Escape from Averageness

One Homebuilder's Stress Test: Why We Map Processes

noreply@blogger.com (Fletcher L. Groves III) — Sat, 07 Aug 2010 21:43:00 +0000

It was clear, at least to some. There was trouble if they did not address these issues. With current reality staring them in the face, they did nothing. That was in 2006. In 2008, they filed for Chapter 11 protection.

We know what we are talking about, because we are the homebuilding industry's leading expert, when it comes to the documentation, analysis, measurement, design and redesign, improvement, and management of operating and business processes. It is our tour de force. SAI Consulting has done more work with processes -- and done it longer -- than anyone in the homebuilding industry.

Every consulting engagement we have ever accepted has dealt -- in some way -- with a client's need to structure itself around its critical business processes, and that is because homebuilding operates under a basic proposition:

The only way a homebuilding company stays in business is by creating value that its customers are willing to pay for, the only way that it creates that value is through the work that it performs, and the only way that it performs this work is through processes (and through a project portfolio, because homebuilding is both process management and project management).

But, that does not do justice to process mapping.

In our view, it is far more than documenting, analyzing, measuring, redesigning, and improving workflow. Process mapping connects work to operating performance, and operating performance to business outcomes. In that sense, this type of engagement is the type of stress test that would benefit any homebuilding company.

Consider a small sampling of the forensics in this case:

In 2006, we were engaged by a well-known homebuilding company to help them map their processes. This was a company that had previously won a National Housing Quality award. Just to apply for a NHQ award, let alone win it, this company's processes had been vetted and judged as part of the examination.

During the engagement:

We pointed out the obvious discrepancies between stated operating performance and stated economic returns. We backed our assertions with indisputable production physics, and questioned whether this performance could have possibly occurred. We pointed out the steady decline of the trends in operating performance and business outcomes, to which they were apparently oblivious.

From a process standpoint -- just one example -- we observed that this company had "a very iterative (product) design process exposed to an impulsive/compulsive design mentality", that this was a process with 132 discrete process activities -- involving a minimum of 33 handoffs, 19 reviews, eight approvals, 14 sections of activities where the work of one person or department was subsequently revised or subjected to rework. Furthermore, that none of these 132 activities, by their own admission, could be classified as value-adding, but almost 30% of them were self-classified as completely non-value-added. It was a process that took 12 months to produce a new plan.

We observed -- and proved -- to this company that they had a cycle time of 279 days in their Start-to-Closing process, and that the resulting asset turn could not possibly be the 5.2 times the company was claiming.

We stressed the need to establish a set of operating and business measures as the performance requirements for the new process designs. Yet, in the end, this company was never able to address the question of performance requirements as a comprehensive, connected set of operating and business outcomes. The only performance requirements that were accepted were the cycle time guidelines imposed by the executive group for certain processes. The need for (or importance of) performance requirements did not strike a chord with either the executive group or the process teams. Given the existing level of operating and business performance, we told them that we found "the level of disinterest -- the lack of resolve -- disturbing".

After all, this was a homebuilding company that had produced a Return on (homebuilding) Assets of only 4.7% in 2005; the targeted economic return should have been eight times that rate. Moreover, this was a homebuilding company that six weeks previous had been forced to take the gut-wrenching action of releasing 40 teammates. We pointed out that the real situation was probably worse, that, in all likelihood, an economic return of 4.7% overstated the company's true performance, since cycle times of 250+ days could not possibly result in an asset turn of 5.2. For that matter, it did not seem that the company could have produced an asset turn of 5.2 with a productivity (revenue/employee) measure of only $700,000.

We told this homebuilding company that we had traveled this country, working with homebuilding companies of all shapes, sizes, rationales, and arguments, companies just like theirs, and that processes like theirs were not just badly-designed processes; they were the outcome of flawed thinking on how to best understand and satisfy the requirements and expectations of their chosen market segment, on how to craft a solution that satisfies the requirements of all of their stakeholders -- company owners and teammates, as well as homebuyers.

We told this company that velocity was a lot of what this type of project was all about. It was about finding ways to design/implement better, more productive processes, in order to increase productivity and reduce cycle time. We told them that processes were simply the logical starting point, the first step in the quest toward a "more-for-less" mentality -- more output, more revenue, for the same investment in WIP and production capacity.

We told them that, in their case, perhaps it also needed to be about something else. Perhaps -- just perhaps -- it also needed to be about finding more ways to create and deliver the value their customers were willing to pay for, were willing to pay a premium for, while still finding ways to become faster and more productive.

At the conclusion, we told this company "there is a long road ahead". We reminded them, that when they "embarked on this journey, (they) knew that this project was more the beginning than the end, that it would be the start of an effort that never really ends; the process of continuous improvement means just that -- a continuous process of improvement".

We asked them the same questions we had begun asking every homebuilding company: "Does the world really need one more average homebuilding company? Will "average" performance -- operating, business, or otherwise -- be sufficient to sustain a homebuilding company in the future?"

We said that it was an urgent question, and we thought the answer was "No". We questioned why there were any average homebuilding companies. We said that we suspected the answer was that there were a lot of builders who did not care, a great many who were still living in the "95-05" mindset and for whom the business of homebuilding had been too easy, but that did not explain the large number who wanted to be extraordinary, exceptional homebuilding companies, yet struggled with mediocre customer satisfaction and average operating and business performance.

We told this homebuilding company that they were not an average homebuilding company in intent or reputation, but they were average -- at best -- in terms of performance. We told them that this project was a start. Whether it was a good start, whether it would be sustained, whether it ultimately would produce the results it was intended to produce, was up to them.

That was 2006. In 2008, they filed for Chapter 11 protection.

Part V: "Ex Disastrium, Scientia"

noreply@blogger.com (Fletcher L. Groves III) — Sun, 25 Jul 2010 01:26:00 +0000

(Excerpted from "The Pipeline")

"Well, someone might as well ask the question", said the intrepid, results-based consultant. "From both a production standpoint and a financial standpoint, at what point does RB Builders breakeven?"

"One of the advantages and benefits of allocating costs on the basis of how they behave in relation to Revenue is the ability to understand and use breakeven analysis", replied the CFO. "But, I have to admit, before you came, we could not have answered that question. The RB Builders Income Statement was prepared according to the NAHB Chart of Accounts, which is to say that it was comparative, compliant . . . and utterly useless. Now, we also produce a Contribution Income Statement.

"According to the 2008 baseline budget, our breakeven point is 155 closings, based on Revenue of about $39 million. However, because of the way the market has deteriorated, the 2008 target budget has a higher production breakeven point; it requires closer to 170 closings, albeit on only slightly higher Revenue ($40.5 million)."

"How did you calculate that?", asked the VP of Construction.

"Let me show you", said the CFO, creating a new data table and adding the data to the first two columns. "This is what we have said, so far. Some parts we do not know yet."

2008 BASE BUDGET
CLOSINGS = 200
REVENUE = $50,000,000
AVG. SP = $250,000
GROSS MARGIN = 22%
BREAKEVEN = 155 UNITS
BREAKEVEN REVENUE = $39,000,000

2008 TARGET BUDGET
CLOSINGS = 250
REVENUE = $60,000,000
AVG. SP = $240,000
GROSS MARGIN = 21%
BREAKEVEN = 170 UNITS
BREAKEVEN REVENUE = $40,500,000

2008 WORST-CASE
CLOSINGS = 140-150
REVENUE = $34,500,000
AVG. SP = $240,000
GROSS MARGIN = 18-19%
BREAKEVEN = ?
BREAKEVEN REVENUE = ?

2008 FULL CAPACITY UTILIZATION
CLOSINGS = 300
REVENUE = $69,000,000
AVG. SP = $230,000
GROSS MARGIN = 15%
BREAKEVEN = ?
BREAKEVEN REVENUE = ?

"Breakeven occurs at the point where overhead is completely absorbed", he said, continuing to write as he spoke. "Overhead is absorbed through the generation of Gross Income, which is comprised of the proceeds that we get to keep from each closing. When you are dealing with averages, one way to figure the breakeven point is to take the average sales price of a home, multiply it by the Gross Margin Ratio, and then divide the resulting Gross Income per home into your overhead."

BREAKEVEN = OVERHEAD / (AVG SP X GM%)
BREAKEVEN = $8,500,000 / ($250,000 X 22%) = 155

"That gives you the unit breakeven point, in other words, the breakeven point in terms of closings. The unit breakeven point in the 2008 Baseline is 155 closings."

"Is there another way to look at breakeven?", asked the intrepid, results-based consultant.

"Sure", he said, writing on the board. "You can calculate the breakeven point in terms of Revenue. You calculate that by dividing overhead by the Gross Margin Ratio, which, by the way, is basically the same measure as Contribution Margin.

"Take the 2008 Baseline and Target we were just discussing."

BREAKEVEN = OVERHEAD / GM%
BASELINE BREAKEVEN = $8,500,000 / 22% = $38,636,000
TARGET BREAKEVEN = $8,500,000 / 21% = $40,476,000

"Like I said, about $39 million and $40.5 million, respectively", he said, pointing back to the data table. "Our overhead under both the 2008 Baseline and the 2008 Target is $8,500,000, but the resulting Gross Margins are different, so the breakeven points are different. In this case, the difference in the unit breakeven point is more substantial than the difference in the Revenue breakeven point.

"Overhead is the same thing as Operating Expense, which is comprised of all our indirect, non-variable costs. Overhead -- or Operating Expense -- is the cost of our production capacity.

"That gives you the breakeven number of closings, and the breakeven Revenue. Equally-important -- since we cannot generate all of our closings and all of our revenue at once -- is the breakeven rate.

"In terms of the scenarios we have been discussing, breakeven in our worst case scenario occurs at around 190 closings, which is at about $46 million in Revenue. That is because we are trying to absorb the same amount of overhead with smaller Gross Margins. It requires more closings, which can become a vicious cycle, with a lot of margin pressure. Anyway, in the worst case scenario, the point at which we fully absorb our overhead occurs at a rate of about 16 closings per month. Of course, we have the production capacity to start and close 25 houses a month."

The CFO filled in the missing data for the last two columns.

2008 BASE BUDGET
CLOSINGS = 200
REVENUE = $50,000,000
AVG. SP = $250,000
GROSS MARGIN = 22%
BREAKEVEN = 155 UNITS
BREAKEVEN REVENUE = $39,000,000

2008 TARGET BUDGET
CLOSINGS = 250
REVENUE = $60,000,000
AVG. SP = $240,000
GROSS MARGIN = 21%
BREAKEVEN = 170 UNITS
BREAKEVEN REVENUE = $40,500,000

2008 WORST-CASE
CLOSINGS = 140-150
REVENUE = $34,500,000
AVG. SP = $240,000
GROSS MARGIN = 18-19%
BREAKEVEN = 190
BREAKEVEN REVENUE = $46,000,000

2008 FULL CAPACITY UTILIZATION
CLOSINGS = 300
REVENUE = $69,000,000
AVG. SP = $230,000
GROSS MARGIN = 15%
BREAKEVEN = 246
BREAKEVEN REVENUE = $56,600,000

"Obviously, at only 140 to 150 closings -- 12 closings per month -- and $34.5 million in Revenue, we would be below the breakeven point in both closings and Revenue, which means we would be losing money.

"But, if we can somehow find a way to more fully-utilize our production capacity -- which we will pay to have anyway, unless we cut our overhead -- and somehow find a way to close more homes, albeit at considerably lower margins, we would breakeven at 246 closings and $56.6 million in Revenue. That occurs at 20-21 closings a month, a rate also well below the 25 closings-per-month we have the capacity to produce.

