How to Be the Big Dog

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Does market share really matter? And if it does, why do even the largest home builders in most markets struggle to achieve market share greater than 10 percent? Can anyone do today what Ray Ellison Homes did in San Antonio in the 1980s — reach a market share greater than 60 percent? We have data from many retail trades that shows dominant market share does, in fact, correlate to superior ...

June 01, 2005

Sidebars:
After Sale to Hovnanian, Orosz Seeks Market Share Home Run
A Market Share Warrior

Does market share really matter? And if it does, why do even the largest home builders in most markets struggle to achieve market share greater than 10 percent? Can anyone do today what Ray Ellison Homes did in San Antonio in the 1980s — reach a market share greater than 60 percent?

We have data from many retail trades that shows dominant market share does, in fact, correlate to superior financial results. The PIMS (Profit Impact of Market Strategy) database was created in 1972 by the Harvard Business School to test business management theory. Today, it is managed by the Strategic Planning Institute, and now contains more than 32 years of data on over 2000 companies. Analysis by the Strategic Planning Institute suggests that long-term relative market share is a proxy for long-term relative financial results.

The SPI analysis defines its terms as follows:

  • Long-term is a four-year average.
  • Relative market share relates the positions of the three largest competitors.
  • Financial results refers to pre-tax return on total capital.

There's plenty of evidence that home building is no exception to this rule. The median public home builder is now producing close to a 25 percent pre-tax return on total capital (twice the cost of capital). The average lead builder in the top 50 markets has almost a 10 percent share, with a relative share of 43 percent (averaged over the last four years). The PIMS database suggests that such leaders should approach a 31 percent pre-tax return on total capital.

Let's not misunderstand, however. Long-term relative market share in itself does not produce the financial results. It is, in reality, a proxy for the steps that do:

  • Superior relative quality is achieved by a combination of skillful product and service design and proper selection of market segments to serve.
  • Providing superior quality enables a successful business to charge premium prices and still gain market share.
  • By gaining share, the business attains scale and/or experience-based cost advantages over its competitors.
  • Higher profitability follows as a result of premium prices, at the same time costs are equal to — or less than — those of competitors. For example, if a builder reaches market leadership, that scale of operations usually creates advantages in purchasing and procurement of capital and land. Such a home builder can even turn cyclical changes into a competitive advantage — pushing margins when the market is hot, then dropping them a little to go after even greater market share when it cools.

"Good" Share Growth

How do you reach for "good" share growth, the kind we describe here, as opposed to market share "bought" through predatory pricing that actually erodes financial performance?

Keep two things in mind. The first is the choice of correct sub-markets. The second is to develop a balanced set of tactics to build share within those sub-markets.

Every building company produces its best returns where its 'prejudice for value' most closely reflects that of the market.

The Charlotte market strategic space map (on page 23) illustrates this process. The market has been subdivided, by price, into five sub-markets (or quintiles) of equal size. Key builders (those with greater than a 1 percent share) are displayed, sorted by their average sales prices — which is one way to assess where their value prejudices are closest to those of the market.

NVR leads this market with just a 6.31 percent absolute share, versus the national average of 10.0 percent. NVR will have difficulty reaching a 10.0 percent share from its current concentration of strength in the 4th quintile price point. The firm's value prejudice is at a relatively high price point, which will not allow it to reach deep into the second or first quintile with "balance." Typically, to reach 10 percent market share, it is necessary for a firm to have its strength concentrated in the middle of the third pricing quintile, in order to maintain balance across all price points.

John Wieland Homes and Neighborhoods' strategy in the Charlotte market is an interesting one. The firm's goal is to dominate not the whole market, but only quintile five. Wieland knows that its value prejudice will not play across a balanced portfolio, but it will in quintile five. A builder's long-term average sales price and its quintile position offer strong hints to where it will be financially successful. This forces the builder to balance unit volume against return per unit. Wieland's strategy is to dominate the one quintile where the firm knows it can please buyers and make money.

