – what is the cost of that added safety?  What is the cost of specifying 95% probabilities of on-time completion over the mean (50%) probability?

Statistically, insisting on that amount of task safety lengthens the job schedule by a factor of 1.64.  Which is how 90-day job schedules become 150-day job schedules.  Built-in safety that three well-known, yet typically un-checked, types of human behavior then conspire to waste, which is why jobs never finish early, are almost always late, despite all of the purported safety.

For the most part, builders are oblivious to the effects of variation on their production system.  Yet, the cost of that variation is apparent and simple to calculate;  it is the Gross Income lost from all of the closings that never occurred, from houses that were never built with the capacity that was available.  For a profitable builder – a builder operating above breakeven – it is even worse;  it is Gross Income that would have become Net Income, and ultimately, Net Profit.

It’s a lot of money.

Moreover, CPM considers task dependency (the predecessor-successor relationships of tasks) in its work breakdown structure, but it does nothing to resolve resource contention;  it does not consider situations in which tasks of different projects/jobs depend on the availability of resources that do not have sufficient capacity to meet the demand being placed upon them.

These two factors – dealing with variation and resolving resource conflict – should be anathema to builders.

CPM was never designed to contend with the production environment homebuilding presents.  CPM is not the problem (the problem is variation and resource conflict), but it is benign to the solution.  ProChain Solutions’ Rob Newbold (Project Management in the Fast Lane) told me that he would go further, saying:  “CPM supports values that perpetuate the problems of homebuilders.”

Which brings us to Critical Chain Project Management.

Developed in 1997, Critical Chain addresses both task dependency and resource contention, and it replaces the padded durations intended to protect the completion date of every task with a smaller project buffer that is fully-capable of protecting the completion date of the project/job;  in the process, CCPM becomes much more aware of system capacity and constraints.

Understand what this different, changed approach means:  it means that Critical Chain substantially reduces the duration of projects – the cycle time of houses under construction – without impacting the reliability of their completion dates.

Consider the explanation of an exercise excerpted from the RB Builders: Lessons from the Pipeline© business case study used in a recent Pipeline workshop™:

“RB Builders’ newly-acquired division has a construction schedule of 120 calendar days, but its calculated cycle time is actually 180 calendar days.  It is widely agreed that the division should be able to build its homes in far-less than the 120 days called for by the schedule, because that duration reflects ‘highly certain’ task durations.

“Switching from CPM to CCPM would immediately reduce the schedule from 120 days to 97 days, cutting the schedule by almost 20% with no diminution of confidence;  it would reduce the actual 180 day cycle time by almost half (46%).”

Critical Chain Project Management does more than just reduce the length of construction schedules.  It also specifies a set of rules preventing behaviors that consume (and waste) the safety CPM builds into task durations and CCPM builds into its project buffer.  CCPM installs a release mechanism that “pulls” starts into the system and keeps work-in-process at the levels required to produce faster cycle times.

CCPM implements simple, visual tools to manage production.

Builders can put a number of these practices into place without necessarily changing the scheduling algorithms from Critical Path to Critical Chain.  They can use add-on applications that convert existing scheduling applications from CPM to CCPM.  Or, they can implement standalone CCPM software applications.

But – Critical Chain will not be a complete, integrated solution for the homebuilding industry until its management technology providers wake up and address it.

 

      

“Risen”

Posted April 21, 2019 By Fletcher Groves

(updated and re-posted on Escape from Averageness® every year, on Easter morning)

The intrepid, results-based consultant reclined into the natural seat, at the back edge of one of the dry-eddy pools, where the beach resumed its slope more steeply upward, toward the higher dunes.

Easter 2019 Ponte Vedra Beach, Florida

She dug the heels of her topsiders into the sand, still damp from the past night’s high tide.  It always felt good, she thought.  Resting her arms on her knees, she gazed eastward into the shades of blues, greens, and oranges comprising sea and sky.  The sun was now just above the horizon, shining brightly on what was a surprisingly clear and cool mid-April morning in northeast Florida.