"And, while we are talking about breakeven rates, I hope it reinforces the importance of even-flow production", said the intrepid, results-based consultant, looking at the VP of Construction and VP of Sales. "We cannot be all over the map each month with sales, starts, and closings, and with WIP."

"Is there any kind of housing market in which demand does not respond to lower sales prices?", asked a sales representative. "What happens if we reduce the sales price -- give more concessions, endure lower margins -- and there are insufficient sales? Is there a limit to how far we can drop prices? In other words, what happens if we build it, we drop the ticket prices, and they still do not come?"

"There is always that possibility", said the VP of Sales. "But -- we still have to price to the market. That is not in our control. To the extent that we extract value, with better margins as the outcome, we do have some control. On the other hand, from what I am hearing, the gains from higher productivity are permanent, and the speed/velocity that enables those gains is something we can always control."

The intrepid, results-based consultant turned to the sales representative. "To answer your question, if the situation gets bad enough, higher productivity becomes moot", she said. "RB Builders would have excess -- and probably unusable -- capacity. In that case, higher productivity might not seem as urgent, or as attractive.

"If we cannot make some combination of higher margin and higher velocity work for us, we might have to take RB Builders out of gear, and glide to some sort of safe landing. A controlled crash would be a better description. Like Apollo 13. Forget the moon, just get the Odyssey and her crew home."

"Perhaps", said the CEO. "But, I am determined that we come out of this situation with a level of sustainable competitive separation. I refuse to accept the sacrifice of having endured this much pain without having something to show for it. Higher productivity might not seem as urgent, right now, but it will someday. I want RB Builders to emerge a much faster and more agile homebuilding company.

"Forget "industry best practices". We need to do better than that, because we would be foolish to believe that our competition will forever come from who it comes from now. Someday, the homebuilding industry is going to change, and that change will as likely come from without, as from within."

"Ex Disastrium, Scientia", said the intrepid, results-based consultant, smiling at her adaptation of NASA trivia.

"Learn from adversity, learn from failure, learn from mistakes.

"But -- own the outcome."

Part IV: "Faced with the prospect of both fewer sales and lower margins"

noreply@blogger.com (Fletcher L. Groves III) — Tue, 06 Jul 2010 15:09:00 +0000

(Note: "The Pipeline" was written in mid-2007. The fact that it survived the past three years with its relevance intact is, you could argue, mere fortuitous insight, but it is also a testament to the immutable principles of production that it illuminates.)

"Rather than ask where your heads disappeared to, let me just say that what you just described is not the reality with which we are dealing", said the VP of Sales. "This coming year -- 2008 -- is going to be a challenge. So, what happens when we are faced with the prospect of both fewer sales and lower margins? What happens when the market is not going to allow us to use -- to economically leverage, as you like to put it -- all of this new-found production capacity?

"I agree that productivity and Throughput-killing variation is the problem when we are faced with an internal constraint, when we are faced with being our own worst enemy. Under those circumstances, "Max-T" is the right approach.

"But, what happens when we are faced with an external constraint?"

"Give us some idea of what you are talking about", said the intrepid, results-based consultant. "Demand is elastic. How many sales, at what margin?"

"The numbers in the GI Baseline and GI Target are a couple of months old", the VP of Sales replied. "They already reflect the expectation of a deteriorating market. We still might be able to achieve those numbers, but, since then, the market has deteriorated even further. It is precipitous. We are looking at the very real possibility of both fewer homebuyers and lower margins."

"How few and how low?", asked a sales representative.

"During 2007, we closed 200 homes, but we only sold 180 homes", the VP of Sales said. "Not exactly the protective backlog of sales that we want. So, we were already seeing the pressure in the market. Our Revenue was $50 million, our average selling price was $250,000, and our Gross Income Margin was 22%. We kept those numbers in the baseline for 2008. However, the 2008 target is $60 million in Revenue, produced on 250 closings, with an average sales price of $240,000, and a Gross Income Margin of 21%. The higher productivity, higher utilization -- whatever you want to call it -- actually gives us more Gross Income in 2008 than we earned in 2007.

"However, now we are thinking maybe only 140 to 150 sales. We think that the average sales price will still be $240,000, but there will be more concessions. More concessions will result in lower margins, somewhere between 18% and 19%. If that scenario happens, we are looking at Revenue of $34.5 million, and Gross Income of $6.5 million.

"In case you missed it, our indirect, non-variable cost is budgeted at $8.5 million.

"That is an operating loss of $2 million, and, frankly, we do not know where the bottom of this recession is. It could get much worse."

"Nevertheless, we need to talk about what we know now. What would you do?", the intrepid, results-based consultant asked the VP of Sales. Glancing toward the CEO, silently with her eyes, she said, "Just let him answer."

"We cannot afford to lose money. But -- I cannot look at the people in this room, and suggest that we fire people whom we have developed and whom we care about, either", said the VP of Sales. "Certainly not as our first resort.

"The market may not turn out to be this bad, but here is what I would do:

"The current job schedule says that we should be able to build our houses in an average of 120 days, and we have been given 100 units of work-in-process to produce as many closings as we can", he said. "That calculates to 300 closings. Despite the challenges of the market, we need to find a way to get those 300 closings.

"Let me qualify part of that statement. The closings are important, but we need to produce as much Gross Income as we can, because that is all we get to keep from whatever Revenue we generate from those 300 closings.

"From a production standpoint, someone else will need to figure out how to beat 60 days out of the current cycle time. From a sales and marketing standpoint, to sell 300 homes, I believe we will need to drop our prices to an average of $230,000. I know, I know. It is a difficult decision. It is $10,000 below the target, and $20,000 below the baseline.

"Our margins would suffer, dropping to 15%, on average. We would need to become much more intuitive and instinctive in our adjustments, and learn to make decisions as fast and as frequently as necessary. We will have to fight for every sale. But -- even with the lower margins -- if we manage to sell, build, and close 300 homes, our Gross Income would be $10.4 million, produced on Revenue of $69 million. Our Net Income Margin would be less than 3%, but we would be profitable.

"Of course, like I said, it could get worse. Much worse.

"Could we find ways to extract more value, and therefore earn higher Gross Income Margins and generate additional Gross Income on every dollar of Revenue? I think so. Could we get our cycle times down to 90 days, and close 400 homes on the same amount of production capacity? Maybe. That is up to us. I am not sure that is what we would want to do right now. The resulting higher production would have even further implications on prices and margins.

"Still, I am starting to realize some things: First, higher velocity can overcome lower margins. Second, productivity gains are permanent."

"In 2008, higher productivity is a case of survival. And -- it may not be enough, if things get a lot worse", said the intrepid, results-based consultant, writing as she spoke. "In the future, the ability to produce more -- more closings, more Revenue, more Gross Income -- on a finite and controlled amount of work-in-process and overhead will be one of the keys to sustainable competitive separation.

BREAKEVEN ANALYSIS

"This discussion raises a question", she said, pointing to the board. "From both a production standpoint and a financial standpoint, at what point does RB Builders breakeven?

"Knowing the answer to that question gives you more insight than you can imagine."

Part III: The Cost of Variation and Long Cycle Time

noreply@blogger.com (Fletcher L. Groves III) — Wed, 23 Jun 2010 17:45:00 +0000

(Excerpted from "The Pipeline")

"So -- how much do you think all of this variation is costing your company?", asked the intrepid, results-based consultant. "Let me ask it two different ways: How much is the lack of productivity costing you? How much is chronically-long cycle time costing you?

"Variation, productivity, cycle time. They are all connected."

"Our cycle time is 180 days, and we are doing it with 200 closings produced on 100 units of work-in-process", said the CFO. "Without getting into an explanation of statistics, we have about a 50% variation from the standard of 120 days and a 100% variation from the cycle time we instinctively believe we should be achieving, which is 90 days.

"As you have taught us, a system will protect itself from variation and uncertainty with some combination of longer cycle time, higher work-in-process, and excess/unused capacity. Our cycle time is very long, which translates into a large buffer. Our work-in-process is where we planned it to be, and only 25% higher than the lowest amount it could possibly be, which is 80 units at a cycle time of 120 days. So, I do not think this is a case of RB Builders having a buffer of additional work-in-process.

"Here is the kicker:

"If we honestly believe we can produce 300 closings with our current production capacity, then we have a huge buffer of excess/unused capacity, which calculates into an overall utilization rate of 67%. In essence, we waste one-third of our capacity. As you have pointed out, that is hardly the picture of high productivity. The inability to utilize our capacity translates into significantly fewer closings. We are paying for the capacity and the work-in-process to produce 300 closings, but we only closed 200 homes. That is a gap of 100 closings.

"In terms of what all of this is costing us, there is clearly a cost associated with excess work-in-process and unused production capacity", the CFO continued. "The additional, "beyond-necessary" work-in-process certainly makes us a bigger company than we need to be, and the excess/unused production capacity alone costs us over $2,800,000 a year.

"But -- I do not think it is about cost. I think it is about opportunity. Unless we opt for cost-cutting and reducing overhead -- a "same-for-less" proposition -- then, I would say that it is "costing" us the opportunity of all the Gross Income on those 100 closings we missed in 2007. Our Gross Income Margin was 22%. We had $50 million in Revenue. If you divide that by the 200 closings that we achieved, the average sales price was $250,000. From there on out, the math is pretty simple."

The CFO walked up to the erasable board, and wrote:

$250,000 X 22% X 100 = $5,500,000

"We gave up $5,500,000 in Gross Income."

The conference room was completely silent. Everyone was aware of the Gross Income Baseline, Target, and Reserve, and the impact an additional $5,500,000 would have on the payout of Gross Income Milestones under the new results-based performance compensation plan RB Builders had just enacted.

The silence was broken by the words of the CEO.

"No. That calculation does not even scratch the surface", he said. "What is the real cost?"

He walked to the front of the conference room.

"If all that this excessive variation, lack of productivity, and longer-than-necessary cycle time cost us was $5,500,000 in Gross Income, that would be bad enough", bristled the CEO. "But -- this is also $5,500,000 that would have dropped straight to our bottom-line, in the form of additional Net Income.

"In terms of the cost of our production capacity, utilizing it would have cost us nothing -- zip, nada, zero. It is non-variable cost. It is overhead. We already paid for it.

"I am not finished with this issue."

The CEO turned to the erasable board, picked up a marker, and added two more rows to the data table:

2005:
WIP = 100
CLOSINGS = 225
CYCLE TIME = 160

2007:
WIP = 100
CLOSINGS = 200
CYCLE TIME = 180

2008:
WIP = 100
CLOSINGS = 240
CYCLE TIME = 150

WIP = 80
CLOSINGS = 240
CYCLE TIME = 120

WIP = 100
CLOSINGS = 300
CYCLE TIME = 120

WIP = ?
CLOSINGS = ?
CYCLE TIME = 90

WIP = ?
CLOSINGS = ?
CYCLE TIME = 90

Turning and nodding at the data table on the board, he asked, "Forget the 180 day cycle time we have now. What do you think RB Builders would look like at a cycle time of 90 days, instead of the 120 days specified under our job schedules?

"It is a rhetorical question. For all of about five more seconds."

The CEO made a quick calculation and filled in the Closing and WIP data that was missing from the table.

