Pipeline Workshops: Thriving on the Velocity Side of ROA

Since homebuilding is an industry that leverages equity with debt, some measure of Return on Assets is the best indicator of economic return.  The expanded view of ROA presented by the DuPont identity makes it very clear that economic return has two components:  Margin (Return on Sales) and Velocity (Asset Turn).

EFA - ROA (capture3)

From an operational perspective, the vast majority of the assets on a builder’s balance sheet are going to be houses in some stage of construction.  That being the case, when we calculate Return on Invested  Assets, we could easily substitute Inventory Turn for Asset Turn.

In order to survive – in order to succeed – homebuilders need to do well on both the margin side and the velocity side of ROA.  Q: How much can I make on every house?  Q: How many houses can I build with a planned, finite, and controlled amount of inventory and production capacity?

As a builder, consider this:  if you generate a Gross Margin of 24% and turn your inventory twice a year, you will be outperformed – better than two-to-one – by a homebuilding enterprise that generates a Gross Margin of only 18%, but turns its inventory four times a year;  you will be outperformed in terms of Net Income, outperformed in terms of Return on Assets.

You will struggle to compete.

Your operation is the picture of a slow, marginally-productive homebuilding company;  your competitor’s operation is the picture of a fast, highly-productive homebuilding company;  your competitor generates 85% more Revenue and 40% more Gross Income than you do, with the same amount of assets.

It is also a picture of the difference between a 180 day cycle time and a 90 day cycle time, and if that contrast is too stark, then consider this:  your competitor with the 18% Gross Margin and a 4x turn produces almost the same ROA as you would with a 24% Gross Margin and a 3x turn;  that’s the picture of your competitor’s 90 day cycle time versus your 120 day cycle time.

In the face of clear differences in economic outcomes, note that your competitors – the two homebuilding companies represented in those scenarios – are exactly the same size as your company, when the real measure of size is the amount of work-in-process you each have to carry;  you and your competitors each have the same resource overhead, the same working capital requirements, the same risk profile.

Compared with other industries, homebuilding is a relatively safe bet when it comes to the question of any penalty price elasticity of supply and demand would be expected to impose on prices in the face of wide-spread, capacity-driven increases in supply.  Homebuilding is essentially a build-to-order process, which tends to regulate short-term supply;  moreover, the demands of higher productivity are so tough, require so much rigor, so much discipline, so much resolve, that most builders won’t do it.

It’s not a choice between higher margin or higher velocity;  it’s the challenge – and the opportunity – of producing higher margin and higher velocity.

Pipeline workshops™ are a two-day immersion into the production physics – into the principles and disciplines – that enable homebuilders to thrive on the velocity side of economic return, that enable builders to thrive on the velocity side of Return on Assets.

 

The next Pipeline workshop™ will be held at the Ponte Vedra Inn and Club, Ponte Vedra Beach, Florida, on October 14-15, 2015.  Cost is $795.00.  Early registration (July 1-31, 2015):  $645.00.

 

Delivered by SAI Consulting.  Sponsored  byBUILDER and Continuum Advisory Group.

For more details:  www.builderevelocity.com