She was in her element.  A seventh-generation Floridian, she loved the waters and land of her native state.  She wished she could have seen for herself the Florida her dad liked to tell her about – the mid-twentieth century Florida of his youth, as he would describe it:  Florida before air conditioning, interstate highways, and theme parks.

This was her routine, every year, on Easter morning.

She reflected on the words of John Eldredge and Brent Curtis, words used to describe the silence, solitude, meditation, and simplicity of what they referred to as “desert communion”:  “We have come to the shores of Heaven together, to the border of the region where our Christianity begins to move from a focus on doing, to one of communion with Christ.”

After a while, she reached over and removed her 35mm SLR camera from its backpack, switched it to manual, adjusted the aperture and exposure, and studied the image in her viewfinder.  Satisfied with her settings and composition, she released the shutter.

“ . . . take the photographs and still-frames of your mind”, she mused, as she reviewed her work.

Setting the camera aside, she turned her thoughts to the pre-dawn darkness of the first Easter morning, as she tried to imagine what the disillusioned, no doubt despairing, friends and followers of Jesus of Nazareth must have been thinking and feeling.

Prophecies notwithstanding, when they went to the gravesite, what did they really expect to find?  By every rational explanation and every shred of evidence, this man of so much promise, in whom they had placed so much hope, was dead.

They had been eyewitnesses to that death, and the effects of the torture that preceded it;  the term excruciating, she reminded herself, comes from the Latin ex crucis, meaning literally, “out of the cross”;  Roman crucifixions left nothing to the imagination.

They had been witnesses to his burial, as well, and the particularly intense security of his tomb.

For His friends and followers, this was certainly more than the physical death of one man;  for them, it was the death of all faith and hope.

Her thoughts moved to a time not far removed from the darkness of the days following the death of Jesus.  Realizing what they had experienced and seen, Peter and others now publicly asserted, that not only had they witnessed His torture, death, and burial, they had been eye-witnesses to His resurrection.

“God’s Kingdom had come, not at the end of time, but within time – and that had changed the texture of both time and history.  History continued, but those shaped by the Easter Effect became the people who knew how history was going to turn out.  Because of that, they could live differently.  The Easter Effect impelled them to bring a new standard of equality into the world and to embrace death – as martyrs, if necessary – because they knew, now, that death did not have the final word in the human story.”  (“The Easter Effect and How It Changed the World”, The Wall Street Journal, March 31, 2018)

Every other event – past, present, or future – either points toward, or proceeds from, the series of events that became Easter.

Rather than abandoning their faith and succumbing to hopelessness, Peter and the others said they were willing to live their lives – to give their lives – for the lives of others, and for the faith and the hope that His crucifixion, death and resurrection gave all of them.

In the words of Paul, subsequently penned to the churches of Galatia, they were all saying, in essence, “I have been crucified with Christ.  It is no longer I who live, but Christ who lives in me.”

It has been that way, for every Christian, ever since.  It had been that way for her.

She smiled, and whispered.

“Risen”.

 

      

(published on EFA® every year since 2012, previously titled simply the “The Debate Over Costing”;  incorporated and republished every year, here as the last in a five-part series) 

Seven years ago, on the BUILDER group on LinkedIn, I had this exchange with Shinn Consulting’s Emma Shinn, on the subject of whether costs on the NAHB Chart of Accounts Income Statement should be allocated according to the rules of absorption costing or the rules of variable costing.

Seven years later, the discussion remains entirely relevant.

The matter of how the NAHB Income Statement Income Statement allocates costs was the subject of an April 2009 post on Escape from Averageness®.  It was also the subject of a series of posts in January 2012, summarizing the results of a CFO survey we conducted on the NAHB Income Statement, preceding the 2012 International Builders Show (IBS).

Here is the exchange in its entirety, unredacted, edited only for clarity:

Emma:  “I do respectfully disagree with your assessment of the NAHB Chart of Accounts – the purpose of the [Chart of Accounts] is to provide a structure for collecting financial information in an organized and meaningful way.  It provides builders the capabilities to produce reports that are meaningful and that will guide them in their decision-making process.

“In no way does it deter or hinder the contribution margin analysis you talk about.  In fact, it facilitates such analysis as it provides the classification of cost and expenses in a way that facilitates the identification of the variable and fixed components.