WIP = 60
CLOSINGS = 240
CYCLE TIME = 90

WIP = 100
CLOSINGS = 400
CYCLE TIME = 90

"We could go with virtually any combination -- any strategy or tactic -- of higher Throughput and lower work-in-process to achieve a 90 day average cycle time, but say that we elect to go with a tactic of "Max-T", a tactic of generating maximum Throughput with a planned, finite, and controlled level of work-in-process. Forget 200 closings on WIP of 100 units, which would be the current cycle time of 180 days. Forget 300 closings on WIP of 100 units, which would be the cycle time specified in our construction schedules. What about 90 days? Although it is a valid option, set aside the idea of making RB Builders a smaller company -- 240 closings, but reducing WIP to only 60 units. Focus on Max-T. What about 400 closings on WIP of 100 units?

"What happens?"

The CFO handled the question. "Well, if our Gross Income Margin remains the same -- which it likely would not, because of price elasticity of supply and demand -- then we would generate an additional $11 million in Gross Income, every penny of which, as you point out, drops straight to our bottom-line in the form of additional Net Income.

"Which means that our unwillingness -- or our inability -- to do anything about the current level of variation that drives our long cycle times is costing RB Builders as much as $11 million in Net Income every year. That is a lot of money."

"Yeah", said the CEO. "Even for a company that would then have $100 million in Revenue. I want everyone to be clear. Our 2008 baseline is $50 million in Revenue, from which we expect to produce $11 million in Gross income and $2,500,000 in Net Income. Our 2008 target is $60 million, producing $12.5 million in Gross Income and $3.4 million in Net Income. As all of you realize, all of our very-considerable bonuses are tied to the Gross Income Reserve that represents the difference between the baseline and the target.

"By appearance, this kind of performance would be over-the-top. But -- if we pull it off -- it means that instead of progressively splitting a GI Reserve of $1,500,000 three-ways between our owners, Retained Earnings, and all of us, dropping our cycle time from 180 days to 90 days means we get to split a GI Reserve of $12.5 million.

"And -- you know what?

"Despite the fact that its Revenue had doubled, RB Builders would be the same size company. It would have the same amount of WIP, the same overhead, the same working capital requirement, the same level of debt."

The Intrepid, Results-Based Consultant says "I Do"

noreply@blogger.com (Fletcher L. Groves III) — Wed, 16 Jun 2010 21:32:00 +0000

The intrepid, results-based consultant gazed lazily at the white sand and the water beyond, and thought, it would definitely take a lot of this to kill you. She sighed contentedly, recalling the last 72 hours.

The planning had been thoroughly intense. Or, perhaps it had just been intensely thorough, she wasn't sure. Whatever. Her wedding had come together just the way she had dreamed. The June weather in Northeast Florida had cooperated, for the most part. The boys had enjoyed the ritual marriage event known as Wedding Party Golf. The rehearsal had been fun. The flowers had miraculously come together. The church was beautiful. The service was reverent, and rich with meaning and promise. The music was awesome. There had been tears of laughter, tears of sentiment, and tears of complete joy. The reception had been perfect. Bob Cummings and the Reflections were everything they were expected to be.

Her sister had been a flawless Maid of Honor. Her Mom had been the model of composure, beauty, and grace. Her new in-laws had been the picture of gracious acceptance and support.

Her Dad had defied all odds, by managing to hold himself together.

The intrepid, results-based consultant was undone by all that her marriage represented. Two families joined together. Life-long friendships, some of forty-plus years, honored. Four generations of fraternity brothers, groomsmen, sorority sisters, bridesmaids, friends, and extended members of both families who had traveled thousands of miles, just to be there. A cloud of witnesses that stood -- and would continue to stand, collectively and individually -- with them, by them, and for them, for the rest of their lives. There was the pang of absence for those who had gone before; the ones they always loved, still missed, and would never forgot, but whom they would one day joyfully see again.

It was the promise, challenge, and adventure of a life to be built, and a lifetime to be spent, together. Permanently. Inseparably.

For sure, there would be good times and bad times in the years to come. There would be easy times and hard times. There would be gains and losses. There would be joy and sorrow. There would laughter and tears. There would be planning; there would be spontaneous-ness. There would be children. There would be careers and career changes. There would be changes in priorities and focus. There would be memories made. There would be legacies formed.

There would be times when they knew each other's thoughts; there would be times when they did not think they were from the same planet.

There would be mistakes. There would be grace. There would be forgiveness offered, and forgiveness accepted.

And, through it all, there would be love, honor, and respect.

The intrepid, results-based consultant turned her head to the side, pushed her sunglasses to the end of her nose, and looked at the handsome young man reclined on the beach beside her.

She smiled, and thought to herself, "My Dad would think this is "utterly cool"".

And, she would be utterly right.

Part II: "Quite the Poster Child for Your Lack of Productivity"

noreply@blogger.com (Fletcher L. Groves III) — Thu, 03 Jun 2010 16:03:00 +0000

(Inspired and excerpted from "The Pipeline")

One of the sales representatives looked at the superintendent, and just laughed. "Which one of the Productionally-Transmitted Diseases would you like to have? PTD, she owns you."

The intrepid, results-based consultant smiled politely. "In a previous session", she said, "someone said RB Builders closed 200 homes in 2007, on an average work-in-process of 100 houses, which is also the baseline for 2008. But, everyone also agreed that the system should be capable of producing 240 closings on 100 units of work-in-process. Later, someone else mentioned that the building schedules averaged 120 days."

Moving to the erasable board, she wrote the following data in a table:

2005:
WIP = 100
CLOSINGS = 225
CYCLE TIME = ?

2007:
WIP = 100
CLOSINGS = 200
CYCLE TIME = ?

2008:
WIP = 100
CLOSINGS = 240
CYCLE TIME = ?

"Someone calculate RB Builders' cycle time", she said. "How many days?"

After a minute, the sales representatives looked up from her calculator, and said, "If I am doing this right, I calculate that, in 2005, our cycle time was 160 days. In 2007, it was 180 days. And, for 2008, we are targeting 150 days."

The intrepid, results-based consultant completed the cycle time column with the calculated cycle times, but added two more rows with identical values.

2005:
WIP = 100
CLOSINGS = 225
CYCLE TIME = 160

2007:
WIP = 100
CLOSINGS = 200
CYCLE TIME = 180

2008:
WIP = 100
CLOSINGS = 240
CYCLE TIME = 150

WIP = ?
CLOSINGS = ?
CYCLE TIME = 120

WIP = ?
CLOSINGS = ?
CYCLE TIME = 120

"Okay", she said. "Tell me what your production system looks like with a cycle time of 120 days."

"There are two ways to look at it", said the superintendent. "We could be closing 240 homes with 80 units of work-in-process. Or -- we could be closing 300 homes with 100 units of work-in-process."

The intrepid, results-based consultant added the new calculations.

2005:
WIP = 100
CLOSINGS = 225
CYCLE TIME = 160

2007:
WIP = 100
CLOSINGS = 200
CYCLE TIME = 180

2008:
WIP = 100
CLOSINGS = 240
CYCLE TIME = 150

WIP = 80
CLOSINGS = 240
CYCLE TIME = 120

WIP = 100
CLOSINGS = 300
CYCLE TIME = 120

"Remember the earlier discussions on margin and velocity?", she asked. "This is where that thinking works. There are two ways RB Builders can increase the amount of Throughput -- the amount of Gross Income -- it generates. Margin is how much money we make on every home we close, and velocity is about how many homes we can build and close in a period."

On the erasable board, she wrote:

MARGIN
VELOCITY

"Most of the time, there are improvement opportunities that permit us to attack margin and velocity simultaneously", she said. "Much like the DuPont formula shows when calculating economic return (Return on Assets), Gross Income is a composite of both margin and velocity. We want the best blend of margin and velocity. They do not often conflict, even though there are sometimes tradeoffs, and times when we might be better served focusing more on the one than the other.

"On occasion, we are forced to make a choice on where to focus, more when we are facing an external (market) constraint than when we are facing an internal (production) constraint. What's the difference? Where was the constraint in 2004-2005? The constraint was in your production system. It was an internal constraint.

"The velocity part of the choice decision lies in how well RB Builders is utilizing its true production capacity", said the intrepid, results-based consultant. "The margin part is determined by the condition of the housing market, and whether that market is going to allow us to use -- to economically leverage -- that capacity. We can control truly-variable direct costs, and we can extract more value, but -- at the end of the day -- the market dictates the price you get for a house.

"And, a lot of people are thinking 2008 might be that kind of year -- imagine -- barely a year removed from the recent, final, halcyon days of the "Age of Homebuilder Entitlement"", she said.

"The point is, we have to learn to manage this relationship. We have to find the best blend of margin and velocity, the composite that generates the greatest amount of Throughput. We have to generate the greatest amount of Gross Income that we can, given the reality of our playing field, given the parameters imposed by the market."

2005:
WIP = 100
CLOSINGS = 225
CYCLE TIME = 160

2007:
WIP = 100
CLOSINGS = 200
CYCLE TIME = 180

2008:
WIP = 100
CLOSINGS = 240
CYCLE TIME = 150

WIP = 80
CLOSINGS = 240
CYCLE TIME = 120

WIP = 100
CLOSINGS = 300
CYCLE TIME = 120

"Back to the issue of variation and uncertainty", she said, gesturing towards the data table, and then looking toward the VP of Construction. "Earlier, you noted a widely-accepted sense that RB Builders should be capable of building every house in less than 90 days.

"Not 180 days, not 150 days, not 120 days", she said, pointing to each number.

"In 90 days."

She wrote the following questions on the board:

WHERE IS VARIATION BEING BUFFERED?
WHAT DOES VARIATION COST?

"Variation is the deviation from the standard. Variation can be applied to duration. It can be applied to cycle time. The standard cycle time is 120 days, and some of you think it should be 90 days. However, it takes you anywhere between 150 to 180 days to build your houses. Quite a bit of deviation from the standard, I should say.

"Your cycle time is quite the poster child for your lack of productivity."

The intrepid, results-based consultant gazed intently around the room, and then asked, "Considering both your gut-instinct and your interpretation of the data in the table, exactly how and where do you think RB Builders' production system is buffering itself -- protecting itself -- from all of this variation and uncertainty?

"And -- how much do you think this variation is costing your company?"

Part I: Waste, Variation, and Other Productionally-Transmitted Diseases

noreply@blogger.com (Fletcher L. Groves III) — Mon, 24 May 2010 17:49:00 +0000

(Excerpted from "The Pipeline")

"In this session, we are just going to talk about how we better manage whatever it is that is preventing the system from producing more with what it has. First, I want to talk about variation and uncertainty", said the intrepid, results-based consultant.

"It was mentioned earlier that variation is a form of waste, because, to the extent that it does not add value, variation is wasteful. That thinking largely comes from the Toyota Production System and the Lean Production methodology that TPS later spawned. But -- Taiichi Ohno did not include variation as a form of waste (muda) in the TPS, opting instead to use the term for unevenness (mura), and associate it with the separate principle of stability; production processes need stability, and variation causes instability.

"Interestingly, in both Lean Production and the TPS, the principle of stability sits between the principle of waste and the principle of standardization, which includes the concept of standards, visual management, and problem-consciousness, which are linked to PDCA problem-solving.

"So, there is that distinction that would seem to differentiate variation from other forms of waste", she said.

"I think there is a reason Mr. Ohno chose to not place waste and variation in the same category. There is no possibility of having either zero waste or zero variation; the goal is to reduce waste and reduce variation, which is achievable. However, given their inherent characteristics, a desire to eliminate waste is more reasonable than a desire to eliminate variation."

