Imagine you’ve just been called downtown for a private meeting with your auditors. They’ve requested you come alone because they have something serious and highly confidential to discuss. Your day is now officially a disaster. “Can’t you just tell me over the phone?” you ask. The reply is an emphatic no; the news must be delivered in person in private. Two hours after arriving at the auditors’ office, you pull out of their driveway, still in shock over what you’ve just been told, one whiff of bus fumes short of nausea. Thoughts bang around in your head like in a pinball machine, bouncing from confusion to denial to anger then panic and finally settling in at despair. “How could this possibly happen on my watch?” you lament as you sit at a traffic light, staring yourself down in the rearview mirror. But you’re a survivor, and at some point as your car climbs the freeway ramp, the old drive kicks in again. A few miles later and you’re full-on engaged and proclaim aloud, “We’ll get to the bottom of this. Today!”
As you speed down the highway, disregarding most traffic laws, you tell the voice-call system in the Silverado to call Sherry in the office. She answers and you instruct her to have the entire senior management team assemble in your office at 2 p.m. sharp for a mandatory meeting. Sherry starts to explain why that will be difficult for one manager and that another is 20 miles away and … you cut her off. “Mandatory!” you tell her, this time more emphatically, “No exceptions, no excuses.”
One by one the team members arrive, some visibly annoyed at the sudden, unscheduled meeting. But their chatter dissipates as they settle in, later noting they’ve never seen that look on your face before. Forgoing small talk, you get right down to it. “I asked you all here today because our auditors called me in for an emergency meeting this morning. I have disturbing news. Someone is stealing from us. Big time. And it’s been going on for years.” An audible gasp fills the room, then a pall of disbelief falls over the team. You continue, “They aren’t sure yet who’s behind it, how much we’re losing, or just how the thief is pulling it off, but it goes way back and it’s been happening right under our noses. They believe the theft is at least $5,000 per unit. And what’s more, the losses seem to come out of every single department. We’re averaging about 10 closings per month now. That’s right, we’re talking about $50K a month! The total loss last year exceeded $500K, and this year we’re looking at $600K or more—unless we find the perpetrator and stop it. This is hard to believe, I know, but we went over the numbers 10 times or more and the loss is real. The auditors suggest we immediately hire a private investigator, but before we take that step, I think there’s a fair chance we can solve this right here, right now. So tell me,” you slowly and deliberately scan the room, stopping to look each team member in the eye, “who’s the thief?”
When Is the Best Time to Tackle Theft?
What will your people say? Who will they suspect? How will they respond when you ask them how to proceed? Remember, this is a real number. The auditors have absolutely determined that someone, or some group, is bleeding off $5K per unit from you—every month. Before you read on, consider what you’d do if this really happened in your operation. If it were true, how long would you wait before launching a full-scale investigation? A quarter? A month? A week? I’m betting the overwhelming majority of presidents, CEOs, and owners would say, “The investigation begins now, this very day, and we won’t cease until we find our thief.” Hardly anything else would get done.
So how would you react if your sales and marketing VP said, “Sounds awful, Mike, but you know we have four new communities this quarter with three model openings in each, we have to get the collateral materials ready, and I have to hire two new salespeople. Can’t this theft thing wait until the third quarter?” You’re about to choke on your coffee when your director of construction chimes in, “Hey, she’s right. We’re nearly doubling our normal rate of starts next quarter and I’m already short two superintendents, and the trade shortage is kicking our butts! I’m thinking maybe fourth quarter we look at this?” By this point you’re in total disbelief, trying to choose your words carefully, when the head of purchasing speaks up, “Well, I don’t know who’s stealing what, Mike, but it’s damn sure not in my department. I’d know. I’m trying to get start packages out for those new projects, then bid packages for the next five, and you already pulled two projects forward by six weeks. Our supers are screaming about the poor quality of trades we’re throwing out there and sales is out of control with its ‘custom options to make the sale’ routine, and I’m short a guy, too! Let’s just push this theft issue back until after year-end when we’ll have time to do it right.” You’re beyond stunned now and meanwhile, your head of finance/accounting sits there shaking her head, muttering, “No way, Mike. Just no way anyone is stealing that much from us. We need a new auditor before we do anything else on this. Those people are nuts.”
After some spirited discussion, you return to your office, when the auditor calls with the name of a top-notch private investigator, a CPA and former IRS agent who specializes in internal business theft. With only slight hesitation you tell him, “Jack, we just can’t tackle the theft problem now. My people are all swamped.” The auditor is dumbfounded. “Hey Mike, wake up! Someone is stealing more than half a million a year from you. That’s first-degree grand theft in this state. Twenty years in the big house. You ignore this for even a month and the bank and your investors will start suspecting you!” You pause, thinking it through, recalling the protests of each of your senior staff members and decide there is nothing you can do. “Call me in January, Jack. Maybe after year-end we’ll have time to catch the thief. Meanwhile, my margins are down and it’s all hands on deck to deal with that problem.” (After the margin comment and the click of the phone hanging up, Jack nearly falls off his chair.)
