Pipeline Workshops™: Thriving on the Velocity Side of Economic Return®
Homebuilding is an industry that leverages equity with debt, therefore, some version of Return on Assets is the best measure of a homebuilding enterprise’s economic return. The most useful version of ROA is the DuPont identity, which expands economic return into two components:
Margin (Return on Sales) and Velocity (Asset Turn).
From an operational perspective, the vast majority of assets on a builder’s balance sheet ought to be houses in some stage of construction, particularly when raw land and developed lot inventory is held off-balance sheet; which means, when we calculate Return on Invested Assets, we can reasonably substitute Inventory Turn for Asset Turn.
The point is to thrive, not just survive. To do that, a builder has to do well on both the margin side and the velocity side of ROA. That understanding fundamentally proposes two questions: (1) How much can I make on every house? (2) 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; you will struggle to survive.
Your operation is a slow, marginally-productive homebuilding company; your competitor’s operation is 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.
In an industry with a capacity shortage, like homebuilding, there is not going to be any price elasticity of supply and demand, because there is not going to be any wide-spread, capacity-driven increases in supply. Besides, 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 even go there.
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, to thrive on the velocity side of Return on Assets.
Come. Participate. Learn.
The next Pipeline workshop™ will be held at the Ponte Vedra Inn and Club, Ponte Vedra Beach, Florida, on October 26-27, 2016. Cost is $850.00. Early registration, open through July 31, 2016, is $725.00.
Delivered by SAI Consulting and Continuum Advisory Group. Sponsored by BUILDER.
For more details: www.builderevelocity.com