Turning to the board, the intrepid, results-based consultant wrote:

DISTINCTIONS: WASTE V. VARIATION
PRODUCTION PHYSICS: LAW OF VARIABILITY BUFFERING

"Then -- beyond that distinction --there is the series of basic laws of production physics that directly or indirectly form our understanding of variation. Five laws, to be exact, but two in particular", she said. "The first law, called the Law of Variability, states that higher levels of variation degrade the performance of the production system.

"The second law, the Law of Variability Buffering, says that variation will always be buffered by some combination of inventory, capacity utilization, or time -- always through a combination of higher work-in-process, excess/unused capacity, or longer durations."

She wrote:

BUFFERS = PROTECTION
THREE WAYS:
1. HIGHER WIP
2. EXCESS/UNUSED CAPACITY
3. LONGER DURATION

"So", she continued, "If all RB Builders does is attack variation by attacking waste (in the form of errors, rework, etc), and it fails to directly attack the variation that causes instability, then it will have to live with a production system that protects itself with some combination -- buffers itself with some level -- of additional work-in-process, longer-than-necessary cycle times, or wasted capacity. Our production system will default to longer durations. Time is the self-determining buffer, the "buffer of last resort", so to speak. If we do nothing about variation, yet limit work-in-process and capacity, the result will be long cycle times. Guaranteed.

"Buffers -- high levels of work-in-process, long cycle times, and unused capacity -- allow the system to compensate for variation, but, regardless of the combination in which they occur, they all result in lost Throughput.

"And -- the true cost of variation is the financial throughput -- the Gross Income -- that RB Builders surrenders to that variation.

"Taken together, you begin to get a sense that variability is a very big deal", the intrepid, results-based consultant continued. "Jack Welch used to say, "Variation is evil." Some variation and uncertainty is natural, and some of it is necessary and planned. But, the instability that variation and uncertainty cause is a decidedly evil form of waste.

"In process religion, the gods of production will not be mocked", she said. "If all we ever do is attack variation by attacking waste, in the form of errors, rework, etc., and we fail to also directly attack the variation that causes instability, then we will have to live with a production system that protects itself with some combination of too much work-in-process, long cycle times, or reduced throughput."

"But -- isn't protection a good thing?", deadpanned a superintendent. "Shouldn't we be practicing safe production?"

"Yes, protection would be a good idea", responded the intrepid, results-based consultant, equally deadpan. "Especially for boys like you, who should be worried about contracting a PTD.

"Let's put it this way", she said. "Which one of the Productionally-Transmitted Diseases would you like to have? Exactly which combination of longer-than-necessary cycle times, higher-than-necessary levels of work-in-process, and lower-than-possible rates of throughput (because of excess and unused capacity) do you really want to contract? I hear they are all really painful.

"Some level of variation and uncertainty is natural, inevitable, and unavoidable", she said. "We have to buffer that. In addition, some variation is necessary, just to protect ourselves in the marketplace. For example, we don't offer only one floorplan and elevation. Lastly -- whenever we are protecting the output of the system from variation and uncertainty -- some level of protective capacity or buffering is needed.

"However -- protecting a system from variation comes at a cost, and to the extent that the variation that necessitates the buffering is unnecessary, avoidable, excessive, or uncontrollable, it is a very bad thing."

"Get busy living, or get busy dying"

noreply@blogger.com (Fletcher L. Groves III) — Mon, 19 Apr 2010 03:15:00 +0000

"I guess it comes down to a simple choice. Get busy living. Or, get busy dying."

If his only object was to exist, or to survive, I imagine that Andy Dufresne would have become like everyone else in Shawshank, and settled for whatever business-as-usual constitutes in that setting. As it was, it took him twenty years to dig out of prison for a crime he did not commit, but Andy Dufresne did not choose to merely exist.

Get busy living, or get busy dying.

My dad once told me, "Son, you see life the way you wish it was". I told him, "No, you taught me to see life the way I choose to make it".

This is the fourth year of this housing recession, one that has surprised even us veterans of many housing recessions with its depth, its duration, and a complexity born of excessive intervention into markets and monetary/fiscal policy. Maybe it will be the last year. Maybe not. Either way, as distracting and difficult a time as right now is, and regardless of how robust or tepid the eventual recovery turns out to be, it is time for builders to decide how they will choose to make the world of homebuilding when this is finally over.

If you think this recession has been a test of survival, wait until you see the recovery.

Ten years ago, I wrote an article for Professional Builder, titled "The Road That Lies Ahead". It was one of a series of articles on the findings of Reference Point, our periodic survey of senior executives regarding management practices in the homebuilding industry.

In part, I said this:

"LIFE ON THE SERENGHETI: It seems obvious to us that the demand for housing in the next five to seven years cannot support the aggregate level of anticipated growth if three-fourths of these builders aim to significantly increase the size of their current operations, even if we factor in a continuation of the current level of acquisition and merger activity and reason that our group of builders might be a particularly aggressive strain.

"On the other hand, we do not see any reason to doubt their intent. A couple of scenarios come to mind. One possibility is that some of the demand is transferred by acquisition or merger, but, beyond that, everyone settles for less growth than they would like -- too many lions, not enough zebras, everyone still hungry, but no one starving.

"The other possibility is that some of these builders might actually develop (or acquire) the capabilities that will allow them to redefine operating and financial performance as we know it. In that case, the current level of industry consolidation begins to pale -- and we will be looking at a group of bigger, stronger, faster lions, capable of eating zebras to their hearts' content . . . "

". . . There is a clear and simple message in all of this: The road ahead is difficult and uncertain, but there is opportunity along with the danger. Do not be complacent. Do not follow the crowd. Do not waste your time and effort on things that do not create value."

Fast-forward, from 2000 to 2010. The only effect this recession has had on those plans is to temporarily suspend them. Those plans will not go away, unless homebuilding itself goes away. In light of that, how will you choose to make your world? How will you create a sustainable way forward in this industry?

Builders have choices about how they move forward from this debacle, but not all of the choices available to them meet the criteria of being sustainable. From the standpoint of what constitutes sustainable competitiveness, I do not think business-as-usual is going to cut it any longer. I do not think settling for being different-but-no-better-no-better-but-no-worse than the competition is going to cut it any longer. I do not think that settling for the adoption of "industry best practices", is going to cut it any longer, either.

There is, after all, such a thing as the tyranny of averageness. At the end of the day, average is still just that. Average. No matter how you cut it, even if it is occurring on a higher plain. The question is this: Does the world really need any average homebuilding companies?

Get busy living, or get busy dying.

In good times, the mental model that has sustained the homebuilding industry has been what you would call "More-for-More": More revenue, more income, along with more of everything else -- more capacity, more investment (land, models, work-in-process), more cash. In challenging times, the mental model defaults to "Less-for-Less": Less revenue, less income, as a result of less overhead, less capacity, a slower burn rate on cash, and (maybe) less investment.

A more-for-more proposition is always about size and growth; a less-for-less proposition is always about cutting costs.

Those are the mental models of business-as-usual.

Neither of these approaches are sufficient to create the type of sustainable competitive separation that will be required going forward. That is because, neither of these approaches has anything to do with the velocity side of economic return, or has anything to do with higher productivity. The mental models of business-as-usual have everything to do with size, cost-cutting, and competing on the margin side of economic return.

The way to create true, sustainable competitive separation is by doing the difficult work on the velocity side of ROA. This is a different mental model. Call it "More-for-Less", or "More-with-Less": More revenue, more income, more throughput, with less inventory, less overhead, a zero required level of working capital.

"More-for-Less". The vast majority of homebuilding enterprises will not let their shadows darken that doorway. It is too hard, it requires too much discipline. Most builders would prefer to compete on the margin side of ROA, partly because it is easier, and partly because it just fits the deal-driven, product-at-the-cost-of-process mentality of the industry. Some builders are better at the margin game than others, but almost any builder finds that it is easier to compete on the margin side of ROA.

Case in point. Lean Homebuilding. Visionary homebuilding companies, in search of the right improvement religion, attempt to adapt the principles of TPS and Lean Thinking to the specific requirements faced by the residential construction industry. Fine, as far as it goes; it needed to happen. Unfortunately, they tend to use Lean only to solve quality problems and eliminate the waste caused by defects. Lean benefits margin, but its focus eschews productivity.

If a homebuilding enterprise will not go after higher productivity -- if it will not tackle the velocity side of Return on Assets -- it is left with only the margin side of ROA, left only with higher margins as a way to carve out sustainable competitive advantage. Left with the same approach as virtually every other homebuilder.

Yes. Margins are important. Yes, value needs to be extracted from direct, variable costs wherever possible, with better houses (better designs, better quality, lower costs, fewer defects), more desirable and affordable communities, and -- somewhere along the way -- a better homebuyer experience and a business-sensible environmental approach.

But, margin is table stakes. It is the easiest of the conditions that are necessary to generate the type of economic return that creates sustainable competitive separation. Margin is too easy to replicate, the advantage in it is too easy to overcome. Margin is fleeting.

Margins are necessary, but they are not sufficient.

There is more to the equation for measuring economic return than simply maximizing how much money a building company can make on each house it builds; Return on Assets is also a function of how many homes can be built for the investment a builder makes in its production capacity, every operating period, in order to build homes.

Return on Sales x Asset Turn . . . Margin x Velocity.

Call it what you want, but the cost of production capacity is all the money a builder spends each and every year in indirect, non-variable cost. Money that will be spent, regardless of the throughput that it generates, and much of which will be wasted. Wasted as a result of unstable schedules with hidden safety in every task, wasted as a result of too much inventory, wasted as a result of uneven sales, starts, and closings, and wasted as a result of the failure to manage a homebuilding company for what it truly is -- the management of a portfolio of projects with dependent and shared, limited outside resources.

Not convinced? Try to calculate a breakeven point from margin alone.

The offered mandate is higher productivity. The offered mandate is to find ways to do more for less, to do more with less. The offered mandate is to exploit the velocity side of ROA. The offered mandate is to eliminate the need for working capital to support building operations.

Particularly relevant if you are not a big public builder, for whom better access to cash and financing is supposedly such an overwhelming competitive advantage. Like any homebuilder, the publics will readily go after the margin side of ROA. However, with margin as table stakes, velocity becomes the antidote, what you do if you are a privately-held builder, what you do if you are not positioned for cash and financing like a publicly-held builder.

As I have said on earlier occasions, elsewhere in this column, access to cash and financing only creates financial capacity, it does not create production capacity that gets utilized or make the publicly-capitalized builders that have better access to it more productive. Unable, or unwilling, to compete on the velocity side of ROA, creating competitive separation for a public builder is reduced to geographic expansion, a quest for market share, and competing on margin. And, using their advantage of cash and better access to financing.

Because that is all they have.

And, unfortunately, that will be enough, if smaller, privately-held builders choose to compete head-to-head with larger, publicly-held builders on those terms.

I guess it comes down to a simple choice. Get busy living, or get busy dying.

"Risen"

noreply@blogger.com (Fletcher L. Groves III) — Mon, 29 Mar 2010 19:34:00 +0000

The intrepid, results-based consultant reclined into the sand, at the back edge of one of the dry eddy pools, where the beach resumed its slope more steeply upward, toward the dunes. She dug her bare feet into still-wet sand, and felt the remnant of last night's high tide through her jeans and shirt. It felt good, she thought, as she rested her arms on her knees, gazed eastward, and studied the movement of sea and sky. She smiled, as she felt the morning sun, now 20 degrees above the horizon, as it warmed her face, on what was still a chilly morning, even though it was the beginning of April.

