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A CASE STUDY
A builder’s most profitable division is now its loss leader. Volume has fallen from 3,000 units to 1,000. Even worse, gross margins went from more than 20 percent to negative. Staff in most departments is down 70 percent and management is discussing a possible market exit. Rebidding efforts have led to significant reductions in direct cost, but these have not kept up with falling sales prices. The options for an overworked purchasing staff look limited.
Unfortunately, this story is known by many in the home-building industry. For one top-10 builder division, Continuum’s takeoff and cost management service offered an answer to some of the market’s seemingly impossible problems.
Continuum’s “30 Days to Savings” Cost Management System Process Flow
At first, many of the builder’s employees were skeptical. They had rebid their projects several times and had not realized additional reductions of late. In addition, the division had almost no staff left. Those who were left were at the office until after 8 p.m. every night just to keep the business running. How would they have time to make significant changes?
Target Low-Hanging Fruit
After completing material quantity takeoffs on the division’s top-10 plans, the best unit pricing available in the market was used to determine the best possible cost for each trade. Several areas of focus appeared. The engineered I-joist packages were priced well above the total determined by summing the cost of all items on the layout. After interviews with the supplier and trade contractors, it was discovered that the supplier was sending two additional long joists with every pack in order to account for errors in the field. It also was charging two times the linear foot cost for precut blocking panels. The team, in partnership with the division’s purchasing staff, also identified numerous order errors resulting in extra, expensive, engineered LVL and Glu Lam beams being sent to the job site.
Continuum worked with the supplier to audit and clean up the joist orders. The excess material was eliminated and a more reasonable rate was negotiated for precut items. The result was between $500 and $2,000 savings per plan. For the division, this resulted in annual savings of $1.2 million.
Lumber presented another large opportunity. Takeoffs indicated potential savings of $2,000 to $8,000 per home. As a first step, this information was presented to the framer with a request for lower pricing. This resulted in large price cuts averaging $2,500 per home.
The same process was followed with roofing, drywall, and foundations. Savings per plan averaged $400 to $1,500 for each trade (see pie chart below).
The initial quantity analysis drove rapid results for the division. In 30 days, an average savings of $5,800 per plan generated $6 million in direct cost savings for the division. The bleeding had been stopped and the focus turned to establishing the process and systems to maintain and grow these savings over time.
Buy Differently
As a result of the process, the division decided to change its method of engaging trades and suppliers. Instead of continuing the typical industry practice of bidding trades in turnkey — labor plus material — lump-sum fashion, each trade is now priced by applying a competitive unit price bid to the material quantities determined from the takeoff. Drywall offers the least complicated example.
After the drywall takeoffs for every active plan in the division were completed, meetings were held with the trades to gain agreement on the material quantities. The builder then asked the drywall contractor to supply one number in its bid: the installed cost per square foot for drywall. The resulting price was well below the lowest price previously seen in this market and translated into an additional savings of more than $500 per plan on drywall. Going forward, the builder has received additional savings on all its plans as drywall prices have fallen by adjusting this price per foot number. This process addressed the two most critical factors in the builder’s purchasing function: It has been able to increase savings while reducing staff time spent rebidding. A once impossible situation has turned around 180 degrees.
The divisional purchasing staff was able to deliver similar results by working to apply this process to foundations, roofing and lumber. Lumber required the largest effort and generated the biggest reward. The division worked with local lumber suppliers to achieve the best unit cost for lumber in the local market. This pricing was first applied to the framer’s lumber list and generated substantial savings. Next, an item-by-item quantity comparison was performed between the framer’s list and the takeoff to identify opportunities for material reduction. This process was completed for every base plan, elevation, and option.
The new lumber lists significantly reduced quantities and drove significant additional cost savings. The division now prices lumber by adjusting a master lumber price list and applying it to each takeoff. Price visibility now exists between the division and the framer. This process lowers the time spent rebidding, allows for more effective long-term relationships with suppliers and trades, and generates lower direct costs. Since the project began, the builder has achieved framing reductions between $4,000 and $12,000 per home. Unlike in many areas of the country where a builder is forced to purchase the lumber directly (a process that requires significant administrative time from the builder), in this division the framer is still responsible for buying and managing the lumber. The builder and framer have simply agreed on the quantity and unit price that the framer will use to purchase the lumber.
Results
The takeoff and cost management service has generated annual savings in excess of $8 million for the division. Total direct cost has been reduced by 15 percent. This division is now the top-10 builder’s leader in terms of cost savings, among more than 20 divisions. Most importantly, margins are now slightly positive in a market where many builders continue to suffer huge losses. Moving forward, the division is well-positioned to deliver the right product to customers for the right price.
