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(published on Escape from Averageness® every year since 2009;  updated, incorporated, and republished, here as the first in the five-part series)

The NAHB Chart of Accounts enables builder-to-builder comparisons, complies with GAAP reporting requirements, and allows the same consultants to give the same presentation year-after-year at IBS.  But, to the extent that its Income Statement presents costs as anything other than a true delineation based on behavior in regard to Revenue, it is – from a managerial accounting standpoint, and therefore, from a larger management standpoint – utterly useless.

It is useless, because it prevents a builder from understanding how it makes money.

The ability to generate cash, make a profit, and produce an economic return depends on an understanding of cost classification.  How costs are classified, or associated, according to structural hierarchy, cost objects, and behavior.

Does it matter how costs are classified?  Does it matter where they are incurred, what caused them to be incurred, or whether they vary in relationship to anything?

Yes, it does matter.

Costs are the most operative part of a home builder’s Income Statement, and an understanding of how costs are allocated and classified provides a basis of operational insight that is otherwise completely missing.  Understanding where costs are incurred and whether they are incurred directly or indirectly is important, but the distinguishing characteristic of costs is how they behave.

Here is the operative question:  Does the cost vary with the volume of Revenue, or does it not?

Cost behavior presents a builder with the truest picture of what its production capacity costs, where its breakeven points are, and how it analyzes changes in costs, production levels, and margins.

Not only the truest picture, but the only picture.

At the core of variable costing is the understanding that costs have attributes, and those costs cannot be managed as if their attributes don’t exist.

Builders need to control their direct, variable costs – the costs that should be “above the line” on their Income Statement;  they need to either reduce the cost, or extract maximum value (benefit in excess of cost) from having incurred it;  they need to exploit it, optimize its potential, find productive ways to get more value out of it, and understand, if they didn’t generate the Revenue, they didn’t incur the cost.

At the same time, they need to leverage their indirect, non-variable costs – the costs that should be “below the line”, costs that will be incurred regardless of the Revenue generated;  the objective should be to produce as many closings as possible, from having incurred the cost in the first place.

Controlling and extracting value from direct, variable costs is how a builder improves margin;  leveraging indirect, non-variable costs is how it increases velocity.  Economic return is Return on Assets;  ROA is margin x velocity;  it is velocity acting upon margin.

Builders must distinguish between variable and non-variable costs, to have any picture whatsoever of breakeven, i.e., the rate at which it absorbs overhead.  If Cost of Sales contains non-variable costs, and Operating Expense contains variable costs, that understanding of breakeven is destroyed.

These three examples of the problem with the NAHB COA Income Statement make our point:

  1. Indirect Construction Cost is treated as a cost 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.  Do Indirect Construction Costs generally vary according to Revenue?    For the most part, they are non-variable costs that will be incurred regardless of the Revenue produced.
  2. Selling Expenses (including Real Estate Commissions) are treated as an Operating Expense, part of overhead. Anything allocated to Selling Expense should, therefore, be a non-variable cost.  Is that the case?    The bulk of Selling Expense is a variable cost.
  3. Financing Costs are treated as an Operating Expense, but it would only be a non-variable cost if a builder had its construction lines of credit fully-drawn every day of the accounting period, or if the LIP balance on the construction line of credit never varied. Is this typically the case?    Are loan fees non-variable costs that do not fluctuate with volume?  Typically, no.

Bottom-line:  Report your financial condition and meet your tax reporting obligations, as required.  Mindlessly compare your company with other builders, if you choose.  But – give yourself cost information that guides your operating decisions.

Next:  Part II:  The Problem with the NAHB Chart of Accounts Income Statement

 

(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/)

 

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At every Pipeline workshop™ we have ever done, one of the most important takeaways, one realized by practically every homebuilding company executive in attendance, is simply this:  something has to be done with the notoriously fragmented value stream that defines their industry, if they are going to have any hope of managing production as a system.

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.”