She was comfortable in her element. A native Floridian, she loved the waters of her home state, although, she wished she could have seen for herself the Cracker Florida her dad liked to tell her about, the Florida of his youth, as he would describe it, before air conditioning, before hordes of people, certainly long before interstates and theme parks.

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

Her thoughts went back to the very first Easter morning, to what the disillusioned friends and followers of the one they called Jesus of Nazareth must have been thinking, as they hid in fear. As far as they knew, this man of so much promise, in whom they had placed so much hope, was dead. They had seen his death with their own eyes. There was no question about it. Roman crucifixions did not leave much to the imagination.

Then, her thoughts moved to a time, not far removed from the darkness of the days immediately following the death of Jesus, as Peter publicly asserted that he and the other followers were also the eyewitnesses to His resurrection, and that, far from abandoning their faith in fear for their own lives and living in hopelessness, they were willing to live for the lives of others, and for the faith and the hope that His crucifixion, death and resurrection gave all of them.

So it has been, that decision, she thought, for every Christian, ever since. So it was for her.

She smiled again, and then whispered.

"Risen".

The Death of Private Homebuilders?

noreply@blogger.com (Fletcher L. Groves III) — Tue, 02 Mar 2010 18:49:00 +0000

John McManus (www.housingcrisis.com) is always an interesting and worthwhile read, particularly his two most recent entries (PRIVATE HOMEBUILDERS MOMENT OF TRUTH APPROACHES WITH 2ND HALF OF 2010 and ORLEANS HOMEBUILDERS FILES VOLUNTARY CHAPTER 11).

Orleans Homebuilders, of course, is a publicly-held company.

One of John's points: "Private home builders are in a fix because most of them depend heavily on banks, and banks are in a fix. The recent increase in the Fed Discount Rate doesn't mean a lot to most of us, but it certainly doesn't bode well for businesses that draw on bank capital with the intensity that home builders do. If it's more expensive for banks to borrow, it's going to be more expensive for their commercial customers to do so, one way or another, and it will be in shorter supply."

One can debate the ultimate winner of this seeming game of chicken between builders and their lenders (include the FDIC if you want to triangulate it). Perhaps survivor would be a better term. Or, maybe, it is just some financial version of the Circle of Life, in which new versions of builders and TARP-less banks emerge as new creatures, eerily traversing the post-apocalyptic landscape, past the skeletons of the previous Era of Homebuilder Entitlement.

Long, long ago, before I became a builder, before I became a consultant, I was a banker, more specifically, a commercial and real estate lender. I have long memories from being on the other side of the table, but my most vivid recollection, from the disaster that was playing out in 1982, was the observation/advice offered by my Dad, who was also a banker:

"Son, leverage is something that makes good times better and bad times worse".

The jury is maybe still out, maybe for awhile longer, but "out" is the operative term, the words of builders and lenders to each other echoing like the lyrics of an old Hall and Oates song: "You're out of touch. I'm out of time."

In mid-2009, I posted an entry to "Escape from Averageness", titled "Apocalypse Now: Is a Shattered Industry What it Takes?". It is archived. You can read it again. But, it bears repeating. Two of the points about our vision of this post-apocalyptic Fixed Residential Investment landscape were that it would be one in which builders achieve 6:1 Inventory Turns, and therefore, need negligible working capital for production operations, and one in which cash on the Balance Sheet is not the defining competitive advantage.

To which , I would add, it would be one in which builders do not even use debt financing for land and lots, let alone allow it on their Balance Sheet.

We shall see.

"The absence of business logic is simply astounding."

noreply@blogger.com (Fletcher L. Groves III) — Tue, 09 Feb 2010 16:49:00 +0000

The intrepid, results-based consultant shook her head, partly in amusement, partly in disbelief. "Just when you think they get it, they don't", she thought to herself. It was another reminder that, early on, RB Builders was still capable of coming to bewildering conclusions, the latest of which centered around the company's team-based performance compensation plan, known as the GIPP, acronym for the Gross Income Participation Pool.

The GIPP was an early prerequisite for the intrepid, results-based consultant even agreeing to become involved with RB Builders, that stipulation, along with a mandatory transition to variable costing, and the subordination of all improvement initiatives to a more focused, constraint-management approach.

The GIPP was new. It was supposed to replace the company's previous practice of paying individual bonuses based on multiple measures, and consisted of a team-based approach focused on performance related to a single business outcome, specifically, increases generated in Gross Income above a specific baseline.

Under the GIPP, the baseline performance was referred to as the Gross Income Baseline (GI Baseline), while the budgeted performance was dubbed the Gross Income Target (or GI Target). The difference between the GI Baseline and the GI Target was referred to as the Gross Income Reserve (GI Reserve). The GI Reserve was scheduled to be paid out progressively, based on the achievement of a number of predetermined "bonus buckets", called Gross Income Milestones. The aggregate teammate share of the GI Reserve represented one-third of the GI Reserve, while the remaining two-thirds was split evenly between owners and retained earnings.

But, now, the GIPP was getting push-back, ostensibly from one of the Regional Vice Presidents. In fact, he wanted to cancel it. It was too late in the planning schedule to start changing the GIPP, let alone cancel and replace it.

The intrepid, results-based consultant was having none of it.

"We have credit facilities that we have to restructure, repay, and replace. We need the cash", explained the Regional VP.

"Where did you get this idea?", she asked.

"It is the best approach to a situation that is growing more difficult by the day", he replied. "We cannot justify bonuses in this economy, in this housing market. We have nothing against bonuses in good times, but they are just not warranted now."

"So, you just want to cancel the GIPP? YOU CANNOT BE SERIOUS!"

"Nice McEnroe impersonation", said the CEO.

"Glad you liked it." The intrepid, results-based consultant turned her attention back to the Regional VP.

"You are concerned that your division will be unable to meet its debt service obligations, if it rewards performance above its baseline?", she asked, rhetorically. "Really? Where is the money going to come from?

"The GIPP will not pay out anything unless there is a reserve created by performance that exceeds the baseline. You do realize that the GIPP is designed to be completely self-funding, that it does not cost the division or RB Builders' owners one red cent?

"You do understand that, right?

"With limitations on investment and work-in-process, and with management controls on non-variable expenses", she continued, "is there any likely scenario under which additional Gross Income will result in less cash flow? Is there any likely scenario under which every cent of that additional Gross Income will not drop straight to the division bottom-line? Where it can be utilized for -- oh, I don't know, say -- debt service, or distributed to teammates and owners before it became retained earnings?

"I can understand being careful with important decisions in uncertain times.

"I can understand increased diligence in determining a baseline that reflects current reality. I can understand having a more progressive structure to the payouts, so that each successive milestone is worth more. I can understand adjusting the distribution of the reserve between teammates, owners, and retained earnings, to 25-25-50, or 30-30-40, instead of equal shares, in order to provide more money to meet extraordinary debt service requirements.

"But, to deny yourselves -- you, your teammates, your owners -- the opportunity to do better? That, I do not understand.

"The absence of business logic is simply astounding."

Principled Lean: Give Toyota Credit

noreply@blogger.com (Fletcher L. Groves III) — Wed, 27 Jan 2010 17:51:00 +0000

The remarkable decisions coming out of Toyota this week -- to stop selling most of its car models, to stop even producing most of its car models, until they solve the gas pedal problem -- are thought-provoking. Even for someone like me, who interprets Lean Production within a particular industry vertical, and judges Lean as less of a religion and more a part of the toolset homebuilding companies need.

Toyota could have -- and should have -- responded more quickly to this problem. Clearly. But, give them credit for walking the walk when they did respond. They stopped the line to fix the problem. They matched the rate of production to the self-imposed limitation on demand; if you are not going to sell cars, then you might as well not make them. They took a longer view than the next couple of quarters' earnings reports.

As I have said previously in this column, homebuilding is not automobile manufacturing.

Homebuilding production is project portfolio management, not continuous flow. Kaizen and PDCA pose limitations to solving anything but the simplest of problems. At best, Lean is only part of the solution for homebuilding companies. There are lots of areas where Toyota -- and Lean Production -- just get it wrong. In particular, Toyota produces to forecast, not direct demand, more the result of a flawed value stream than a flawed production system.

But, they understand how to solve problems with standards, they understand that inventory is an asset only on some balance sheet (and is a liability in every other sense), and they have the courage to make tough decisions and live their principles.

I wonder how many homebuilding companies would have done the same.

"God with us"

noreply@blogger.com (Fletcher L. Groves III) — Sat, 19 Dec 2009 20:41:00 +0000

The intrepid, results-based consultant wearily plopped into one of the chairs in the airport club of this week's carrier. Friday evening, she thought to herself, should make it home before the storm making its way through the mid-Atlantic cancelled her departure.

"Headed home?", the man in the chair beside her asked.

"Yes."

Last week of work this year. She was headed home for a well-deserved break with her family and friends. She was looking forward to it immensely.

Her mind turned away from work. She thought about the season. She wondered what Bethlehem must have been like, thought about the young mother and father with their new-born son, to everyone else, just another child born into the world, controlled and protected by the Roman Empire.

She considered the grace, love, and mercy of the Creator of the universe, the Author of all that was good. She thought about the words of Paul, buried deep in his first letter written to the small group of believers in Corinth, describing faith, hope, and love, the principles of the grace she pondered.

"Father", she said softly. "Thank you.

"Thank you for giving me a faith that looks back into history and trusts that the claims this child would one day make about Himself are true, and that every moment of time and event of history either points towards, or proceeds from, that truth.

"Thank you for giving me a hope that looks forward, and understands that one day, notwithstanding that I have eternal life right now, this world that I live in will end, that I will be transformed, that the pains of this world will end, and that I will live constantly and eternally in your presence.

"And, thank you for giving me a love that will sustain me, motivate me, and give me purpose and perspective, for as long as You choose to keep me on your earth."

The intrepid, results-based consultant thought about the events of that night, long ago. There was a birth. There would later be a death and a resurrection. But, right now, her thoughts were about newness and life.

"And you shall call his name Immanuel".

"God with us".

Three Ways to Measure the Pipeline

noreply@blogger.com (Fletcher L. Groves III) — Tue, 01 Dec 2009 21:10:00 +0000

Excerpted from "The Pipeline".

The intrepid, results-based consultant helps RB Builders understand how to measure its production system:

"We need to create a visual reference", said the intrepid, results-based consultant. "Whether we choose to call it an analogy, a concept, or a metaphor, the clearest picture -- the best visual image -- we can convey of the RB Builders production system is that of a pipeline.

"We live in a world of systems. A homebuilding company is not some loosely-connected set of independent, and unrelated, parts. It is not some collection of processes, departments, systems, resources, policies, and other isolated pieces of a whole. A homebuilding company is both a system, and a part of a larger system. It is a set of interdependent parts that must work together to accomplish a stated purpose.

"Viewed as a pipeline", she said, "production systems have neither unlimited capacity nor unlimited size. If you increase the level of work-in-process, the only way the system can hold the additional work is to lengthen the pipe. The diameter of the pipe is fixed. If we put more work-in-process in the pipe, it does not become a bigger, wider pipe. It just becomes a longer pipe. So, what is the length of the pipe?"

"The length of the pipe is the time it takes to build a home", replied the VP of Construction. "It is cycle time."

"That's right", she said. "Duration, or cycle time, is the measure of the length of the pipe. The longer the pipeline, the more time it takes to get from one end of it to the other. In fact, given the same amount of effort, the added friction and the increased number of corners resulting from the added length actually tends to reduce the output."

One of the superintendents raised his hand. "Okay. So, are you saying we need a bigger, wider pipe?"