Takeoff and cost management is key to higher margins.
Virtually all large U.S. builders are losing an average of $2,000 to $4,000 per home due to inaccurate takeoff procedures, inflated waste factors, and careless use of materials on site, according to research conducted by Continuum Advisory Group, which has analyzed building materials packages for more than 1,000 different house plans in multiple divisions of the nation’s top home builders between 2006 and today.
This means that a builder that completes 250 homes per year will reduce its annual profits by $500,000 to $1 million — a significant drain on profitability.
The Problem
Call it the home builders’ “latte factor,” a term that describes why someone who spends $4.99 per day at Starbucks can’t afford to save a couple of hundred dollars each month. A few bucks a day may not seem like much, but it adds up to a hefty annual expense.
The same process is bleeding profits from builder divisions. Material takeoffs are rounded up to the next highest number, then padded with generous waste. Inaccurate deliveries aren’t identified as such, so the builder pays for stock it never receives. Materials are then used inefficiently, so more has to be ordered to make up the shortfall. But while a few studs here and a few sheets of plywood there seem like no big deal, they add up to thousands of dollars in unnecessary expense on each home.
A few years ago — when everyone could get a mortgage, prices were rising, and buyers were standing in line — the most important objective was to build and close homes quickly. Material conservation was not nearly as critical, particularly with the amount of price inflation that was present in most major markets. However, with home prices falling nationwide, builders who want to stay in business have no choice but to run tighter operations.
Where the Profits Are
The top areas of physical waste are found in framing and siding (including brick veneer), roofing, concrete, and drywall. The reasons for this waste include:
Not paying enough attention to details. Most builders do not know exactly how much of what materials go into their homes. That lack of detailed knowledge means they are cheating themselves out of a powerful negotiating tool to use with trade partners. But the builders are not alone: Even their trade partners would be hard-pressed to give an accounting of the stock they use because they tend to pass the buck for takeoffs to their suppliers. Of course the supplier is in the business of selling building materials, and while most suppliers want to be accurate, they are so busy that they only have time to do estimates rather than takeoffs. In fact, many shipments are inaccurate, with too much of one item and too little of another. The result: repetitive field orders that never make it into the budgeting process. That hampers the builder’s ability to accurately analyze the cost of building a plan.
Generous waste factors. Regardless of who figures the materials order, trade contractors always add a waste factor to cover damaged material, theft, and installation mistakes. Most add 10–15 percent, but the actual waste is higher, because takeoffs are rounded up to the next highest number before the waste factor is added in.
Bundling of materials and labor. Contracts that roll materials and labor into one price give little or no incentive for suppliers or installers to use materials wisely, and they hide the potential savings. For instance, if drywall is selling for $10 per sheet, most builders assume that reducing the drywall takeoff by five sheets will save them $50. The truth is that the drywaller charges a price per sheet that includes materials and labor. If that price is $35 then the builder can actually save $175.
Overextended job supervisors. Many builders have cut costs by reducing staff. With fewer job supervisors, the ones who are left are responsible for more jobs than before. So when a package is dropped at the site, they do not have time to verify the count. They also do not have time to hold trade partners accountable. When a trade partner comes up short, most supers automatically stamp the field purchase order, and the true cause of the shortage is never identified. There is no incentive for the trade partner to conserve material, and all shortages get coded as takeoff errors, regardless of the true cause. This makes accurate estimating and budgeting impossible.
Transferring material from lot to lot. This is another practice that plays havoc with estimating. If a framing, siding, roofing, or drywall crew is finishing a house on one lot and it’s short of materials, it will often take some from the house next door, leaving a shortage on that job. This has a domino effect as more homes are built. The effect on the construction manager and purchasing manager, who are trying to determine the correct material quantities, is much like the popular carnival game Whack a Mole: Each time they think that they have the problem figured out, it pops back up on another lot!
Unclear lines of responsibility. Many builders lack a system for ensuring that unused materials get returned and credited. The field supervisor may think it is an accounting issue, but the accountants cannot track down a missing credit if they are not notified of the return.
Culture of “close enough.” The residential building industry has operated for years on the premise that material quantities need only be “close enough” to produce acceptable financial results and to avoid material shortages. The industry does not have a continuous improvement culture and operates in a classic cyclical fashion. When times are good, builders and trades make lots of profit, and when times are tough, they share the pain of losing money. This culture and mentality causes significant volatility in the financial performance of all the players in the residential supply chain and destroys millions of dollars of value through every cycle.
