Pipeline Workshops™: Thriving on the Velocity Side of Return on Assets®

Since homebuilding is an industry that leverages equity with debt, some version of Return on Assets is the best measure of a homebuilding enterprise’s economic return.  The most useful version of ROA is the DuPont identity, which expands economic return into two components:  Margin (reflected as Return on Sales) and Velocity (reflected as Asset Turn).

 

EFA - ROA (capture3)

 

From an operational perspective, the vast majority of assets on a builder’s balance sheet ought to be houses in some stage of construction, particularly when raw land and developed lot inventory is held off-balance sheet;  which means, when we calculate Return on Invested  Assets, we can readily substitute Inventory Turn for Asset Turn.

The point is to thrive, not just survive.  To do that, a builder has to do well on both the margin side and the velocity side of ROA.  That understanding fundamentally proposes two questions:  (1) How much can I make on every house?  (2) How many houses can I build with a planned, finite, and controlled amount of inventory and production capacity?

As a builder, consider this:  if you generate a Gross Margin of 24% and turn your inventory twice a year, you will be outperformed – better than two-to-one – by a homebuilding enterprise that generates a Gross Margin of only 18%, but turns its inventory four times a year;  you will be outperformed in terms of Net Income, outperformed in terms of Return on Assets.

You will struggle to compete;  you will struggle to survive.

Your operation is a slow, marginally-productive homebuilding company;  your competitor’s operation is a fast, highly-productive homebuilding company;  your competitor generates 85% more Revenue and 40% more Gross Income than you do, with the same amount of assets.

It is also a picture of the difference between a 180 day cycle time and a 90 day cycle time, and if that contrast is too stark, then consider this:  your competitor with the 18% Gross Margin and a 4x turn produces almost the same ROA as you would with a 24% Gross Margin and a 3x turn;  that’s the picture of your competitor’s 90 day cycle time versus your 120 day cycle time.

In the face of clear differences in economic outcomes, note that your competitors – the two homebuilding companies represented in those scenarios – are exactly the same size as your company, when the real measure of size is the amount of work-in-process you each have to carry;  you and your competitors each have the same resource overhead, the same working capital requirements, the same risk profile.

In an industry with a capacity shortage, like homebuilding, there is not going to be any price elasticity of supply and demand, because there is not going to be any wide-spread, capacity-driven increases in supply.  Homebuilding is essentially a build-to-order process, which tends to regulate short-term supply.  Moreover, the demands of higher productivity are so tough, require so much rigor, so much discipline, so much resolve, that most builders won’t attempt it.

It’s not a choice between higher margin or higher velocity;  it’s the challenge – and the opportunity – of producing higher margin and higher velocity.

Pipeline workshops™ are a two-day immersion into the production physics – into the principles and disciplines – that enable homebuilders to thrive on the velocity side of economic return, that enable builders to thrive on the velocity side of Return on Assets.

Come.  Participate.  Learn.

 

The next Pipeline workshop™ will be held at the Ponte Vedra Inn and Club, Ponte Vedra Beach, Florida, on March 16-17, 2016.  Cost is $850.00.

Delivered by SAI Consulting and Continuum Advisory Group.  Sponsored by BUILDER and BuilderMT.

For more details:  www.builderevelocity.com