The intrepid, results-based consultant quietly smiled. "Well, that depends", she replied. "Does your production pipeline have a cost?"

"Everything has a cost", said the VP of Construction, turning to the CFO. "Am I right?"

The CFO smiled wryly, nodded affirmatively, and replied, "Yes, everything has a cost."

"So -- what is the cost of your pipeline?", she asked.

"Well, we have never thought about it that way", the CFO responded. "I suppose the cost would be whatever we spend to have a pipeline in place. The nature of a production pipeline is that of a relatively fixed object, heavy and difficult to move. I would say that the cost of our pipeline is all of the non-variable cost we incur every year, to have the capacity to build homes."

"Yes", she replied. "The cost of the pipeline is what RB Builders pays every year, in the form of operating costs and resources, to have the use of it. You pay for the cost of the pipeline, whether you use it or not. That puts the cost of the pipeline squarely in the category of non-variable costs.

"In order to understand productivity and production capacity, you must first understand how costs behave in relation to Revenue, and, more importantly, how you manage those costs on the basis of that behavior.

"On the one hand, you want to control your direct, variable costs -- you want to reduce the cost. Really, though, what you want to do is extract maximum value from it. Value is the difference between the price you sell a house for, and what it cost you to deliver it.

"On the other hand, you want to leverage your indirect, non-variable costs. Those are the costs you expect to incur regardless of the Revenue you generate, and you want to produce as much output -- as much Revenue, as much Gross Income -- as you can from them.

"So, would a bigger, wider pipe cost more than your current pipe?"

Thinking for a moment, the CFO replied, "Yes, it would. There is a connection between the size of a pipe and its cost. There is also a connection between the size of a pipe and its capacity, but that is an issue of utilization. When we invest in a pipe, the cost of the pipe is related to its size.

"So -- yes -- a bigger, wider pipe would cost more than our current pipe."

"Wait a minute. I want to talk about utilization", said the VP of Construction. "Our production pipeline is usually full. Are you saying that we do not utilize our production capacity?"

"No. Well, maybe", said the CFO. "I do not know how effectively or efficiently we are using the capacity the pipe was designed to achieve. All I am saying is that there is a relationship between the size of the pipe we design or buy, and what it costs us. The price of the pipe is related to its size. It is up to us to utilize the investment, to use the capacity."

"There are three ways to measure the pipeline", said the intrepid, results-based consultant. "Its size is defined by the amount of work-in-process it is intended -- it is designed -- to carry. Its length is determined by its cycle time. Its capacity is defined as the rate of output -- the rate of throughput -- that a pipeline that size can produce, with a planned, finite, and controlled level of work-in-process."

Lean Homebuilding

noreply@blogger.com (Fletcher L. Groves III) — Thu, 29 Oct 2009 17:56:00 +0000

Excerpted from "The Pipeline".

The intrepid, results-based consultant helps RB Builders understand the benefits and limitations of Lean Production:

"This part is going to be production physics. It is going to seem very theoretical, and I am not even giving all of it to you. You are going to have to trust me and accept it as laws of physics. Not blindly. With an open mind. I need you to grasp the basic concepts, and just stick with me. I promise I will give you something concrete.

"But -- you simply cannot understand what we are doing in reality, unless you understand the concept.

"I apologize. That is the way it is."

"Do not apologize", said the CEO. "Just do it. We have trusted you in a lot of ways, and, so far, you have not let us down. We will do our best to keep up with you."

The intrepid, results-based consultant smiled, nodded appreciatively, and then continued. "From an overall enterprise standpoint, RB Builders has decided that it wants to embrace -- as strongly as possible -- the tenets of Lean Homebuilding, particularly when it comes to standardization of work, elimination of waste, visual management, kaizen, PDCA problem-solving, A-3 planning and policy deployment, and other areas.

"Culturally-speaking, RB Builders has decided that it wants to become a Lean Homebuilding enterprise, embodying the most useful and transferable elements of Lean Thinking. In the case of RB Builders, Lean Homebuilding's most beneficial contribution, to this point, is having embedded a process of continuous improvement.

"However -- Lean Production, even crafted as Lean Homebuilding, is not the total answer. By itself, Lean Production -- or Lean Homebuilding -- cannot get RB Builders to where it needs to go.

"As useful, beneficial, and vital as Lean Homebuilding has been in the area of continuous improvement, it has not been as effective in the area of production management, in the areas of what is generally known as "flow", at least, not straight out-of-the-box.

"Like every other worthwhile production method, Lean Production does not come from a homebuilding environment. That is a problem, because -- as a homebuilding company -- RB's production system has different parameters, faces different conditions, and imposes different requirements.

"We could discuss this for hours, but we do not have the time", she said. "Let me give you several quick examples to highlight the type of "Lean issue" we see in various areas of production.

"First of all, Lean Production places a heavy emphasis on what it terms "Just-in-Time" replenishment, or JIT -- the principle of producing only what is needed or ordered, leveling demand, leveling production, pull, continuous flow, etc.

"But -- how does that work in homebuilding?

"As the second example, consider production leveling, or heijunka. A typical Lean manufacturer levels production based on forecast orders, not actual customer orders. Some companies are better at making and adjusting forecasts than others, but, at best, it is a mix of "change-to-order" and "build-to-order". It is really "build-to-forecast". To the extent there is variation in the forecasts, they either have to carry a large inventory of finished goods, have to promise very long delivery dates, or have to live with a lot of excess, and unused, capacity.

"That would be the equivalent of RB Builders having to very accurately forecast the demand for every plan it offered in every community -- or -- live with some combination of an enormous inventory of completed homes, in addition to its required work-in-process), live with long delivery date promises, or live with a ton of unused production capacity.

"How in the world does something like that ever work in homebuilding?

"Finally", she said, "consider the challenge of achieving continuous flow with a totally outsourced labor force, in a fragmented value stream, with as many manufacturing facilities or production plants as we have communities. How would we make that work?

"Think about it."

"So -- are you saying that we should abandon our commitment to Lean Homebuilding?", asked the VP of Construction.

"No. That is not what she is saying", answered the CEO. "She is saying find a way to use the tools that work best for us, without regard to the religion or the denomination from which they came.

"She is saying, understand the playing field. She is saying, understand the parameters. She is saying, understand the world we live in.

"She is saying, do what works. She is saying, above all, get results."

"Ten Years After"

noreply@blogger.com (Fletcher L. Groves III) — Mon, 28 Sep 2009 19:37:00 +0000

In the Spring of 1998, building upon its many years of process improvement experience in other industries, SAI Consulting began to help homebuilding companies map -- to document, analyze, and improve -- their business processes. Ten Years After (with a slight nod to the Woodstock Generation), we thought it would be worthwhile to reach back across the spectrum of those clients, to offer insight from our observations of their experiences and how their efforts have fared.

A COMMITMENT TO PROCESSES: The difficulties, the sometimes indifferent results, and the "tailing-off" of continuous improvement and process maintenance efforts leads us to conclude that the clients who find themselves in that position were not committed to the role of processes as the primary mechanism for how they created value for customers.

In almost any other industry, the central role of processes is indisputable. We have long characterized the homebuilding industry as having a "deal-driven" mentality, a proclivity to non-standard, non-repetitive work, which it substitutes for process discipline. Owners and management would rather spend their time deploying assets than leveraging their non-variable expenses (and thereby, becoming more productive).

It is a contra-process management mentality that manifests its presence when, no matter how many times they have done a particular sequence of tasks, they act as if they have never done it before.

THE MEANS TO AN END, NOT THE END IN ITSELF: The clients who enjoyed the greatest success from their project, and from their effort, were the ones who understood that processes were simply a means to an end, just one of the tools at their disposal in the pursuit of improved operating performance and the resulting business outcomes.

Mapping their processes was universally an eye-opening experience for these clients, but it was not that fact that made the difference. It was what they did with what they saw. Yes, they removed non-value added activities and value-killing characteristics in their processes, and they made the remaining value-adding activities flow more smoothly. But, they also began to systematically solve core problems and remove limitations.

They went far beyond the processes that were their initial step.

LEADERSHIP AND COMMITMENT AT THE TOP: The successful projects had the buy-in and commitment from owners and senior management, in stark contrast to the unsuccessful projects, in which owners and senior managers were either indifferent, acquiescent, or hostile.

Invariably, the feedback on the unsuccessful projects received from the clients themselves, concluded that those projects were doomed from the outset by the attitudes and behavior of owners and management. It was not uncommon to learn that there were agendas that had little to do with better processes and continuous improvement. There was little appetite for -- or expectation of -- the change that would be necessary to achieve results.

In contrast, the most successful projects were resolutely lead by owners and managers who had a vision of what the work could accomplish and a determination to see that result achieved. These leaders and their teams also demonstrated a willingness and capability to make the changes that were necessary.

LEARNING AS AN OUTCOME: We have never had a homebuilding client that actually understood anything about processes, workflow, and process improvement going into the engagement. For the most successful and far-reaching projects, clients treated learning as an outcome.

For those clients, it was not enough to simply document, analyze, and redesign processes and workflow. In the most successful projects, clients took it upon themselves to learn about processes, production systems, and much more. In the less successful projects, clients learned little about anything.

ADAPTING THE SOLUTION TO THE CONTEXT: To the extent that clients entered their project with a preconceived notion of the direction of the solution that would come from mapping their processes, they often sacrificed a better, stronger set of improvements.

Homebuilding is not automobile manufacturing or healthcare. It has a unique set of requirements that exist within their own context and parameters. Solutions do not come in convenient, dehydrated packages, to which you add water. Blindly imposing solutions from different environments did not work. The most successful engagements crafted the solution (including the processes) to match the specific requirements of the homebuilding industry.

NOTE: The entire report, including the process mapping methodology used, the survey itself, an analysis of the survey responses, the problems and issues, and the recent advances, improvements, and solutions in process management, is available upon request.

The Velocity Side of Return on Assets

noreply@blogger.com (Fletcher L. Groves III) — Sat, 15 Aug 2009 17:21:00 +0000

In a recent weblog entry ("There's No Longer Room To Cut -- It Is Time To Start Growing"), Jamie Pirrello (Big Builder Contributing Editor) makes a number of points about the current reality faced by privately-capitalized builders. John McManus (Big Builder Editor in Chief) adds his comments on the Housing Crisis weblog.

Those points are, chiefly, that (1) builders have cut as much overhead as they can, (2) they need top line (revenue) growth, (3) in a period of lower demand, they must take market share from someone else, and (4) taking market share from someone else requires differentiation born of superior talent delivering superior value.

John concludes that the need to have the right product in the right price position in the right location with the right process and the right vendor structure, supported and sold by the right team is a tall order for privately-capitalized builders, particularly as a competitive strategy.

Undoubtedly. But -- is that a sufficient strategy?

In what currently passes as the housing market, builders may be more consumed with liquidity and cash flow, but the reason they are in business is not about survival. It is about economic return, which also takes into consideration profitability. The most widely-accepted measure of economic return (Return on Assets) is a function of both margin (Return on Sales) and velocity (Asset Turn). ROA is not just about how much a homebuilding company makes on each house it builds; it is also about how many houses it can build with what it spends every year for its production capacity.

The mental model of the homebuilding industry in good times is "More-for-More". More Revenue, more income, in exchange for more of everything else -- more capacity (non-variable cost), more investment (land, models, work-in-process), more cash. In challenging times, the mental model becomes "Less-for-Less" -- less Revenue, less income, as a result of less capacity, a slower burn rate, and (maybe) less investment. A more-for-more proposition is always about size and growth; a less-for-less proposition is always about cutting costs.

