Pipeline Workshops™: Lessons from the Pipeline©

(excerpted from the Lessons from the Pipeline© business case that will be used in the upcoming Pipeline workshop™)

Three Pipelines to the Horizon

It is the beginning of 2016.  RB Builders aims to extend its reputation as a builder that can thrive on both the margin and velocity sides of Return on Assets, by expanding into yet another, new-for-it geographical market, through the late-2015 acquisition of another existing homebuilding operation.

In the same timeframe, RB Builders has also decided to create a de novo building operation in a different geographical market;  one of the stated objectives in starting this new division is to test different models of building operations.

Like its predecessor, the newly-acquired building division has historically generated much lower operating results and business outcomes than its new parent.

RB Builders is satisfied with the land/lot positions that has come with the acquisition;  it has completed the conversion of the management technology system and started the conversion of the business and operating processes;  RB Builders is confident that it can unify, develop, and improve the capabilities of the team currently in-place, to one replicating its own.

The startup division has no operating history;  it begins life, out-of-the-box, with RB Builders’ management technology, processes, and a new-but-already-savvy, motivated, mutually-accountable homebuilding team.

This road is a now-familiar path for RB Builders.

 

RB BUILDERS:  At the beginning of 2008, eight years earlier, shortly after the end of the halcyon period known as the Age of Homebuilder Entitlement®, RB Builders had begun its own transformation process, to extract itself from what it self-described as “the tar pits of averageness”, by building a sense of urgency towards results.

As a result of this program, RB Builders made massive strides.

During the ensuing five-year period (2008-2012), annual Revenue had grown from $50 million to more $121 million.  During the same period, the number of closings had increased from 200 houses per year to 453 houses per year.  Despite the margin pressure, overall Gross Margin had increased slightly, from 22% to 24%;  as a result, RB Builders’ Gross Income had grown from $11 million $29.5 million.

During this period, Operating Expense had increased (from $8.5 million to $11 million), but that increase was far less than the same-period increase in Revenue.  As a result, RB Builder’s Net Income had risen from $2.5 million to $16.5 million;  Net Margin had grown from 5% to 14%.

In 2008, RB Builder’s cycle time had been 180 days;  by the end of 2012, cycle time had been reduced to 65 days.  In 2008, the average amount of work-in-process had been 100 houses under construction;  by the end of 2012, average work-in-process had decreased to 80 houses under construction.

RB Builders had targeted an inventory turn of 2.5x in 2008.  By keeping work-in-process at 80 houses and closing 453 houses, RB Builders had increased its 2012 physical inventory turn to 5.7x.  In 2008, RB Builders had turned the value of its assets twice;  in 2012, it turned the value of its assets 4.7x.

Because it had been able to maintain margins while significantly improving velocity, RB Builders saw Return on Invested Assets increase almost six-fold during the five-year period, from 11% in 2008 to 64% in 2012.

In 2013, RB Builders had moved all of its raw land holdings and developed lot inventory off of its balance sheet, and into subsidiaries, serving to further increase both Asset Turn and ROIA, had those measures been restated to reflect the remaining assets.

It had been a remarkable transformation.

The division that RB Builders acquired late in 2014 remained on-track toward meeting its two-year plan to increase its closings and Revenue from 48 homes and $12 million in 2014, to 120 homes and $30 million in the upcoming year (2016), with the level of Operating Expense and work-in-process unchanged from when it was acquired in 2014.

 

THE NEWLY-ACQUIRED DIVISION:  In the year just being completed (2015), RB Builders has acquired its second homebuilding operation.  In its final year of independent operation, this operation had closed 72 houses, and generated $18 million in Revenue.  With its $13.68 million in Cost of Sales now reflecting only its direct, variable costs, the operation generated $4.32 million in Gross Income, a 24% Gross Margin.

With its $2.88 million in Operating Expense now reflecting only its indirect, non-variable costs, the operation had produced $1.44 million in Net Income, resulting in an 8% Net Margin.

During 2015, the newly-acquired operation had a calculated cycle time of 250 days, even though its job schedules specified 120 days;  in 2015, its average work-in-process was 50 houses under construction.  With 72 houses closed and an average work-in-process of 50 houses under construction, the newly-acquired building operation was turning its physical inventory slightly above 1.4x in 2015.

Adopting the policy of RB Builders, and moving all raw land holdings and developed lot inventory off of its balance sheet into subsidiaries, the newly-acquired building operation had shown restated work-in-process of $6.56 million;  with $18 million in Revenue, it had reported an asset turnover ratio of 2.7x.

With its Net Margin of 8% and its restated asset turn of 2.7x, the new operation had posted a Return on Invested Assets of 21.6%.

 

THE DE NOVO DIVISION:  As a startup building operation, the de novo division had no reported operating or financial history in 2015.  Staffed with a combination of RB Builders teammates and new hires, the division was started in the third quarter of 2015, with the first closings expected to occur at the beginning of the first quarter of 2016.

The new operation has a sufficient rolling lot takedown position in a single development;  owned lots are held off of its balance sheet in an RB Builders subsidiary until committed to job budgets.  The de novo division starts life with a $1.2 million construction line of credit that provides an acceptable ratio of inventory and presales starts.

The de novo division has a 2016 proforma operating statement that projects $9 million in Revenue on 36 closings.  Its projected $6.84 million in Cost of Sales, under what RB Builders characterizes as a “traditional fully-outsourced building model”, gives the startup operation a projected $2.16 million in Gross Income and a projected 24% Gross Margin.

Achieving its proforma operating budget during its inaugural year will enable the startup operation to evenly-split its Gross Income between Operating Expense and Net Income;  projected Net Income of $1.08 million produces a 12% Net Margin.

The startup operation is expected to run its production system in a manner that achieves a calculated cycle time of 90 days.  The construction line of credit is sufficient for average work-in-process of nine houses under construction;  with expected closings of 36 houses, the de novo division should turn its physical inventory 4.0x in 2016.

Presuming the new operation (1) manages to produce its $9 million in projected Revenue and (2) manages to consistently be at near a fully-drawn position on its $1.2 million line of construction credit with its work-in-process, it expects to have an asset turnover ratio of 7.5x.

With its Net Margin of 12% and its expected asset turn of 7.5x, the new operation projects a scorching Return on Invested Assets of 90.0%.

 

This is the nature of the series of questions attendees will have to consider and answer at the upcoming Pipeline workshop:

Q:  What happens when the newly-acquired division is required to more than double its closings over a two-year period, and meet that requirement with less work-in-process, a smaller line of credit, and the same amount of overhead?

Q:  How can RB Builders correctly assert that variation in the production system, evidenced by its 2015 cycle times and other operating performance measures, is costing its newly-acquired division between $4.3 and $4.7 million per year in lost Net Income, when the division was only reporting annual Net Income of $1.4 million?

Q:  What does the de novo division’s team conclude when it is asked to determine whether it would be strategically and economically beneficial to immediately transform its brand-new “traditional fully-outsourced building model” into what RB Builders describes as a “vertically-integrated building model”?

Q:  How does price elasticity of supply and demand affect the decisions?

 

Come.  Participate.  Learn.  Lessons from the Pipeline© is the underlying business case study that will be used at the next Pipeline workshop™, being held October 14-15, 2015, at the Ponte Vedra Inn and Club, Ponte Vedra Beach, Florida.  Cost is $795.00.

Sponsored by BUILDER and Continuum Advisory Group.

Details:  www.buildervelocity.com