Part II: “Tell me what [it] looks like with a cycle time of 120 days.”

(excerpted from The Pipeline: A Picture of Homebuilding Production, originally posted on Escape from Averageness in June 2010, updated and reposted here)

One of the sales representatives looked at the superintendent, and laughed.  “Which one of the Productionally-Transmitted Diseases would you like to have.  Good one.”

The intrepid, results-based consultant smiled and continued.

“In a previous session, someone said RB Builders closed 200 homes in 2007, on an average work-in-process of 100 houses, which is also the baseline for 2008.  But, everyone also agreed that your production system should be capable of producing 240 closings on those 100 units of work-in-process.  Later, someone else mentioned that the building schedules [stipulate an average cycle time] of 120 days.”

Moving to the erasable board, she wrote the following data in a table:

 

2005:

  • WIP = 100
  • CLOSINGS = 225
  • CYCLE TIME = ? 

2007:

  • WIP = 100
  • CLOSINGS = 200
  • CYCLE TIME = ? 

2008:

  • WIP = 100
  • CLOSINGS = 240
  • CYCLE TIME = ?

 

“Someone calculate RB Builders’ cycle time”, she said.  “How many days?”

After a minute, the sales representatives looked up from her calculator, and said, “If I am doing this right, I calculate that, in 2005, our cycle time was 160 days.  In 2007, it was 180 days.  And, for 2008, we are targeting 150 days.”

The intrepid, results-based consultant completed the cycle time column with the calculated cycle times, but added two more rows with identical values.

 

2005:

  • WIP = 100
  • CLOSINGS = 225
  • CYCLE TIME = 160 days 

2007:

  • WIP = 100
  • CLOSINGS = 200
  • CYCLE TIME = 180 days 

2008:

  • WIP = 100
  • CLOSINGS = 240
  • CYCLE TIME = 150 days 

 WIP = ?

  • CLOSINGS = ?
  • CYCLE TIME = 120 days 

 WIP = ?

  • CLOSINGS = ?
  • CYCLE TIME = 120 days

 

‘Okay”, she said.  “Tell me what your production system looks like with a cycle time of 120 days.”

“There are two ways to look at it”, said the superintendent.  “We could be closing 240 houses with 80 units of work-in-process.  Or – we could be closing 300 houses with 100 units of work-in-process.”

The intrepid, results-based consultant added the new calculations.

 

2005:

  • WIP = 100
  • CLOSINGS = 225
  • CYCLE TIME = 160 days 

2007:

  • WIP = 100
  • CLOSINGS = 200
  • CYCLE TIME = 180 days 

2008:

  • WIP = 100
  • CLOSINGS = 240
  • CYCLE TIME = 150 days

 

  • WIP = 80
  • CLOSINGS = 240
  • CYCLE TIME = 120 days 

 

  • WIP = 100
  • CLOSINGS = 300
  • CYCLE TIME = 120 days

 

“Remember our discussions on margin and velocity?”, she asked.  “This is where that comes into play.  There are always two ways RB Builders can increase the amount of Throughput – the amount of Gross Income – it generates.  Margin is how much money we make on every house we close, and velocity is about how many houses we can build and close in a period.”

 

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

 

4 Comments

  1. Ping from Steven G. Twiss:

    If you increase velocity, margin will increase because the time under construction decreased.

    The trick is increasing velocity while maintaining quality and safety with existing personnel & contractors, i.e., not increasing overhead.

  2. Ping from Fletcher Groves:

    Steve — Margin does not increase as a result of faster completions; you don’t make more money, you make it faster.

    That’s the entire point; economic return is a function of both margin and velocity, but they are not the same thing.

  3. Ping from Jesse Murphy:

    Velocity is typically impacted by backlog, but there is no reason to slow down the construction time due to lack of backlog.

    Money comes at closing. Buyers sometimes die before closing; buyers sometimes lose their loan qualification; some lenders stop lending.

    Whether is is one house or two hundred, get it built and get it closed.

    Working with a builder that did 200 closings or more each month, you understand velocity, quality, customer serviced and the other parts that put money in your pocket.

    Velocity can increase profits due to bargaining power with contractors. Higher volume lets them keep their workers busy.

    Jesse Murphy

  4. Ping from Fletcher Groves:

    As we note in the justification for Pipeline workshops:

    “A homebuilding enterprise that generates a Gross Margin of 24% and turns its inventory twice a year will be outperformed – by a 2:1 margin – by a homebuilding enterprise that generates a Gross Margin of 18% and turns its inventory four times a year; outperformed in terms of Net Income; outperformed in terms of Return on Assets.

    “The former is the picture of a slower, marginally-productive homebuilding company, and the latter is the picture of a fast, highly-productive homebuilding company; the later generates twice the Revenue and half-again more Contribution. If the contrast between a 90 and 180 day cycle time is too stark, consider this: an 18% Gross Margin with a 4x turn is the exact equivalent of a 24% Gross Margin and a 3x turn; 90 days vs. 120 days.

    “In the face of clear differences in economic outcomes, it is important to note that the homebuilding companies in all three scenarios are exactly the same size, when the real measure of size is the amount of work-in-process they each have to carry; they have the same resource overhead, the same working capital requirements, the same risk profile.”