| Competing on Price Is the Choice of Many Builders |
| Written by Jonathan Smoke | |
| 07.03.2007 | |
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Discuss this article on the forums. (0 posts) At the June Bank of America 2007 Homebuilders Conference, the public builders presented their views of the current market situation and were subjected to many insightful questions by the conference participants. You can read transcripts of the presentations in our Builder News section. A lot of time was spent discussing pricing and incentives. A very revealing picture was painted by Don Tomnitz, President and CEO of D.R. Horton, Inc. in the transcript from his company’s presentation. “In California in the fourth calendar quarter of '06, we went to what we called in a number of our markets, rock bottom pricing. And we had a really good sales jump in that fourth quarter. Then in the first quarter of calendar year '07, which was our second quarter -- get all this straight here -- we went to what we called rock solid pricing. It reminded me of the airline industry. We raised our prices and they didn't stick.
The other market, just to digress a little further, which was a solid market for us was Arizona. And we had a meeting amongst all of our regional presidents and D.R. Horton, our Chairman, who I have been with, oh, it will be 24 years this August, looked at our numbers in Arizona and he said, gee, you have already accomplished 90% of your sales and closings for the whole fiscal year in Arizona. Raise your prices. We raised them. What happened was in that quarter that just ended 3/31, our sales did not meet our expectations, so we adjusted our pricing effective about May 15 of this year. And we expect to -- especially in California -- to increase our sales to a level higher than what we had in the first quarter, calendar year '06. And we're adjusting our pricing as we go across the country. Because we have one solid goal. We have an inventory of land and lots. We have jettisoned about half of our option lots. I think we jettisoned about as many of our option lots as we want to. And now we have 66% of our lots that we own. And Horton and I know one thing for sure, the best thing that we can do on those 66% that we own is build -- build, sell and close a home on those. And that is the way we're going to work our way through that land position.” What do we learn from this exchange? Pricing power is only in the hands of the buyer, and lower prices and incentives are lubricants being used to move current sales. Attempts to raise prices slowed down sales in the first quarter, so to meet volume goals, builders like D.R. Horton are willing to lower prices in order to move inventory and meet their goals. This strategy is not limited to big builders. On the contrary it could be argued that smaller builders have even more incentive to lower prices. Here’s the argument: Smaller builders have less capital available to keep them afloat when inventory is up and sales pace has dropped. So closings are vital to keep the necessary cash flowing required to keep the operation afloat.  Unlike larger builders, small builders have barriers to exit a market. What I mean by that is that they find it difficult to exit a tough environment as it is usually the only market in which they operate. Large builders on the other hand can choose to exit a market as part of a portfolio management decision. Therefore, when times are tough, a small builder has tremendous incentive to do whatever it takes to survive. And that means they will lower prices and/or offer incentives that lower their margins, even to the point of making them negative, in order to generate cash flow to keep the operation alive.Negative margin can’t continue forever, but the hope is that this survival strategy will buy enough time for the organization to make it through the downturn. Of course, the problem is that when others respond with the same survival strategy, competition becomes more influenced by price, which puts even more power in the hands of the consumer. This in turn puts more pressure on prices to fall. Larger builders tend to protect some level of margins as long as they are not facing a significant spec inventory. But if large builders like D.R. Horton can compete on low price strategy like Wal-Mart in retail, times will be even more difficult for small builders and big builder counterparts who are not as willing or not as suited to compete on price. We’ll likely see just how widespread these new home pricing pressures are through the end of 2007, though we will have to get creative in how we measure them. Since the figures that the Commerce Department reports are from gross sales, they do not reflect the actual prices net of incentives that builders offer. We are looking into a better way to measure new home prices within markets. Stay tuned for what we find. 
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