“There are only two choices.”

(excerpted from The Pipeline;  previously published on EFA in February 2012 under the same title;  republished here, with our current thoughts, part of our retrospective Above Average: The Best of Escape from Averageness, 2009-2012)  

 

The intrepid, results-based consultant re-capped the erasable marker and set it down. “Right now – let me ask a different question:  What were your choices for dealing with the issue of capacity utilization?  Before the current downturn in the housing market, what would your alternatives have been for getting throughput up to the designed level?”

“Based on what I’ve learned from this discussion, I would say we probably had two options”, said the VP of Construction.  “We could have added production capacity; technically, that shouldn’t really count as an option for increasing utilization, because it alters the design capacity of the pipe.

“The other option would have been to better utilize the production capacity we already had.”

“Exactly”, she said.  “There are only two choices.  You can either add capacity or become more productive.  It is a decision that cuts to the core of how you view size and growth.  What size is RB Builders?”

“$50 million”, answered the VP of Sales.  “That was our Revenue for 2007.”

“And, that is how most homebuilders would answer that question”, she said.  “The answer to the question of size is usually about the amount of annual Revenue, or the annual number of closings. However, the most relevant measure of the size of a homebuilding company is the amount – and the value – of the work-in-process that it carries.

“Size is about capacity, not output.

“As we have already seen, there is a direct correlation between work-in-process and production capacity, which we prefer to define as the rate of throughput (or output), that can be generated with a planned, finite, controlled level of work-in-process.  There is an equally strong and direct correlation between work-in-process, cycle time, and velocity (or Inventory Turn).  Finally, work-in-process is one of the ways a production system will protect itself – buffer itself – from variation and uncertainty.”

“You mentioned growth along with size”, the CFO reminded her.

“Yes, I did”, she said.  “If size is defined as capacity, rather than Revenue or closings, what is the implication for growth?  How, then, should RB Builders grow?”  Seeing the blank stares all around the room, she continued.  “The answer is, based on that definition, RB Builders should not want to grow.

“By that definition, even when faced with acceptable justification, RB Builders should see growth as a last resort.  RB Builders doesn’t want to add production capacity, it wants to increase its productivity, by increasing the utilization of the production capacity it already owns.  Adding production capacity – getting bigger – is a “more-for-more” proposition”, she continued.  “It’s the easy road.  Anyone can do it.  Anyone can resort to adding production capacity, anyone can resort to spending more money.

“True, sustainable competitive separation comes from doing what your competition will not – or cannot – do.  Like finding ways to become more productive.

“Beyond the competitive aspect, there are other problems that come from simply being big”, she said.  “Big homebuilding companies tend to be slow, clumsy homebuilding companies, unable to respond quickly to changing circumstances, incapable of exploiting opportunities in the marketplace.

“And – there is risk,” she added.  “Adding production capacity means additional work-in-process and additional resources.  Risk increases exponentially with an increase in core size – with higher WIP and Operating Expense.  Once you increase production capacity, it becomes much harder to fully utilize it.  There are fewer options.  It is very difficult to downsize your way out of excess production capacity.

“Size forces you into positions you shouldn’t be in;  size forces you down roads where you shouldn’t go.”

The Pipeline: A Picture of Homebuilding Production is available on amazon.com, barnesandnoble.com, the publisher website (virtualbookworm.com), and the author website (thepipelinebook.com).