Choose Correct Tactics Mix

Market share is built by investments in place, product, price and promotion. Place is the number of locations and their geographic distribution. Product is the number of house plans built and the perceived quality of those plans in the eyes of home shoppers. Price is the number of quintiles covered and the spec-adjusted performance of the firm in price per square foot. Promotion is the perception created by marketing and sales investments. Balanced investment in all four produces share growth with the greatest returns.

You need a significant share of building locations to get a significant share of house sales. And they can't all be in one quadrant of the market geographically. To build dominant share, you have to be in two or more quadrants, preferably all four. If you want to dominate quintile five pricing and you have no locations in the key quintile five geographic corridor, you will never reach a dominant share. It takes balance and volume to reach a great "place" score.

If you survey shoppers, how well does your product score against the competition on street presence of the elevations and traffic pattern efficiency of the floor plans? There are perhaps 20 different measures that can be used to score product.

If you only build in one pricing quintile, you can never reach more than a 20 percent share of the total market. But it's hard to be good in more than three quintiles. Think of how many product lines and house plans you would have to build, and how many locations you would have to buy. To build through four quintiles, a builder will probably even need different sets of subcontractors.

Promotion really has three aspects: traffic counts, closing ratio against those traffic counts and the perceived quality of marketing promotions, ads, signs, brochures, etc. This gets complex, and expensive, when product offerings stretch across multiple pricing quintiles.

Many builders invest most in their strongest tactic rather than make investments in their weakest. Some may think they can win in the marketplace because every one of their locations is an "A" site. Or because their product is so incredible, it doesn't matter where they build it. Or because they consistently have the lowest price per square foot.

Those are all ineffective ways to build market share. Profitable share requires balanced investment in all the tactical areas. It's like a chain: only as strong as its weakest link, but you need multiple links to have something that works. Share will grow, with better financial results, when you address your weakest tactic rather than continuing to over-invest in the strongest.

Barriers Above 10 percent Share

It's hard for any builder today to grow beyond a 10 percent share in a top 50 housing market. There are a few exceptions, such as KB Home in San Antonio (thanks to its acquisition of the remnants of Ray Ellison's empire), and M/I Homes' domination of its hometown of Columbus, Ohio, which has exceeded 20 percent at times.

However, the competition is already fierce in most major markets and growing tougher every day. And the value prejudice of one company in a single market can only cover so much and continue to improve financial results. Every building company builds houses a certain way — and it will run into trouble if moving into a price quintile requires it to build a different way.

Quintile four and five builders have trouble dropping specs to reach the value prejudice of the market at quintile one or two. Builders in those lower price quintiles find it tough building houses better to move up to quintile four or five. One company embracing such a broad spectrum of vision, values and volume goals can easily lose its way.

When I was at Crosland Communities in Charlotte N.C., we got to 25 percent market share, second only to Ray Ellison in San Antonio. So we climbed on a plane to go see what they were doing. The capital turns were incredible, but we came away with the sense that Ray wasn't in the home building business as much as land speculation. They controlled a full circle of land around the city, but didn't build on it. Instead, they went out to the next circle, with the strategy that building there would increase the value of the land in the inner circle. They owned huge amounts of land — a risky business.

The other piece of the puzzle was the unique nature of the San Antonio market, which was largely military, with very narrow pricing bands. The quintiles were very tight, so it was not nearly as much of a stretch to build across four, or all five, with a single organization.

It would be difficult for any builder to reach that level of market domination today, in San Antonio or anywhere else.

The Acquisition Error

One way builders — especially public ones — try to overcome the limits of reach from an established value prejudice is via acquisition. If the builder is strongest in quintile four or five, then why not acquire a local company that specializes in quintile one or two? It's a solid strategy, but one that usually goes awry because the acquisitor tries to consolidate certain operations and — in the process — ends up destroying the very value prejudice it sought to acquire.

You have to be careful what functions — if any — you choose to consolidate. Land acquisition and development can probably be united for two disparate home building companies. Anything that's business-to-business will work. But everything that touches the customer should never be united. That contradicts the value prejudice of the acquired company.

Where so many acquiring companies mess up is when they consolidate elements that touch the retail side of the business. They end up with a hodgepodge that's neither one nor the other. That's a recipe for declining market share and bad financial results. It's amazing how often big public builders acquire a small local firm to extend market share and end up losing all of that share with a decision to consolidate the brand.