“The contribution margin analysis does not deter from the analysis of the traditional income statement and the valuable information it provides to the builders.  The contribution margin analysis does provide an expanded view and I agree with you in that builders can benefit from also looking at the income statement from this point of view as it refines further the behavior of fixed vs. variable cost and expenses.

“However, your assessment of the NAHB Chart of Accounts is unfounded and could not be farther away from the reality of what the purpose of the [Chart of Accounts] is set up to be.”

Fletcher: “Emma, you don’t have to take my word for it. As part of the survey, we asked CFOs for their insight related to the structure of the NAHB Income Statement (i.e., line item accounts in series 300-900), as it relates to cost allocation (variable v. absorption) and management tools (breakeven, CVP, etc.).

“This an excerpt from one CFO:

“’I am intimately familiar with both the strengths and weaknesses of the NAHB Chart of Accounts.  It was a great tool for benchmarking our performance with other builders and to industry standards.  It was interesting to benchmark our company, but the statements produced utilizing the NAHB Chart of Accounts were of no use when it came to making pricing decisions.’

“The thoughtful examination of any managerial accounting or cost accounting textbook validates this CFO’s statements.”

Emma:  “Once again, I respectfully disagree with that assessment.  There is nothing in the chart of accounts that prevents a company from preparing a statement utilizing other analytical tools.  The income statement you call the ‘NAHB Income Statement’ is the standard income statement presented in any accounting principles class.

“If you want to do further analysis for specific managerial considerations, that is always highly encouraged.  However, I again say the NAHB Chart of Accounts vs. the charts of accounts I normally encounter in my reviews of builders’ operations facilitates further analysis;  it does not preclude the analysis.

“Accounting, in my view, is primarily a management tool and we continue to encourage builders to view it as a very powerful means to help direct their management decisions.  That is not to take away the role accounting also plays in reporting results to third parties, such as lenders and investors.”

Fletcher: “Emma, the NAHB COA Income Statement has a lot of attributes.  However, there is a difference between what something ‘does not deter or hinder’ or ‘does not preclude’, on the one hand, and what it positively, proactively enables, on the other.

“That may be all our differing views are about.  However, here are two of the specific points made on the matter, posted on SAI’s Escape from Averageness® weblog in April 2009:

“’The NAHB COA Income Statement treats Indirect Construction Cost as one of the costs that is deducted from Revenue to determine Gross Profit (the only difference between Gross Margin and Gross Profit is the inclusion of Indirect Construction Cost).  But – do Indirect Construction Costs vary according to Revenue?  Probably not.  For the most part, they are non-variable costs that will most likely be incurred regardless of the Revenue produced.

‘The NAHB COA Income Statement treats Selling Expenses (including Real Estate Commissions) as an Operating Expense, as a part of overhead.  Anything allocated to Selling Expense, therefore, should be a non-variable cost.  Is that the case?  No.  The bulk of Selling Expense is a variable cost.’

“Emma – some of the CFOs in the survey were very out-spoken on this issue, and the shortcomings of absorption costing are well-documented.”

(variable costing and the Contribution Income Statement format are addressed at every Pipeline workshop™;  learn more here:  http://buildervelocity.com or http://saiconsulting.com/buildervelocity-pipeline-workshops/)

 

      

(published every year on EFA® since 2012;  updated, incorporated, and republished here, as the fourth in a five-part series)

“The NAHB Chart of Accounts is designed for historical financial reporting.  It is not a managerial accounting tool.  NAHB would do its members a great service by developing guidance on cost and managerial accounting.

“In my roles as both a CFO and a President of a homebuilding company, I am intimately familiar with both the strengths and weaknesses of the NAHB Chart of Accounts.  It was a great tool for benchmarking our performance with other builders and to industry standards.  It was interesting to benchmark our company, but the statements produced utilizing the NAHB Chart of Accounts were of no use when it came to making pricing decisions.”

So said, in part, one of the CFOs participating in SAI’s survey regarding the format and the utilization of their company’s particular Income Statement in relation to the NAHB Chart of Accounts Income Statement.