They went on to describe a set of processes, which they termed tasks:  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 homebuilding company has its own value stream;  it owns that 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 homebuilding.

Look at the value stream of almost any homebuilding enterprise, and you will find a combination of independent, separately-owned, non-proprietary, non-exclusive, unaffiliated businesses, each having their own goals, that are often at-odds with each other.

We have a descriptive phrase for a completely outsourced building model like this.  We call it “strip-mining the value stream”.

Technology – specifically, offsite manufacturing processes – will improve quality, reduce waste and variation, reduce cycle times, increase productivity.  By all means, consider it.  But, by definition, manufacturing off-site doesn’t unify the value stream, unless you own or joint venture the facility.

In her final comments to the team at RB Builders, before she left them the first time (The Pipeline: A Picture of Homebuilding Production©, Second Edition), the intrepid, results-based consultant reviewed the components of RB Builders’ production management system – the RB-IPS – and said this:

“It is a production management system that specifies the means by which RB Builders fosters epic relationships of mutual interest with its building partners and supply partners.  The RB-IPS provides both the process and the program for progressively transforming subcontractors and suppliers into true partners, into trusted allies, joined by shared, mutual interests.”

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;  they understand that they can no longer dictate the terms.

Is vertical integration part of the answer?  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.  That suggestion usually falls on deaf ears, or is dismissed as a radical, undoable notion.

Which is where opportunity always lies, in radical, undoable notions.

Whether or not vertical integration has a future strategic role to play in the homebuilding industry remains to be seen.  At each Pipeline workshop™, the contrast between outsourced and integrated building models is now portrayed in one of the Pipeline games™;  it is an area that has been covered in the Lessons from the Pipeline© business case at previous workshops;  and it was added as its own section in the second edition of The Pipeline: A Picture of Homebuilding Production© (released for publication in 2016).

The outcome of the vertical integration question doesn’t change the underlying imperative.  Success in unifying the effort of even the existing value stream has profound ramifications, on both the margin and velocity components of Return on Assets;  and success in unifying the value stream has profound implications for creating competitive separation.

With or without vertical integration, addressing the issue will require Epic Partnering™.

Come.  Participate.  Learn.

 

Epic Partnering™ – the attributes of the relationships being fostered, the program, the process – is one of the three Velocity Accelerators® (together with Business Process Improvement and Critical Chain Project Management) that will be explored at the next Pipeline workshop™, March 20-21, 2019, at the Ponte Vedra Inn and Club, in Ponte Vedra Beach, Florida.

The cost is $895.00 per person;  for team pricing, inquire here (flgroves@saiconsulting.com).

Delivered by SAI Consulting and Continuum Advisory Group.

Sponsored by MiTek Industries and Specitup.

Details:  www.buildervelocity.com

 

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Velocity Accelerators®: Business Process Improvement

Posted February 9, 2019 By Fletcher Groves

An overwhelming portion of SAI Consulting’s work, in and out of homebuilding, has been about enabling clients to effectively structure themselves around their core-critical business processes;  it is a fact that Business Process Improvement is the area of our practice for which we are most recognized.

It is a similarly important area for Continuum Advisory Group, the consulting firm that joins SAI in the facilitation of open, sponsored Pipeline workshops™ and Pipeline seminars™.

There is a very good reason for our firms’ collective focus on improving (and managing) business processes, and it is simply this:

The most basic, most fundamental premise in all of business is this:  the reason an enterprise exists – every business enterprise, certainly every homebuilding enterprise – is to make money;  the way an enterprise makes money is by delivering value to its customers and other stakeholders;  that value can only be delivered through the work that the enterprise performs, work that has to be performed in some manner of workflow;  the most common form of that workflow is work performed in processes.

Make money . . . by delivering value . . . through the work you perform . . . in processes.

From a business standpoint, processes are critically, centrally important;  they exist – they matter – whether homebuilders are intentional about them or not.

How important is Business Process Improvement to a homebuilding company?  Important enough that, sometime ago, we sacrificed one of the highly-regarded Pipeline games™, so that we could elevate improvement of workflow to the level of a Velocity Accelerator®.