However, neither of these mental models (more-for-more; less-for-less) have anything to do with the velocity side of economic return, or have anything to do with higher productivity.

The mental model of higher productivity is "More-for-Less" -- more Revenue, more income, with less capacity and less investment. It seeks more-for-less, but it would settle for more-for-the-same. If a homebuilder does not go after higher productivity -- if it will not tackle the velocity side of Return on Assets -- it is left with only higher margins with which to carve out any sustainable competitive separation. Since the market determines the price, all that that builder can do is to try to increase the margin by extracting more value from his variable costs.

Builders do need to extract -- to create -- as much value as they can, with better designs, better quality, better pricing, fewer defects, better locations.

Higher margins are necessary, but they are not sufficient.

Builders need velocity. They need to turn their work-in-process faster, which will result in faster cycle times. They need to increase productivity.

And, what -- you ask -- is "productivity"? From any managerial standpoint -- operations, manufacturing, production, or otherwise; from any industry vertical standpoint -- auto manufacturing, homebuilding, or any other industry; from any enterprise standpoint -- Toyota, or anyone else; from any expert or business leader standpoint -- Drucker to Goldratt to Ohno, the conventional, accepted formula for calculating productivity is Revenue divided by Operating Expense.
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The only way a homebuilding company can lower its price breakeven point in a margin-constrained housing market is to leverage its capacity -- to increase the amount of Revenue it can generate with the same level of Operating Expense.

Skeptical about the application to the homebuilding industry? Join the crowd. The broad efforts to increase productivity and capacity utilization get scant attention when the perception is the homebuilding industry has excess capacity (another worthwhile topic that I will get around to someday).

For now, consider the following simple scenario:

Same local housing market, two builders in direct competition, each has the same dollar value of overhead, which they will spend regardless of how many houses they sell and build. Builder A has a cycle time of 150 days; Builder B has a cycle time of 90 days. Builder A turns his work-in-process 2.4x per year; Builder B turns his work-in-process 4.0x per year. Builder A can build 20 houses a month and breaks even at 19 houses a month. Builder B also breaks even at 19 houses, but can build 34 houses a month. Same margins, completely different Net Income scenarios, because every dollar of Gross Income above the breakeven point drops straight to both builders' bottom-line. But -- which builder can push it to the hard deck?

Because of its higher productivity, Builder B is in a much better position to compete on margin, an advantage that works in both good markets and bad markets. With 60% more Revenue, most would consider Builder B to be a much bigger homebuilding company. But, it is not. Builder B is the same size as Builder A, when the measure of size is capacity.

Productivity is a much more sustainable basis for creating competitive separation, because it is so much harder to achieve. There is always a risk in generalizing, but the homebuilding industry, as a whole, lacks the resolve and discipline to do the hard work required by more-for-less. And, that, ostensibly, is why the publics have the advantage over privately-capitalized builders. The publicly-capitalized builders have better access to cash and financing.

But, better access to cash and financing only creates financial capacity; it does not create production capacity. It does not make publicly-capitalized builders more productive. Arguably, the homebuilding industry owns no production capacity, because builders generally do not do any of the value-creating work; at best, they do value-enabling work. Unless it is a craft builder, a homebuilding company merely strip mines the value stream (selective, tactical vertical integration; yes -- another story).

And, so, it becomes a matter of geographic expansion, a quest for market share, and competing on margin, because that is all they have.

I do not believe the single family run-rate (as John puts it) will remain at a place-keeping 550,000 units; the demographics support much higher long-term demand. In some ways, a return to normal demand would be the worst movement that could happen, because, if it comes soon enough, it will allow a return to business-as-usual.

A Real Fish Story

noreply@blogger.com (Fletcher L. Groves III) — Sat, 25 Jul 2009 18:34:00 +0000

As a consultant, you become accustomed to common themes: same industry vertical; same problems; if you are particularly unimaginative or lazy, the same solutions. Occasionally, though, you get an opportunity to work on something different. Such was the case with an engagement with which we have been involved over the past 10 months. In it, is something homebuilders might want to consider.

Gro-Grouper, Inc. is a marine aquaculture business formed for the purpose of providing a fresh, high-quality marine finfish (Black Grouper) to upscale restaurants, fresh markets, and on-line retail customers, located anywhere within the United States. It aims to become the largest provider of this species in North America, and it will have the only production facility in the world that provides a renewable source of Black Grouper, raised in an environmentally-sound, ecologically-sustainable manner -- fish that are spawned, raised, and processed in its own recirculating marine aquaculture tank facility, and packaged and distributed through a dependable, on-demand, next-day replenishment system. It has a better product delivered through a vastly superior supply chain.

We helped to develop the business case and the resulting business plan. Just emerging from the planning stage, Gro-Grouper is now seeking its second round of capital to fund its pilot.

It is compelling; it is sustainable; it is green; by every indication, it will be enormously profitable; it is breathtaking in its innovation and approach; it is good for everything and everybody concerned; it exploits only the problem -- the crisis -- that created the opportunity.

In a single word, it is . . . cool.

The thought occurred to me. What would this type of project look like in the homebuilding industry?

Sadly, it would never happen. We would never see an idea this sweeping, this ambitious, emanating from homebuilding. We would be told to nibble around the edges, told to engineer incremental improvements that did not change anything about the underlying business model. We would be told that the goal is industry best practices, that being no-worse-but-no-better than everyone else will somehow create sustainable competitive separation.

The excuse would have been that homebuilding is different; the presumption would have been that nothing fundamental needs to change.

Well, homebuilding is different. It has its own requirements and parameters, and it cannot simply copy, for example, the Lean Production practices of the Toyota Production System. That, however, does not preclude change or tenure business-as-usual. And, as for change, I can only imagine how secure the French felt behind the Maginot Line.

I was talking with a homebuilding executive the other day. We were discussing new approaches to long-standing ways of doing business. He wondered whether it was worth the effort to fight for change. I told him that his company was not worth working for if it did not change, that the homebuilding industry was not worth working in if it did not change, and that he should at least ask himself why he was struggling for 10% Net Income Margins in the best of times, when he could be making 40% Net Income Margins growing fish.

Apocalypse Now: Is a Shattered Industry What It Takes?

noreply@blogger.com (Fletcher L. Groves III) — Wed, 24 Jun 2009 17:11:00 +0000

Everyone likes to talk about the "green shoots" that appear and disappear in the housing market and homebuilding industry, as the hopeful evidence for a return to business-as-usual. I think the worst Residential Fixed Investment disaster in three generations should count for more than a return to business-as-usual.

If we are going to pay this steep a price, why not just blow up the dysfunctional business model of production homebuilding?

It is a solution that has undoubtedly crossed the minds of every one of us who understand Lean Production and the Toyota Production System; those of us who understand constraint management and Critical Chain Project Management; those of us who understand Six Sigma and the effect of variation; those of us who understand production physics; those of us who stare across the chasm, and roll our eyes at everything we see.

Custom homebuilding is excluded. The building of one-off or highly-individualized homes could benefit from the selective use of the tools in the toolbox, but custom homebuilding is a separate, specialized value stream. It is a separate culture.

So, what is the vision of a post-apocalyptic home building industry?

To cite a few:

-- One in which the deal-driven mentality that pervades the industry is at least relegated to the land side of the business, and is replaced with a much more disciplined, process-centric approach to production home building.

-- One in which the constant question is: "Does this create value?" And, the decisions are based on the outcome.

-- One in which builders achieve 6:1 Inventory Turns, and the debate about build-to-order (presale) versus build-to-forecast (inventory or spec) becomes a moot point (Note: Toyota has not solved this one, either; they still build-to-forecast and swamp dealer lots with inventory).

-- One in which building companies need negligible working capital for production operations, and one in which cash on the Balance Sheet is not the defining competitive advantage of large, public homebuilding companies.

-- One in which homebuilding companies do not strip-mine the value stream by outsourcing 90% of the work, with all of the attendant duplication in overhead and difficulty in coordinating schedules and resources, and, instead, actually build the houses.

-- One which understands that a homebuilding company is first and foremost a project portfolio organization.

-- One in which geographic expansion and increased market share are not the only models for growth.

-- One in which the absurd cost approach used in the NAHB Chart of Accounts Income Statement is changed, so that builders can actually use the information that it provides to make decisions. You know, small decisions, like determining breakeven and the cost of production capacity.

-- One in which a preoccupation with "Industry Best Practices" is recognized as the self-limitation that it is.

-- One in which agility and speed counts for more than size. One in which a savvy, accountable, and motivated homebuilding team trumps an executive committee.

-- One in which the mental model is "More-for-Less", not "More-for-More" or "Less-for-Less".

Well, one can only hope.

The NAHB Chart of Accounts Income Statement: Comparative, Compliant . . . and Utterly Useless.

noreply@blogger.com (Fletcher L. Groves III) — Sun, 12 Apr 2009 05:54:00 +0000

Yes -- the NAHB Chart of Accounts permits comparisons with other builders. Yes -- the NAHB Chart of Accounts complies with GAAP reporting requirements. Yes -- the NAHB Chart of Accounts allows certain consultants to give the same presentation every year at IBS. However, to the extent that the NAHB Chart of Accounts presents its Income Statement as anything other than a true delineation of costs based on their behavior in regard to Revenue, it is utterly useless.

The NAHB COA Income Statement is useless because it prevents a builder from understanding how it makes money.

The ability to generate positive cash flow, make a profit, and produce a satisfactory economic return begins with an understanding of cost. An understanding of how costs are classified (or associated) according to structural hierarchy and cost objects, but most importantly, an understanding of how they are classified according to behavior.

Why does it matter how costs are classified? All of the costs of building a home and running a building company are accounted for in the calculation of residual Net Income. So -- what does it matter where they are incurred, what caused them to be incurred, or whether they move in relationship to anything?

And -- even if it does matter -- why start with costs?

It starts with an understanding of cost, because costs are the most operative part of a building company's Income Statement, and a deep, intuitive, and instinctive understanding for how costs are allocated and classified provides a basis of operational insight that cannot be acquired through any other means.

Understanding where costs are incurred and whether they are incurred directly or indirectly is marginally important, but the truly distinguishing characteristic of costs is how they behave. Operative question: Does the cost vary with the volume of an activity, or does it not?

Cost behavior is so distinctive, because it presents a building company with the truest picture of what its production capacity costs, where it achieves (and passes) breakeven, and how it analyzes changes in costs, production levels, and margins. Not only is it the truest picture, it is the only picture. It requires a variable costing approach to managerial accounting.

There is no more vital understanding to have -- in all of managerial accounting -- than an understanding of variable costing and the Contribution Income Statement format. This is true, regardless of how the financial statements of a building company are reported or presented. It is true, regardless of the quest for comparativeness to support the industry's fascination with meeting "industry best practices". It is true, regardless of the talking heads at IBS telling builders that all they need to do is to "stay between the lines".

At the core of the variable costing approach is the understanding that all costs are not created with the same attributes, and, therefore, cannot be managed the same way. There is a reason why builders need to differentiate between variable and non-variable costs.

Builders need to control direct, variable costs, the costs that are "above the line" on their Income Statement. They need to reduce the cost and/or extract maximum value from it. On the other hand -- and at the same time -- they need to leverage their indirect, non-variable costs, the costs that are "below the line". Those are costs builders expect to incur regardless of the Revenue the cost generates, and they want to produce as much output (Revenue, Gross Income) as they can, from having incurred the cost in the first place.

