Margin Is Not Sufficient

Part production simulation and part business game, Pipeline games™ are played in multiple scenarios at every Pipeline workshop™.  The insight delivered by multiple teams discovering the effect of operating decisions on business outcomes never fails to intrigue us.

Case in Point:  In every previous Pipeline workshop™ (as well as the 2014 and 2015 Housing Leadership Summit), we have specified the appropriate levels of work-in-process, what we refer to as Necessary WIP, Maximum WIP, and Minimum WIP.  However, at the most recent workshop, we gave each team far more latitude in determining what level of work-in-process they would carry.

It was a calculated tradeoff, a decision to forgo the enforcement of production principles to allow adverse discovery.  Since a Pipeline game™ has to provide a production scenario with predetermined starting and ending points, we know that builders – to one degree or another – will be tempted to game the system, by loading WIP early and not loading it late.

However, in a real business scenario, production occurs without regard to arbitrary beginning and ending points, and we know that a decision to load work-in-process early in a period and not load it late would have a devastating impact on operating performance and economic return, before and after.

Revenue (capture)

Net Margin (capture)

Take a look at the Revenue, Net Income Margin results in the charts above;  in these games, it was not unusual for a team to exceed budget expectations in those line items.  The production system in a Pipeline game™ purposely induces variation, and the Law of Variability Buffering – one of the laws of production physics – makes it clear that a system will buffer (protect) itself from variation and uncertainty through some combination of longer duration (cycle time), additional inventory (work-in-process), and excess/reserve capacity.

If you look at the results in the Inventory Turn and Cycle Time charts below, that is exactly what occurred.  The production system, to one degree or another, used two of the three buffers (and, if we showed you the progressively higher capacity and predictability of the resources we used in each game, you would see that the system used the third buffer, as well).

Inventory Turn (capture)

Cycle Time (capture)

That is the only explanation for how a production system can generate Revenue sufficient to absorb its Operating Expense, often exceeding its projected Net Income and Net Margin, yet fall miserably short on achieving the expected operating performance measures (inventory turn and cycle time) that drive the velocity side of Return on Assets.

ROIA (capture)

Margin is necessary, but it is not sufficient.  You also need velocity.  The answer to the question of how builders get more – more Revenue, more closings, higher Net Income – cannot be to have more of everything else:  more people, more trades, more plans, more money, more inventory, more time, more capacity.

Anybody – any of your competitors – can do more with more.

You have to do more with what you have.

 

Join the movement.  Join us at a Pipeline workshop™.  Read the book (it’s available from all the bookseller sites).  Join the BuilderVelocity™ group on LinkedIn;  contribute to the discussion.

Come.  Participate.  Learn.

Request to join the group:  https://www.linkedin.com/grp/home?gid=6571634

Register for a workshop:  http://buildervelocity.com/