The Road That Lies Ahead . . . and The Road Less Traveled

(initially published on Escape from Averageness® in January 2011;  updated, revised, brought into the present here, to reflect the thinking that came out – the thinking that is still coming out – of the 2018 Housing Leadership Summit, held May 14-16, 2018, in Laguna Nigel, CA)

“Where is the homebuilding industry headed over the next five to ten years on the issues of growth, consolidation, and supply chain management?”

Despite what you are thinking, this is not a current battery of questions.  At the dawn of the current century, these and other questions were posed in a volume of Reference Point™, which was the study of management practices in the homebuilding industry we periodically conducted among the C-Levels of a select group of larger building companies.

Now, almost 20 years later, as we more clearly face what I then termed “the inevitable assertion of power that will herald the Era of Consolidation” – the point at which publicly-held homebuilding companies (and large privately-held building companies, and now investors, from both within and without the industry) got serious about consolidation – I thought it might be worthwhile to look back and summarize some of what builders told us then, and how we observed and commented on the findings at that time:

 

GROWTH STRATEGIES:

“ . . . almost three-fourths (71%) of these executives predicted that their own building operations would become ‘much larger’;  almost everyone else (27%) predicted that the size of their operations would remain about the same . . . these findings were very consistent with the findings from an earlier Reference Point™ study.

“We thought it would be interesting to see how all of this growth was going to materialize.  When we asked these executives what primary strategy they would use to meet their growth projections, 41% identified ‘geographic expansion into new markets’, 39% selected ‘higher market share in current markets and buyer segments’, and the remaining 21% identified ‘new market share in additional buyer segments’;  not a single executive we surveyed identified ‘vertical integration’ – a decision to supply more of the component parts themselves – as a primary strategy.”

 

CONSOLIDATION:

“At separate points in the study, we asked two questions designed to determine the extent to which industry consolidation – some combination of growth, merger, and acquisition – would reduce the number of active building companies in the years ahead.

“We asked them whether, over the long term (10+ years), they could foresee the type of widespread consolidation of operations and market share that has occurred in other industries.  Overall, more than 70% of these executives said they could foresee the circumstances for such a consolidation.

“We then asked these senior managers whether they thought the number of homebuilding operations in their markets would increase or decrease in the next five to seven years.  Overall, almost half (49%) thought there would be fewer building companies, while more than one-third (38%) thought the number of building companies would remain about the same;  about one-in-ten (13%) believed the number of builders would actually increase.

“Their responses differed in significant respects from those expressed in our previous studies . . . at that time, less than one-in-ten (9%) thought there would be a significant decline in the number of builders . . . for those who thought there would be an increase . . . the situation has been reversed.”

So – ponder the implication of this combination of facts:  seven out of ten executives surveyed thought their own companies would be “much larger”, but five out of ten also thought the overall number of homebuilding companies in their markets would increase or remain the same.

 

SUPPLY CHAIN MANAGEMENT:

“We asked two questions related to distribution channels and supply chain management.  We wanted to know whether builders viewed these two issues – closely related to change in many other industries – as something the homebuilding industry would need to address within the next 10 years.

“Asked whether they could foresee . . . changes that could include the circumvention of established delivery systems similar to what has occurred in other industries . . . a slight majority (54%) believed the industry would have to deal with this issue in the next ten years;  the rest did not see this as an important issue.

“On the matter of supply chain management, there was much stronger agreement.  Asked whether they could foresee homebuilding companies taking the lead in collaborating . . . to manage all of the activities in the process of creating the housing product . . . a Pareto-esque majority (80%) expected the industry to move in that direction.”

We then offered the following comments and observations:

 

THE ROAD LESS TRAVELED:

“Even if builders chose to reject the notion of widespread consolidation and outright circumvention of established delivery systems, and dismissed the level of growth projected by such a high percentage of builders as collective boardroom fantasy, the dependence of so many builders on growth strategies aimed at geographic expansion and higher market share in current buyer segments ought to raise a couple of red flags:

“First, assuming that a strategy based on expansion into new geographic markets represented real growth, and not just the transfer of demand through acquisition or merger, then it would have the effect of forcing more competition on the existing level of demand.  The first victims would be the builders that could not compete for the available lots.  But, then what?  How would the builders that survived assert themselves in the market?

“Second, a strategy based on capturing a higher share of the market in current buyer segments asked a more naked version of the same question:  how would builders acquire more business – in the same buyer segment, in the same geographic market?  Could those types of gains be sustained?

“Growth fueled by a strategy of geographic expansion and higher market share in current buyer segments is essentially a strip-mining operation – an attempt to create value out of something a mile wide and an inch deep.  But what choice would builders have?  As an industry, we have outsourced almost every value-added activity in the building process.

 “Moreover, we could talk all day about the need to increase productivity, but (1) that would be a difficult proposition when someone else is doing all the work, and, (2) there would be no real point in improving productivity unless a productive use could be found for the additional capacity.

“And, besides, just where would all that additional production capacity be invested?  In more expansion?  In higher market share?

“When we look at it in these terms, there has to be a better way.”

“. . . 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 to 2018.  In the time since this study, consolidation has clearly occurred in the homebuilding industry.  In 2003, the 100 largest builders (by closings) had a 34% market share;  today, the 100 largest builders have a 63% market share.

I concluded with this point, 18 years ago:

 

LIFE ON THE SERENGETI: 

“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 is 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 . . . “