The thoughtful examination of any managerial accounting or cost accounting textbook validates this CFO’s statements.

To cite one:

“Financial accounting is mainly concerned with the historical aspects of external reporting . . . governed by generally-accepted accounting principles (GAAP).  Management accounting, on the other hand, is concerned primarily with providing information to internal managers . . . charged with planning and controlling the operations of the firm . . . not subject to GAAP . . . one thing is clear from the NAA definition of management accounting:

“The major function of cost accounting is cost accumulation for inventory valuation and income determination.  Management accounting, however, emphasizes the use of the cost data for planning, control, and decision-making purposes.”

Accounting Handbook, Barron’s, J. Siegel and J. Shim, 1990.

To cite another:

“Although an Income Statement prepared in the functional format may be useful for external reporting purposes, it has serious limitations when used for internal purposes . . . the Contribution Income Statement emphasizes the behavior of costs, and therefore, is extremely helpful to a manager in judging the impact on profits, of changes in price, cost, or volume.”

Managerial Accounting, 10th Ed., McGraw-Hill Irwin, R. Garrison and E. Noreen, 2003.

To cite yet another, directed towards resolving the need for a company to prepare multiple sets of financial information:

“For companies committed to maintaining variable contribution information, there are two choices available . . . 1. maintain their accounting system on a full-absorption GAAP basis, with separate calculations and analysis of variable contribution information [or] 2. maintain their accounting systems on a variable contribution basis with a monthly reconciliation to GAAP . . . if the only real reason for maintaining full-absorption accounting is to satisfy external requirements, doesn’t it make more sense to use option 2 and perform simple month-end reconciliation to GAAP?”

The Measurement Nightmare: How the Theory of Constraints Can Resolve Conflicting Strategies, Policies, and Measures, APICS series, The St. Lucie Press, D. Smith, 2000.

The last of the preceding excerpts is consistent with the others;  in fairness, it comes from Throughput Accounting (the emergent cost accounting methodology supporting Theory of Constraints), which places it outside the mainstream.  Throughput Accounting uses a profit and loss statement that is an outlier to even a Contribution Margin P&L, by refusing to assign costs to inventory, and expensing product costs immediately;  literally, it has no internal use for GAAP compliance.

In the similarly nascent and outlying world of cost accounting methods that aim to support Lean Production, in its broadest sense, as a management system – as a business strategy, as an operating philosophy – the advice is more obtuse;  Lean Accounting sees no conflict with GAAP, uses an operating statement that clearly mixes variable and non-variable costs, but nevertheless states these among its Lean Accounting Concepts and Principles:  “2. Do not confuse a fixed cost for a variable cost” and “3. Eliminate absorption accounting for manufacturing transactions.”

The Real Numbers: Management Accounting in a Lean Organization, Managing Times Press, J. E. Cunningham, O. J. Fiume, E. Adams, 2003.

At best, comparison with “industry best practices” promotes a satisfaction with some sort of competitive equality, a settling for the expediency of the ideas of someone else.  The real problem with best practices is that it stifles creativity and innovation, works against creating competitive advantage, and creates the illusion of continuous improvement.

GAAP-for-the-sake-of-GAAP?  Compliance-for-the-sake-of-compliance?  If you are a builder, you manage every day;  you only report periodically.  You are not in the business of complying with generally-accepted accounting principles;  you are in the business of making money.  Emphasizing compliance is a case of the tail wagging the dog.

Bottom-line:  the two arguable attributes of the NAHB Chart of Accounts Income Statement – comparativeness-driven conformity and reporting-driven compliance – might be desirable, and to a degree necessary, but they are not a justification to sacrifice sound managerial accounting.  You cannot properly and effectively manage a homebuilding operation using the cost allocations recommended in the NAHB Chart of Accounts Income Statement.

Next:  Part V:  Groves and Shinn:  The Debate Over Costing

 

(variable costing and the Contribution Income Statement format are addressed at every Pipeline workshop™;  learn more here:  http://buildervelocity.com or http://saiconsulting.com/buildervelocity-pipeline-workshops/)