At SAI, we repeatedly make the point that Pipeline workshops™ are all about thriving on the velocity side of Return on Assets®, but better process workflow pays off on both sides of economic return;  it drives both higher margins and higher velocity, drives a higher Return on Sales as much as it drives higher Asset Turn.

Consider:

Start-to-Completion (the sub-process within Prospect-to-Closing that is the aorta of workflow in a homebuilding company) is not, at its core, process management;  Start-to-Completion is multi-project management;  it is project portfolio management, with embedded and supporting processes;  it is workflow in which all of the non-supervisory work is performed by external resources (trades and suppliers).

Since it is not managed like a process, we don’t treat it as a process;  we don’t map it like it is a process;  we exclude it.

Nevertheless – even excluding STC – the results from the dozens of process mapping engagements we have  performed over the past two decades show that fully 25% of all the work a homebuilding company does perform – the work that consumes a building company’s overhead – is completely non-value-adding.

Ponder that revelation for a moment.

Here is the bottom-line:

If your Operating Expense represents – meaning it consumes – just eight percent of Revenue, you are throwing away $20,000 of every $1,000,000 in Revenue you generate.

The most visible element of BPI (and BPM) is the mapping of process workflows;  however, process mapping involves far more than documenting – and confirming, accepting as-is – the current state of that workflow;  it includes redesigning those workflows in ways that improve them, which invariably reveals other issues – the root causes, the core problems – that affect profitability and economic return.

Which makes understanding and improving workflow the means to a much more important end.

Business Process Improvement is the tip of the spear, the front-end of a continuous improvement methodology in which the activities and elements of workflow that add value are preserved, the activities and elements that add no value are eliminated, and the remaining activities and elements that enable value are refined to make the workflow more clear, more consistent, more streamlined, more connected, more succinct, more fit for its intended, defined purpose.

The analogy from our Pipeline workshops™ is that we want a shorter, straighter pipe.

Because it is so foundational, it is impossible to overstate the importance of understanding and improving the way work is performed, before starting down the long road on other improvement initiatives, before the process of continuous improvement moves anywhere else.

In addition to being the means to a more important end – and the front-end of a process of continuous improvement – BPI ushers in a new perspective.

It shifts the organizational view away from the internal structure of work performed in functions. towards the flow of work performed in value-adding processes;  BPI shifts the perspective from vertical to horizontal;  it turns a homebuilding enterprise 90 degrees from vertical, lays the enterprise on its side, and aligns its workflow with the value it seeks to create.

It’s about getting horizontal.

Lastly, processes are also the centric element of the operating model that forms any strategic value discipline that serves to deliver exceptional levels of the specific and distinctive value demanded by a narrowly-defined segment of homebuyers.

 

Come.  Participate.  Learn.

Business Process Improvement is one of three Velocity Accelerators® (along with Critical Chain Project Management and Epic Partnering™) that will be explored at the next Pipeline workshop™, March 20-21, 2019, at the Ponte Vedra Inn and Club, in Ponte Vedra Beach, Florida.

The cost is $895.00 per person;  for team pricing, inquire here (flgroves@saiconsulting.com)

Delivered by SAI Consulting and Continuum Advisory Group.

Sponsored by MiTek Industries and Specitup.

Details:  www.buildervelocity.com

 

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Pipeline Workshops™: Velocity Accelerators®

Posted February 2, 2019 By Fletcher Groves

If you had to choose a single word to associate with a Pipeline Workshop™, it would be velocity – a vector measure that means speed in a purposeful direction.

We want to elevate velocity to an equal standing with margin, because, together, they are the components of economic return.  In each Pipeline workshop™, we select specific areas of production management for a deeper dive – more discussion, the use of pointed and challenging exercises from the RB Builders: Lessons for the Pipeline© business case, etc.

These areas are known as Velocity Accelerators®.