Something goes wrong with the acquired company and, rather than fix it, they just roll it into the parent corporation.

It's always better to have multiple brands. Buyers have a prejudice against buying a $350,000 house from the same company that builds at $120,000. I think that's more than just a prejudice. It's really buyer intelligence.

QUINTILE I II III IV V
Price <$130,000- $130,001 $157,001 $197,001
$157,000 $197,000 $280,500 >$280,500
Units 3,150 3,150 3,150 3,150 3,150
Builder Total Share Ave Share Ave Price
Simonini 0.27 1.36 1.36 $968,420
Poore 0.16 .86 0.85 $795,790
QUINTILE V
Wieland 2.36 11.73 11.73 $501,420
Orleans 1.56 1.91 5.86 3.88 $337,670
Niblock 1.42 3.30 3.63 3.46 $301,430
St.Lawrence 1.16 1.27 3.95 2.61 $314,870
Shea 3.21 0.77 8.10 7.11 5.32 $285,460
QUINTILE IV
M/I 1.03 0.83 2.92 1.34 1.69 $256,760
Arvida 2.60 0.33 1.50 2.05 6.39 2.71 2.59 $236,670
NVR 6.31 2.42 3.72 8.11 11.63 5.61 6.29 $216,990
Pulte 2.59 1.06 4.10 6.80 0.92 3.22 $215,490
Horton 2.67 1.21 2.31 4.62 3.30 1.91 2.67 $203,180
Centex 4.47 2.06 5.63 4.52 6.23 3.86 4.46 $204,930
QUINTILE III
Hovnanian 2.18 0.69 0.81 5.67 3.50 0.25 2.18 $188,740
Ryland 3.19 1.67 4.16 5.23 3.91 0.92 3.19 $185,590
Lennar 1.60 1.08 2.69 1.83 1.65 1.81 $185,120
MDC 2.67 2.94 6.35 3.88 4.39 $182,920
QUINTILE II
KB 2.58 2.58 5.50 3.88 0.73 0.16 2.58 $154,060
Eastwood 2.73 1.34 6.47 5.74 4.51 $151,280
Mercedes 1.08 2.09 1.38 0.83 0.95 0.16 1.08 $149,870
Stand. Pacific 1.44 2.87 2.44 1.57 0.19 0.16 1.44 $145,880
Homelife 2.69 3.33 6.66 3.33 4.44 $144,970
Mulvaney 1.58 2.94 2.63 2.31 2.62 $141,960
Craft 1.42 2.42 3.69 0.80 2.30 $141,090
Beazer 4.35 8.85 8.38 4.30 7.17 $139,330
QUINTILE I
Liberty 0.79 3.89 3.89 $106,320
TOTAL MRK
Top 3 Bldrs 15.13 16.07 21.15 20.20 26.53 24.71
Leader's Relative % 41.70 55.07 38.95 40.14 43.83 47.48
Source: 4Q04 MORE Reports & Newton Graham Consultants

 

After Sale to Hovnanian, Orosz Seeks Market Share Home Run

Orlando builder Bill Orosz of Cambridge Homes is a long-time client of market share management pontiff Chuck Graham. He applied Graham's theories of managing toward long-term return on capital into a lucrative deal to sell his company to Hovnanian Enterprises in March this year. Now, with Ara Hovnanian's Wall Street capital behind him, Orosz is swinging for the fences in market share.

"I met Chuck when he spoke at Benchmark in Phoenix in the 1990s," Orosz says today. "It took a couple of years before any of what he was talking about really jelled with our team. But eventually, we got everybody focused on return on capital as our most important measure. One of the first things that led us to was a decision to abandon the entry-level pricing quintile where we were concentrating production. At that time, the whole Orlando market was falling all over each other, trying to get more unit volume — at very low prices."

Graham was actually alarmed that Orosz would abandon what seemed to be an established "prejudice for value" so completely. "At first, my position was, 'If that's where you are, you need to find a way to make it work,'" Graham says today. "But the more Cambridge tried to build market share at that price point, the more financials were hurt. So Bill made the move upstream in price."

