Archive for October, 2011

Part II: Factors and Circumstances

Posted October 1, 2011 By Fletcher Groves

This second part of the series chronicling the Fidelity Homes “From The Ground Up” project at its ten-year mid-point anniversary deals with the planning that went into the start-up of this company, and with the factors and circumstances that were in-play at the time.

“Don’t be afraid to see what you see.” – Ronald Reagan

At SAI, we repeatedly use Reagan’s admonition to encourage clients to plan their initiatives and make their decisions from the basis of what we term “current reality” – from the basis of a brutally-honest, lucid assessment of current capacity and capability, as well as the parameters of the situation they face, the factors that must be considered about the manner in which that capability and capacity must be deployed. From a strategic planning standpoint, this internal-external perspective is basically what constitutes SWOT Analysis.

At the time that the “From The Ground Up” series started, Bill Lurz (who, as a senior editor at Professional Builder, managed the project) noted the degree to which the creation of Fidelity Homes paralleled an earlier PB series (“Think Fast”) that was a vetted list of do’s-and-don’ts for a hypothetical, new millennium, start-up building company. Written, as it was, in 2000, some of the recommendations reflected the resource capacity shortages of the coming housing bubble, as well as green technology.

Given the new enterprise’s stated vision, mission, and values, several of the recommendations seem particularly relevant to the Fidelity case:

— Over-capitalize the business.

— Control as much land as possible, without actually buying it.

— Keep the best teammates, by giving them a financial stake in the company’s success.

— Invest in the development of teammates and building partners.

— Don’t just build what everyone else builds.

— Build to niche markets and do infill developments.

— Create even-flow sales, starts, and closings.

— Develop a strategic plan to access capital.

The co-founders of Fidelity, David Hunihan and Todd Menke, shared the initial business planning responsibilities, with David writing the marketing plan and Todd writing the business plan. Those two documents were subsequently merged. In the “From The Ground Up” series, there was a set of goals from what was described as the company’s strategic plan; all of the operating margins and ratios were derived from NAHB benchmarks. I asked David and Todd whether there was also a full-fledged operating plan and budget, how many years did that operating plan and budget cover, and what it showed; I haven’t heard back.

In fairness to whatever I might say regarding the sufficiency of that planning, I did not have any of those documents to review, either at the time I helped Fidelity design its core business processes, or when I prepared to write this series ten years later.

So – to the point: What was the landscape – what were the factors and circumstances, the parameters – that framed David’s and Todd’s decisions for Fidelity in 2001?

— There were two early/mid-30’s sales executives with the energy and the shared values to pursue their vision for a new homebuilding company. While both David and Todd were accomplished salesmen, they were inexperienced in homebuilding operations and in running their own businesses.

— There was the blueprint for a TQM-centered homebuilding company with solid corporate values in key areas, like homebuyer satisfaction, trade partnering, and teammate transparency.

— There were the “Think Fast” admonishments – offered hypothetically to “a young (but seasoned) executive in a production building firm that takes the plunge and starts the first new homebuilding company of the new millennium” with the goal “to grow it quickly into a major force in the market” – notably recommending having a capital buffer, having a big-as-you-can-make-it land/lot buffer, and having a plan to access more capital for future growth.

On that last piece of advice, PB quoted the advice from fellow Florida builder Joel Channing: “We got started doing workouts with financial institutions in the 1970’s. It was an easy jump from that to joint-venturing. But, today, there are no workouts, because nobody is failing, although that could change sometime soon”.

Unspoken, in all of this advice, is the tacit recognition that the homebuilding industry offers relative ease-of-entry.

— There was a business plan. There was a marketing plan. There was a set of goals from a strategic plan, much of which reflected industry best practices. We do not know if Fidelity had a full-fledged operating plan and budget, how many years that plan covered, or what that plan showed. All of which, by necessity, would have been largely proforma.

— There was a start-up business and operating situation, with everything that a start-up scenario entails. And, there was the commitment from Fidelity and its principals to be the poster child for the “From The Ground Up” aquarium project, with everything that commitment would require.

— There was a principled decision to not compete with the homebuilding operation for which David and Todd had previously worked, which dictated, to a degree, the locations, products, and price ranges within which Fidelity could operate.

— At the start, the D/E Ratio was 20:1. Over the ensuing years, there would be additional debt capital raises and bank borrowings to meet funding requirements. While there was an injection of equity capital when Todd’s interest was bought-out, debt was the financial backbone of Fidelity. There was big debt, relative to size, and the promise of big returns to those investors.

— There was a project/community acquisition business model that was opportunity/deal-driven, not particularly strategy-driven.

— There was an economy and a housing market that was improving, as it emerged from a business investment-led recession. Nowhere, in 2000-01, was there a forecast for what was to occur between 2003 and 2008.

In putting together this ten-year retrospective, I had asked David which factors – if they had changed, if they had not occurred, if they had been better anticipated, if they had been approached differently – would have changed the eventual outcome.

“I have been over this time and again, and I don’t feel there is much we could have done differently”, he replied. “There were so many circumstances that led us to our situation. It [became] the worst real estate downturn in our lifetime and builders with a lot more capital than we had either failed or remain impaired to this day.

“Perhaps, if we hadn’t had the delays in the two communities; in [one community] we would have had better margins and a better return on assets, in [the other] we would have been sold out. But had that occurred, I am sure we would have put the funds into land purchases.”

My perspective: Hindsight is what it is. In hindsight, I doubt that current reality was regarded as seriously as it should have been, and I doubt that it transferred into adequate operational planning and budgeting. There were assumptions about financing with debt capital and pipelining land/lots. I think there were distractions, and those distractions were magnified by the failure to prioritize. And, absent those specific distractions, there would still have been the normal pressures that are exhibited in any start-up.

But – that’s the way businesses start. David and Todd had a vision, and they aggressively pursued it. They had much to learn, and they were open to learning it. They could have done some things better, but they also did a lot of things right. As I said – as I always say – in my post remembering 9/11, I think these guys represent the entrepreneurial spirit and personal courage that makes this country and this industry great. In a business-as-usual world, in a non-extraordinary economy and housing market, Fidelity Homes would have almost certainly succeeded doing things the way they did.

I think homebuilding ease of entry cuts both ways. Without it, David and Todd don’t start Fidelity. However, ease-of-entry doesn’t demand rigor commensurate with the risk – a risk obscured, in this case, and in this era, by presumptive assurances of business-as-usual. Which is why I think that the most under-appreciated factor was uncertainty and variation.

For most of its eight-year life, Fidelity was not dealing simply with common-cause variation, the type that naturally occurs within the upper and lower control limits of the process, in this case, the homebuilding system; there was also special-cause variation – variation that is outside the normal limits, uncontrolled, but also unanticipated, unexpected, which makes it more like uncertainty.

Variation (common-cause) is a reflection of our ability – or our inability – to achieve repeatable results; uncertainty (special-cause) is a reflection of not knowing what the results will be.

Uncertainty is about risk.

Given the presumptive assurances of business-as-usual, where does anything like 2002-06 or 2007-2008 fit into the predictability of a homebuilding operation? Into normal, or expected? By any measure – the economy; the job market; home price movements; starts; the widening gap between new home sales and sales of existing homes; the availability of financing, either permanent or ADC – it was not variation or uncertainty inherent to the process.

It was – and still is – unprecedented.

Next: Resolve