Velocity Accelerators® tend to be important areas that do not receive sufficient industry attention;  in fact, beyond a passing understanding, Velocity Accelerators® are often the first meaningful exposure to these areas builders attending a Pipeline workshop™ have experienced, making these sessions something of a mini-boot camp.

For the upcoming workshop (Pipeline Workshop™ No. 11, held March 20-21, 2019, at the Ponte Vedra Inn and Club, in Ponte Vedra Beach, Florida), we are highlighting three areas:

 

Epic Partnering™.  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;  they understand that they can no longer dictate the terms of engagement.

Developing the business relationships that unify a builder’s value stream is a program of milestones and features, and it is a transformative process;  it is both a program and a process.

Epic Partnering™ has profound implications on both the margin velocity sides of economic return.

 

Business Process Improvement (BPI).  The most basic, most fundamental proposition in the business of building homes is this:  the reason a builder exists is to make money;  the way a builder makes money is by delivering value – benefit in excess of cost – to its homebuyers and other stakeholders;  that value can only be delivered through the work that the building enterprise performs;  value-delivering work has to be performed in some manner of workflow, which includes work performed in processes.

Make money . . . by delivering extraordinary value . . . through the work a builder performs . . . in processes.

BPI is the front-end of a process of continuous improvement, one that fundamentally changes the perspective of workflow, and becomes the driving component of the operating model that forms a builder’s strategic value discipline.

As with Epic Partnering™, BPI improves both margin and velocity.

 

Critical Chain Project Management (CCPM).  Developed more than sixty years old, the scheduling algorithm known as the Critical Path Method (CPM) was never intended to function in the environment of homebuilding production, which is essentially project portfolio management with surrounding, supporting, and embedded processes.

CPM was never designed to function in environments in which velocity is important, where faster cycle time and higher inventory turns are critical drivers of business outcomes.  Moreover, CPM is oblivious to the devastating effect variation has on the scheduling of a production system.

CCPM is the leading edge – the future – of project scheduling for homebuilding;  it promises significant improvements in managing homebuilding production – faster cycle times, faster inventory turns;  enabling homebuilders to generate more Revenue, more Gross Income, with a planned, finite, and controlled amount of work-in-process and production capacity.

Unlike either Epic Partnering™ or Business Process Improvement,  Critical Chain is purely a velocity proposition.

 

The reason we are only highlighting three Velocity Accelerators® at this workshop, instead of the five we highlighted in previous workshops, is to give these three sufficient emphasis.  We still manage to touch on two other Velocity Accelerators®:

Building Information Modeling (BIM).  Building Information Modeling (BIM) explores building design in a 3D model of the three spatial dimensions of width, height, and depth (some would also say time and cost), and links to multiple databases with information on costs, schedules, specifications, engineering data, and more.

BIM integrates, consolidates, and links information;  it makes data more accurate, useful, and manageable.

As with Epic Partnering™ and Business Process Improvement, BIM has implications for both the margin side and velocity side of Return on Assets:  on the margin side, better, more collaborative designs with fewer design errors, more accurate job cost books, job budgets, and purchase orders;  on the velocity side, plans that are easier to build, more dependable job schedules, shorter cycle times, faster inventory turns.

Plus – a more satisfying homebuying experience and a higher quality product.

Building Information Modeling holds the possibility of “making product 35% faster and 25% less costly to build”, according to Continuum AG’s Clark Ellis.

Yet, for all its promise to transform the homebuilding industry, BIM has had a shallow adoption curve, largely because implementing BIM requires a lot of money, too much determination and resolve, a different mental model, and a willingness to abandon past practices.

Which is where opportunity lives.

 

Open-Book Management and Team-Based Performance Compensation:  The efforts of a homebuilding company to improve operating performance and business outcomes will become far more difficult – it will likely fail – if it does not succeed first in creating a homebuilding team that works toward commonly-held and commonly understood business goals, versus being a collection of so-called teammates working toward individual goals.

What would be missing, is an underlying business logic that forms the necessary context for understanding everything else.