In fact, Cambridge moved quickly to a new average sale price nearly double what it had been. "Our product was over-specified at entry level," Orosz says. "It's tough to do high quality at the low end of the market. That's a value buyer. But we were never comfortable reducing our spec level. We had to jump up a couple of quintiles to give ourselves room to build market share by spilling into the quintiles on either side. At first, we went right to the third quintile from the first. Today, we're in the fourth and fifth, with only a small amount of production in the third."

Graham says Cambridge actually found the right product for a prejudice for value that already existed in the firm. "They were more comfortable at the higher price point than they ever were at the low end. They found the right pricing to deliver their best value to buyers."

Orosz maintains his firm was already "hard-wired" for the new price point: "We were just too high a quality builder to be where we were. Architecture, trades, everything is integrated. As we moved up in price, everything came together for us. It's different in selling techniques and the way you handle customers. We hit our stride." Here's how Cambridge Homes' financial results changed after the upstream move in price point: During the nine months ending with the third quarter of 2000, Cambridge closed 310 homes at an average price of $177,917, and job profits (excluding project and corporate fixed marketing and general and administrative expenses) exceeded 13%. During the nine months ending with the fourth quarter of 2004, the company closed 436 homes at an average price of $259,753, and job profits exceeded 24%.

During that time, Cambridge moved from a company focused on the third and fourth pricing quintiles to one focused on the fourth and fifth. Sales dollars increased 100%. Unit volume in-creased 40%. The percentage of job profit in-creased 84%. The application of the space-mapping process helped Cambridge discover a better field of battle-one more suited to its in-herent value prejudices.

"When Chuck started working with us, a decade ago, our pricing was in the high 70s range, Orosz says, "Our average sale price will be well over $300,000 this year. Of course, much of that is price appreciation in the market."

Cambridge even moved into traditional neighborhood design product and began building at Disney's Celebration and Baldwin Park, a high-profile redevelopment of a former Navy training center in central Orlando. "We're now building 120 to 140 different house plans at all times," Orosz says, "and updating them constantly. The oldest plan we build has been in the portfolio for only four years."

When Cambridge moved up in units, from 400 to 600 units a year, over the past several years, the firm's market share stayed nearly level because of increasing competition — especially from public builders. "The market grew around us," Orosz says. "The reason we didn't grow more than we did is because we are so focused on return on capital. We maximized the profit potential of the sites we had rather than chasing new land positions at high prices. We had a great 'place' strategy. And our financials went way up."

Never comfortable getting into bidding wars for high-profile sites, Orosz is now excited to use Hovnanian's capital base to move into new market niches. "We'll stay mostly in the pricing quintiles we're in now," he says, "It's hard to be good in more than three quintiles. But we'll increase the breadth of our product offerings by going into active adult. Hovnanian has a lot of experience in that area. It's a big part of the central Florida market, but we shied away from it because we didn't want to go through the brain damage to learn it. Now we can tap into the expertise that Hovnanian has as well as the public capital. Active adult could be 20 percent to 30 percent of our business within a couple of years."

Orosz also sees Cambridge moving into mid-rise and high-rise development with Hovnanian talent showing him the way to exploit small infill sites. "Ara has a lot of interest in those kinds of things," Orosz says, "and Hovnanian has products that will work here. As our capital base expands, we'll do a lot of new things, but we have a company that's used to change. We embrace it. But we'll stay focused on return on capital.

"When Ara Hovnanian and I began discussing acquisition, we spent a lot of time together. The topic of return on capital came up after about five minutes. We compensate our people very heavily on it, and all levels of our organization are focused on process as a result. We'll grow faster now, but we'll keep our eye on return on capital."

A Market Share Warrior

Chuck Graham is a principal of Newton Graham Consultants, a Charlotte, N.C.-based management consulting firm that specializes in the pursuit of superior financial returns via dominant home builder market share positions. Newton Graham has production builder clients in many markets across the country.

But Graham is more than just a management theorist. As vice president of marketing for Professional Builder's 1986 Builder of the Year John Crosland, Graham was part of a management team that actually achieved a 25 percent share of market in Charlotte, N.C., before Crosland Communities was sold to Centex Homes at the end of 1986.

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