Power Takeoffs
Luckily, there’s a straightforward fix for the above problems, and it has an almost immediate payback for the builder.
Much of this waste can be eliminated by working with the individual trades on cutting direct costs, specifically the amount of material that goes into a home.
Many purchasing managers have been told to renegotiate their contracts, but because they let trade partners figure materials, they do not have enough information to get into a good negotiation position. Working with a third party, the purchasing manager can gather the information needed to negotiate the best contract price. An accurate takeoff is a powerful negotiating tool, especially when it’s backed up with a system for helping trade partners work with the new takeoff amounts.
This system has been proven to significantly reduce waste factors: Builders who have implemented it are now working with waste factors of just 4 percent for panels and 8 percent for dimensional lumber.
In addition, reasonable unit pricing for installation labor brings further cost transparency, making it easier to realize potential cost savings and providing an objective baseline for future interaction with trades and suppliers.
This is not a value-engineering process. Builders do not have to change their plans or specs. Instead, builders should “unbundle” materials and labor and identify the exact amount of materials needed for each phase of construction. Then, compare takeoff quantities to the current materials packages, and create a new target budget. Look for areas where less costly products could be substituted without impacting the design or structural integrity of the house. Builders may then work with their architectural and engineering staff to decide whether to make these changes.
More detailed takeoffs improve potential savings. Using the drywall example again, do a separate takeoff for the first and second floor walls, the first and second floor ceiling sheets, and the garage. This helps both the builder and the trade partner get a better grasp of where shortages are occurring and where they can save money.
This system has been proven to significantly reduce waste factors: Builders who have implemented it are now working with waste factors of just 4 percent for panels and 8 percent for dimensional lumber.
Builders can even save on engineered lumber. For instance, one builder used a lot of I-joists. The supplier was creating excessive waste by shipping longer spans than necessary and shipping extra pieces that never got returned. The builder saved an average of $400 to $1,000 per house on I-joists alone.
On the Jobsite
After creating detailed materials lists, builders must work to ensure that their entire team — from the purchasing department to project managers, job supervisors, and trade contractors — learns to work with the new numbers.
Get trade partners involved early in the process. Meet with a representative of the framer when you’re counting the house to gather his input and to show him where the potential savings are. It is critical to understand how the home is built in each specific location, and the trades are consistently the best source of this understanding. For instance, they can point out details that are not specified on the plan but are required by the local inspector. A takeoff based solely on the plans will miss this local nuance and will not be completely accurate. Accuracy is essential to gaining the trade’s buy-in and to making the process work.
The process does require some new work habits. Job supervisors have to pay closer attention to the actual material packages, and trade contractors need to be more careful with details, such as how they cut up framing stock. Most will adjust. By the end of the process, the builder is getting consistently lower prices, and the trade partners have gotten used to working with the lower takeoff amounts.
The key to getting cooperation from trades and staff is to show some immediate savings. To do this, spend 30 days working with a few key trades. Framing and drywall are two places where builders can get a good bang for their buck. Homing in on material management and waste reduction will often find $600 or $700 in savings on drywall alone in a typical 1900-square-foot house.
Another way to get buy-in from trade contractors is to show them how the system can benefit their entire operation. Companies that focus on using materials more efficiently end up planning their jobs more carefully, which means their workers become more productive. Trade contractors who have gone through this process generally become better managed and more profitable on all of their jobs.
The Bottom Line
Builders can no longer afford their Starbuck’s latte in the current residential building market. Across the country, profits are slowly draining from building divisions at an average of $2,000 to $4,000 per home from inaccurate takeoff procedures, inflated waste factors, and careless use of materials. Fortunately, builders can stop the drip by implementing a takeoff and cost-management plan.
Clark Ellis is a principal and founding partner with Continuum Advisory Group, where he provides consulting services to home builders, real estate developers, manufacturers, and installing contractors. His expertise includes market strategy, planning, market research, training and development, and process improvement. Eliss holds an MBA in marketing and general management from the Babcock Graduate School of Management at Wake Forest University and a bachelor’s degree in political science from the University of North Carolina at Chapel Hill.
Mitch Cohen is a principal and founding partner with Continuum Advisory Group, where he consults with national builders on financial matters, such as integrating financial models into their businesses to enable them to build more profitable homes. He also works with building product manufacturers in the residential space to improve their ability to deliver products and services that add value to their trade partners and end users. Cohen has a bachelor’s degree in management and marketing from California State University at Fresno.