To become the kind of savvy, motivated, mutually-accountable homebuilding team required to compete effectively today in the business world, everyone on the team has to learn the “business” of homebuilding, they have to understand their individual responsibilities as part of the overall team, and they have to understand what is at stake, individually and collectively.

That is the role of Open-Book Management.

But, it is not enough that teammates understand the business outcome that is at stake;  they must each have a personal stake in that business outcome.

That is the role of performance compensation.

 

We like the balance between the three selected Velocity Accelerators®:  a blend of immediate and long-range initiatives that accelerate velocity, but also improve margins.

Come.  Participate.  Learn.

 

The next Pipeline workshop™ will be held March 20-21, 2019 at the Ponte Vedra Inn and Club, in Ponte Vedra Beach, Florida.  The cost is $895.00 per person;  for team pricing, inquire here (flgroves@saiconsulting.com)

Delivered by SAI Consulting and Continuum Advisory Group.

Sponsored by MiTek Industries and Specitup.

Details:  www.buildervelocity.com

 

Pipeline Workshops™: What’s your Production IQ®?

Posted January 27, 2019 By Fletcher Groves

The fundamental understanding that emerges from the DuPont identity regarding Return on Assets is this:  remove the financial leverage (equity multiplier) from the formula, and economic return becomes a function of profitability (Return on Sales) and operating efficiency (Asset Turnover).

Economic return is margin x velocity;  it is a co-equal dependency.

Is margin proficiency necessary?  Yes.  Is it sufficient?  No.  Does superior margin hold-forth the possibility of achieving sustainable competitive separation?  Absolutely not.

We’re not alone in this assessment:

“ . . . [asset] turnover is just as important as profit margin.”  Barron’s Accounting Handbook (Siegel, Shim), 1990, 1997, p. 150.

“ . . . [improving] inventory turnover . . . increases asset velocity, one of the most under-appreciated components of making money . . . higher velocity improves productivity and reduces working capital.  It also improves cash flow, the life-blood of any business.”  Execution: The Discipline of Getting Things Done (Bossidy, Charan, 2002, p. 17)

Nevertheless, in the homebuilding industry, action on the velocity side of Return on Assets – almost without fail – takes a backseat to action on the margin side of ROA.

Pipeline workshops™ are aimed at changing that paradigm.

The motivation to attend a Pipeline workshop™ starts with the willingness to acknowledge and remedy what amounts to a profound lack of knowledge regarding production principles and disciplines.

The last part of that statement bears repeating.

In the homebuilding industry, there is a profound lack of knowledge regarding production systems.

Do you disagree?  Are you confident that you already know this stuff?  Then, prove it.  You – and your team – take the test.

  1. If a homebuilding production system is a pipeline, what determines the size, capacity, length, and cost of the pipe? What controls the flow?
  2. Is even-flow production a mechanism or an outcome?
  3. What is the most operative, useful measure of size for a homebuilding company?  a. revenue   b. number of employees  c. houses under construction  d. annual closings
  4. There are three activities that describe “what happens to money” in a homebuilding business, the terms for which can be used to express and link the formulae for operating performance (productivity, cycle time, and inventory turn) to the equations for financial performance (Net Income and Return on Assets).  What are the terms for those activities?  What do those activities represent?
  5. What type of workflow is homebuilding?  Is it process management, project management, or a combination of both?  If it is a combination, which element does it favor?
  6. True or False:  A production system that unbalances capacity across the resources that perform the work does a better job of optimizing the utilization of capacity than a production system that balances capacity across those resources.
  7. In what three ways will a production system protect itself from variation and uncertainty?
  8. In scheduling a portfolio of jobs, which algorithm considers both task dependency and resource contention?  Is it Critical Path or Critical Chain?
  9. Calculating the cycle time of a production system requires knowledge of what two operational measures?  Determining the level of necessary work-in-process requires knowledge of what two operational measures?  Estimating the rate of closings requires knowledge of what two operational measures?
  10. True or False:  Building reasonable safety into task durations is the best way to insure a high percentage of on-time completions.
  11. Which measure of operating performance is the reciprocal of cycle time?
  12. Lean Production views homebuilding as a build-to-order process.  Which resource does Lean recommend using as its pacemaker?
  13. What is the difference between measured cycle time and calculated cycle time?  What is the best use for each?
  14. What is – and what is not – the true cost of variation in a production system?
  15. What three human behaviors consume the time safety built into a job schedule?
  16. How does the matrix for managing starts in a push release system differ from the same matrix in a pull release system?
  17. As a matter of standard deviation, increasing the probability that a task will finish on-time from 50% to 95% will cause the anticipated duration of the task to increase by a factor of how much?  In statistical terms, how many standard deviations does this represent?
  18. Is trade partnering a program or a process?
  19. True or False:  The NAHB Chart of Accounts Income Statement prevents a builder from calculating a breakeven point and a breakeven rate.
  20. How does velocity differ from speed?