Back to Reality: Grand Theft Is Continuing and It's Obvious
This is a totally, completely, even outrageously preposterous scenario, right? Pure nonsense. I mean really, you discover that someone is stealing $5K per unit, costing you hundreds of thousands, maybe millions, of dollars and your entire team decides they have bigger fish to fry and you opt to not even begin the investigation for six months? All while you’re looking for margin? This could never, ever happen. Not in your company. Not on your watch. Except for one thing … my colleagues and I at TrueNorth find this everywhere we go. And I mean everywhere. It’s grand theft in the first degree and it’s going on right under everyone’s noses. It bleeds 3 percent, 5 percent—sometimes as much as 10 percent—off a builder’s bottom line.
Five thousand dollars per unit? That’s just a start. We’ve watched teams uncover $10K to $15K losses on average homes, and as much as $20K to $25K on thoroughly bloated, blinged-out higher-price homes. And that’s just “round one.” Then there are the losses in land development, driving up finished lot costs by thousands, even tens of thousands, and losses in process, such as the build schedule, which can drain away similar amounts. And we haven’t even touched the losses in overhead categories. Would you suspect that some lurk there?
And all of it—every last cent—is nothing but theft of what by rights should be yours. No one comes in with a gun and holds you up, and you’re not the victim of a Russian hacking scheme transferring money from your accounts in Chicago to theirs in Chechnya. No, this money leaves with your specific approval, via payments signed off and duly recorded in the books. It exits your office through your legitimate channels in a variety of categories, masked under the heading, “Business as Usual.” The money goes to materials, labor, product, and process that are—or at least should be—unnecessary. And all of it is preventable. Let’s take just one example, which to many may sound boring: foundations. Yet the TrueNorth team has been amazed by how many ways people come up with to waste significant dollars on what, on the surface, seems to be a simple process. A few examples:
• Wisconsin: “Boil out” resulting from poor form-board installation. Average concrete waste of 2 yards; $300 per unit, with labor.
• North Carolina: Excavator uses oversize bucket resulting in oversize footers; 3 yards average; $350 per unit.
• Michigan: Four yards of excess concrete in basement foundations due to “lazy engineering”; $400 per unit.
• Alberta, Canada: Grade-beams grossly oversized; $550 per unit.
• North Texas: Overdesign puts extra cable in a third of the beams and another third are specified too deep; $650 per unit.
• South Texas: Sloppy trenching for post-tension slabs, locally known as digging “muffins vs. brownies”; 8 yards; $900 per unit.
• Oklahoma: Switch from stick-built roofs to trusses. No one removes interior-grade beams; $1,000 per unit for material and labor.
• Illinois: Wrong materials for backfill of basement walls; 20 percent of homes leak, averaging $1,200 per unit to fix.
• Colorado: Switching to new soils-test firm; multiple total failures; cost exceeds $12 million.
I could go on, of course, giving you a hundred examples of loss on foundation alone and every other element in home building, internal or external. But stop here and visualize the process. In each of these cases, the builder “writes a check” for material or labor by a trade, a supplier, a service provider, such as an engineer, or internal overhead for admin and management. That check is either larger than it should be, or it should never have been written at all because in every instance the loss—the theft of your margin—is preventable. Our work in nearly 200 Lean Process implementations over more than 10 years has yielded literally tens of thousands of examples in every aspect of the business, from the foundation to the design center, from the accounting department to land development. Absolutely no one is immune. Virtually everyone reading this could be locked up for Grand Theft Home Building in the first degree.
Yes, It's Stealing Home Builders' Margin
Is Grand Theft too strong a term to describe what’s happening out there, all the money bleeding right out the back door of your office? When we simply call it loss, it doesn’t fire up the stomach acid or make the blood boil. The result is builders continually push back getting truly serious about recovering these losses. If we call it theft, however, stealing your margin, siphoning money from your bank account ... well, that provokes a more visceral reaction. It makes you angry. It makes you commit to leaving no stone unturned to find these thieves of profit and banish them forever. That’s the reaction we need. The dollar amounts we’re talking about far exceed the minimum requirements for grand theft in the first degree in all 50 states. The official position on grand theft by the law, however, is that it requires “intent.” Do I think anyone in this business sets out each day having made the conscious decision, with full intent, to bleed off profit margin? Of course not. We’re not talking about embezzlement here, and yes that happens, though it’s rare. But at what point does willful inaction begin to approach mindful intent? I suggest you walk a fine line when you know the loss is there, you know there are ways to stop it, but at best you keep putting it off and, at worst, you ignore it or just pretend it isn’t happening. Are you now anything more than an accomplice to the crime?
There are so many issues fighting for your attention, and thus it takes a lot—perhaps even something dramatic—to get you to focus on any one of them. So, let’s just call this what it is and be brutally honest. Are the margin bandits still at large in your company? My sincere suggestion is that this month, no, this week, you form your “Grand Theft Home Building” team and resolve to find exactly what it is in your product and process that’s stealing your profit. Identify the bandits, measure them, study them, and take specific, intensely targeted steps to eradicate them from your firm forever. Committing to that level of positive intent may just keep you on the right side of the law—unless, of course, you choose to put it off again.
Next, we’ll tackle one of the biggest margin bandits of all, the VPO.
For a free PDF of “Grand Theft Home Building,” and 12 additional supporting columns on finding lost profit, email [email protected].