A building company has to control and extract value from its direct, variable costs, and it has to leverage its indirect, non-variable costs. That is how productivity increases. That is how production capacity is utilized as fully as possible.

A building company has to distinguish between variable and non-variable costs, in order to have a picture of breakeven, of the rate at which it absorbs overhead. If its Cost of Sales contains non-variable costs, and its overhead contains variable costs, that understanding is destroyed.

That is the problem with the NAHB COA Income Statement.

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.

The same argument could be made (albeit less strenuously) regarding Financing Costs, which the NAHB COA Income Statement also treats as an Operating Expense. Construction interest would only be a non-variable cost, if a builder had its construction line of credit fully-drawn every day of the accounting period, or if the LIP balance on the line of credit never varied. Are loan fees non-variable costs that do not fluctuate with volume? Clearly, they are not.

My advice? Report your financial condition and tax obligations as required. Mindlessly compare your building company with other building companies if you choose.

But, figure out how to manage costs.

Fast, Nimble, Adaptable

noreply@blogger.com (Fletcher L. Groves III) — Fri, 20 Mar 2009 01:53:00 +0000

I want to comment on recent posts on two other web logs. One of them is at housingcrisis.com and the other is Bill Lurz's Ear to the Ground web log on housingzone.com. In different ways, both posts speak to the dangers of averageness -- and the antidote to that averageness -- that "Escape from Averageness" addresses.

On the "Bottoms Fish" post (on housingcrisis.com), the point is made that "home sales volume may hit its low point this year . . . that point finally means that from a sector standpoint, some homebuilders will have reached their moment of opportunity. Access to cash and capital will have a lot to do with who is there to jump on the chance to thrive amid a wide landscape of distress -- lowest direct costs per square foot will be a building company's lever back into high volume business. Equally important . . . will be who will nail the right product for the moment . . . "

On the "Game Plan for the Future?" post (housingzone.com), Bill Lurz describes what he terms the "land-heavy, debt-light" land acquisition strategy of Pat Neal: "For a number of years, he has been buying land -- when he finds a good deal -- for cash, with his own money, then entitling it to the maximum density he can get. But he does not always build to that density. This strategy allows Neal to build to the market. Whatever product will sell best is what he builds."

Although secondary, certainly unintentional, and probably unnoticed, both cases validate the need for homebuilders to deliver extraordinary levels of distinctive value to a narrowly-defined segment of the homebuying market. They also both hint at the main attribute required to drive that kind of value: a fast, nimble, adaptable business operating model.

That type of value and that attribute simply does not emerge from a focus on "industry best practices".

The problem with best practices

noreply@blogger.com (Fletcher L. Groves III) — Mon, 02 Mar 2009 01:50:00 +0000

Virtually every consulting engagement that I have lead at SAI Consulting, has, in some way, dealt with processes. There is a reason. When you talk about an enterprise, whether it is a homebuilding company or a company in some other industry vertical, the most basic proposition of that enterprise -- the reason for its existence -- is the value that it creates for customers and other stakeholders. That value is created by the work that it performs, and that work has to be performed in processes.

Those processes exist -- they are present -- whether intentional or not.

From a process standpoint, during the course of conducting those engagements, we have seen almost everything and worked on most of it. Business Process Improvement (BPI), Business Process Management (BPM), Business Process Reengineering (BPR), all of the notation languages, process flowcharting, process modeling, value stream mapping, the new execution languages that accompany it, not to mention the TQM, Six Sigma, Lean, Lean Six Sigma, and Theory of Constraints methodologies that act upon it.

To process management, you can add project management. Different, yet complementary.

Given the essential nature of processes (not to mention project management), I am struck by the homebuilding industry's fascination with "industry best practices". Were it any other industry vertical, the argument could be made that industry best practices might be a worthwhile baseline (although a dangerous measure to settle for).

Homebuilding is different. The deal-driven mentality that permeates homebuilding, coupled with an unfathomable disregard for process discipline, and a degree of outsourcing that relegates value creation to the level of strip mining, makes industry best practices a perspective you can just throw out. Not that the case for robust, dependable, effective processes has not been made. The National Housing Quality (NHQ) Award program, sponsored for more than 15 years by Professional Builder, NAHB Research Center, and others, was modeled after the Malcolm Baldrige Award program.

Processes are front-and-center in the NHQ, yet even those widely-regarded best practices are not widely-adopted (it is a measure of the depth of this housing market and economic debacle that its victims include previous NHQ winners).

But, the bigger problem is the limitation of best practices. At best, industry best practices promote a satisfaction with some sort of competitive equality, a settling for the expediency of the ideas of someone else. The problem with best practices is that it stifles creativity and innovation, works against creating competitive advantage, and creates the illusion of continuous improvement. It is one step above average-ness, something like above-average-ness.

My advice? Figure your processes out for yourselves, and regard industry best practices as something to understand, but nothing to settle for.

Making performance compensation live up to its name

noreply@blogger.com (Fletcher L. Groves III) — Mon, 16 Feb 2009 15:58:00 +0000

Reference Point is our periodic survey of management practices conducted with homebuilding companies listed on Professional Builder's Survey of Housing Giants. Ten years ago, we asked the senior management of these companies to respond to a series of statements intended to measure the context of business logic they attempted to infuse into their operations.

On a scale of one to ten, they scored a four.

Our conclusion was then, and is now, that the efforts of a homebuilding company to improve operating performance and business outcomes will largely fail, if it does not somehow succeed first in creating a homebuilding team that works toward commonly-held and commonly understood business goals, versus merely being a collection of so-called "teammates" working toward individual goals. What is missing, is an underlying business logic that forms the necessary context for understanding everything else.

To become the kind of savvy, accountable, and motivated homebuilding team that is required to compete effectively 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.

Moreover, it is not enough that teammates merely understand the business outcome that is at stake, they must have a stake in that business outcome. That is the role of performance compensation.

What attributes should a good performance compensation plan have?

It should be simple. It should be visible and transparent. It should be compelling. It should bonus on a single business outcome, not an operating outcome. It should pay bonuses fast and frequently. It should be self-funding, meaning that the bonuses must pay for themselves out of the additional income that the company produces over and above the baseline plan (the one where everyone justifies their salaries and gets to keep their job). It should represent a very significant portion of the compensation of every teammate. It should include every single employee in the company. It should provide only for the possibility of winners or losers, not winners and losers. It should give managers the right to lead and to demand results.

Who has the P&L responsibility in your company? The answer needs to be, "Everyone".

Narrow your focus

noreply@blogger.com (Fletcher L. Groves III) — Tue, 10 Feb 2009 20:06:00 +0000

"In many ways, RB Builders was . . . just another homebuilding company . . . with a middle-of-the-road approach to delivering the value its homebuyers demanded . . . locked into an operating model -- into organizational structures, management systems, processes, cultures, and employees -- that could not deliver extraordinary levels of distinctive value . . . indistinguishable from other builders, and unable to create any type of competitive advantage . . . "

There are two sets of questions that lie at the heart of what a homebuilding company does, and therefore, what a homebuilding company is. The first set of questions is about the value buyers want. What band of the value spectrum do your buyers really want, and want so much they are willing to pay for it? Upon what combination of price, product attribute, and personal attention will they base their buying decision?

The second set of questions is about how the homebuilding company that you own, manage, or work for delivers that value. Can your company deliver extraordinarily and distinctive levels of that specific value with its current operating model? By operating model, I mean processes, organizational structure, management systems, even the type of employees you have, and the culture you promote.

You can make it as complicated as you choose, but, fundamentally, there are only three value propositions you can offer homebuyers on which they will base their buying decision. You can promise them the best comparable price ("Best Price"). You can promise them the best location, best design, or best quality, regardless of price ("Best Product"). Or, you can promise to meet their individual and particular (sometimes unique) requirements for both product and homebuying experience ("Best Solution").

Value is defined by homebuyers. While most of their decisions are a combination of all three factors, they do not assign them equal value. One of the factors tends to be the most influential and it trumps all of the others in the buying decision. Homebuyers do not demand equal levels of price, product attribute, and service. Yes, they would like to have extraordinary levels of value in all three, but they will demand -- they will choose -- to have extraordinary levels of value in one component over the other two.

On the other hand, that value is produced by you. Most homebuilders tend to see themselves from two perspectives, neither of which enable them to provide the extraordinary level of distinctive value their buyers require. First, they see themselves as "all things to all people", capable of meeting different bands of the value spectrum equally well. Second, they also tend to see the capabilities of their own operating model as no better than the average homebuilder.

Selecting the value at which to excel is a strategic decision. It requires focus, and that focus requires a choice about the component of value. The offer of value must choose one component over the other two. At the same time, the offer of the chosen component of value cannot ignore the threshold requirements that must be met for the components of value that were not chosen. It is a question of emphasis, not exclusion. The offer cannot focus on one component to the complete exclusion of the other components. If the value delivered in the other two components falls below the threshold, the customer will reject it and go somewhere else.

The choice of a value proposition -- and the choice of an operating model that delivers it -- breaks out on both geographic market and product segments. You can slice it any way you choose, but, at the end of the day, within every market and product segment, there is only room for two or three homebuilders to effectively compete. The rest are superfluous, irrelevant, unnecessary -- and unable to compete.

So -- you better narrow your focus.

The antidote to average-ness

noreply@blogger.com (Fletcher L. Groves III) — Tue, 03 Feb 2009 18:32:00 +0000

In the Lean World, the term "sensei" connotes the idea of wise counsel. My buddy Pascal Dennis would no doubt have a more authentic and appropriate term, but both of us would probably agree that serving the homebuilding industry can feel less like a sensei and more like being a voice in the wilderness. Qualifying as a true VITW would seem to require that you endure at least 10 years of frustration. On that basis, I could certainly qualify.

If I have learned anything over the years, it is to reduce things -- problems, solutions, challenges, opportunities -- to their essence. It was not always so. Ten years ago, when SAI was just beginning its work in helping homebuilding companies to understand and improve their business processes, I characterized the effort to achieve and sustain improvements in business performance as involving "a certain chemistry -- a complexity and a comprehensiveness", and, for that reason, "improving performance tends to be hard, involved work." I went on to say that, "It is hard work because performance cannot be improved without doing things differently, and change is threatening to most people; it is involved work because improving performance requires more than a simple, one-dimensional approach -- it requires a continuous effort on more than one front."

In retrospect, I do think it is hard, involved work, but not because it is complex. Even at the time I was saying how complex it was, I was also saying that "it seems to us that business performance improvement really boils down to getting the job done -- viewing the issue, sustaining the effort, and getting the results -- in three critical dimensions."

I would substitute "focused" for "complex", but I would also say that those three dimensions are as true and relevant today as they were 10 years ago. For a homebuilding company, improving operating performance and business outcomes still comes down to having a strategic and marketing discipline, creating a business context in which everything makes sense, and having a perspective toward how value is created.

Discipline: It has to narrow its focus, by designing its operating model to deliver exceptional levels of the specific and distinctive value demanded by a narrowly defined segment of homebuyers.

Context: It has to be a company of business-people. A savvy, accountable, and motivated homebuilding team comprised of savvy, accountable, and motivated teammates. It must teach its employees the real numbers of the business, give them the authority -- and responsibility -- to act on that knowledge, and then give them a real stake in the financial outcome.

Perspective: It has to organize and focus its efforts around the systemic manner in which it performs work and creates value for its buyers. Sometimes it is about process management. Sometimes it is about project management. Sometimes it is about solving problems, and sometimes it is about managing constraints. It is always about understanding the cause-and-effect nature of the system in which it operates.

Everything else is just a means to an end.