| Scale Can Be Good and Bad for Big Builders |
| Written by Jonathan Smoke | |
| 02.29.2008 | |
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Discuss this article on the forums. (0 posts) Yesterday at the Wachovia Homebuilding and Building Products Conference, several big builders presented their current performance and strategies. As I listened in on several presentations, an ironic theme jumped out at me regarding the benefits and downsides of scale. In Centex’s presentation, Tim Eller, Centex’s Chairman, President and CEO stated that a key part of their strategy is to concentrate investment in markets with greatest long-term profit potential that reward high relative market share. He later walked through internal analysis of how Centex’s operating margins and returns on assets were positively correlated with strong relative market share. The tactical implication is that Centex is exiting markets where they cannot attain a top three position, and they will make investments to ensure they have a strong market share in each market in which they remain. I don’t question this strategy for Centex as one of the nation’s largest builders. Economies of scale can bring benefits to any sort of enterprise, including homebuilding. Within homebuilding, scale can improve margins by lowering the cost of materials and services purchased. Scale also leverages brand and marketing investments. Scale enables public builders to gain access to lower costs of capital. Scale can also help ensure builders get exposure to the best land deals.  But scale can be a limiting factor. This is because scale limits the number of markets in which big builders can operate. There are 939 metropolitan and micropolitan statistical areas in the United States. Builders who must attain scale in terms of units and/or in terms of market share will be limited to operating in a certain number of those markets—likely at most 100 of the largest markets, although some smaller markets can be picked up by being in close proximity to larger markets.What are the implications of this? Unlike other industries like automobiles, homebuilding will never fully consolidate unless large companies can develop a new approach to serving smaller markets well. It also means there is a lot of opportunity in hundreds of markets for smaller builders to exploit. Remember that Wal-Mart, the current epitome of scale in the retail world, started out in Arkansas with the express strategy of serving customers in rural and smaller markets that the then kings of retail ignored. Large housing markets tend to have similar characteristics; therefore, big builders will experience little benefit from geographic diversity. Just listen to Bob Toll’s remarks in the Toll Brothers' presentation yesterday. He joked that geographic diversity didn’t help Toll avoid the current downturn. Look at the markets they are in – high growth, coastal oriented, and largely bubble markets. If you are interested in listening to the builder presentations yourself, you can see the schedule and access current and recorded presentations at this link. 
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