(the answers are at the bottom of the post)

We know, just a quiz.  Like any quiz, the questions represent a very small portion of the production and business knowledge required to effectively manage homebuilding production, increase operating performance, generate higher Net Income, and improve Return on Assets.

Every homebuilding company has to determine how it will manage production within a specific context, within parameters that include its market, its product mix, its choice of an information/management technology system, its financial situation.

But, the ability to manage production starts with an understanding of the underlying principles and disciplines.

It starts with what you learn in a Pipeline workshop™.

Come.  Participate.  Learn.

 

The next Pipeline workshop™ is at the Ponte Vedra Inn and Club, Ponte Vedra Beach, Florida, on March 20-21, 2019.  The cost is $895.00 per person;  for team pricing, inquire here (flgroves@saiconsulting.com).

Delivered by SAI Consulting and Continuum Advisory Group.

Sponsored by MiTek Industries and Specitup.

Details:  www.buildervelocity.com 

 

Answers: 

(1) size is the amount of work-in-process, capacity is the rate of throughput (with a planned, finite, and controlled amount of work-in-process), length is cycle time, cost is all of the indirect, non-variable expenses associated with overhead, flow is controlled by the valve that allows starts to occur at the rate of closings;  (2) even-flow production is an outcome, not a mechanism;  (3) c: houses under construction;  (4) money generated through sales is called Throughput, money invested in whatever will be turned into Throughput is known as Inventory or Investment, and money spent turning Inventory into Throughput is called Operating Expense;  (5) homebuilding is multi-project (project portfolio) management with embedded and supporting processes;  (6) True;  (7) higher work-in-process, longer duration, or more capacity;  (8) Critical Chain;  (9) work-in-process and closings, expressed in units, cycle time expressed in days;  if two are known, the third can be calculated;  (10) False;  (11) inventory turn;  (12) the most capacity-constrained resource;  (13) measured cycle time is the average (mean) duration of a series of jobs;  calculated cycle time reflects the relationship between the inventory (work-in-process) a production system carries and the closings (throughput) it produces;  measured cycle time is about forensics, calculated cycle time is about the system;  (14) the true cost of variation in a production system is not the cost of waste or excess, it is the Contribution (Gross Income) from every house that was not built and closed because of variation in the system, Gross Income that would have dropped straight to the bottom-line as Net Income;  (15) procrastination (student syndrome), expand to whatever time is allowed (Parkinson’s Law), multi-tasking;  (16) the start matrix in a push system determines both the order and rate of starts, whereas in a pull system, the start matrix only determines the order of starts (the rate of starts is governed by the rate of closings);  (17) a factor of 1.64 (reciprocal .61), meaning that four out of every 10 days in the job schedule is padding (safety) intended to assure on-time completion of every task, and, therefore, the on-time completion of the job;  two standard deviations;  (18) establishing epic relationships with trade partners is both a program and a process;  (19) True;  (20) velocity is a vector measure;  it is speed in a specific direction;  velocity is targeted, purposeful speed.