Builders that purchase labor and material on bid price alone are guaranteed only that they will never operate by lowest total cost
Some years ago, I worked on a project with “Ryan,” a 30-something purchasing manager for a national builder hired from outside the industry, as was the rage at the time. Unlike so many of his alien brethren, he had worked hard to understand the differences and nuances of home building before launching his personal reform campaign upon our always complex, frequently convoluted, and sometimes wondrous supply chain. Ryan learned where the costs and margins really lie, not just for the builder, but also for the suppliers and trades. He discovered the insidious nature of waste and that a dollar was a dollar, no matter if it fell to the builder, supplier, or trade. It all counted. He accepted that he could not simply force his company to change overnight, as it was inescapably tied to industry practices that, as inefficient as they often appeared, evolved over decades.
Ryan was a true bright light in a company long known for treating its suppliers as something less than disposable commodities, never as business partners. He was a rising star, and if Professional Builder had asked for a list of “Top 10 Young Pros Changing the Face of Home Building,” Ryan would have been one of my nominees.
Ryan, however, like all who labor to change home building’s long-entrenched operating practices, had a battle on his hands. So many in his company — and I wish I could say this was unusual — had risen in both position and financial status through the time-honored tradition of “management whack-a-mole” — keep ’em scared, keep ’em down, maintain control. This tradition kills both innovation and any sense of continual improvement, but when the name of the game was just get the houses built for customers-in-queue, no one cared much.
Ryan led a tremendous success in one of his firm’s divisions and pushed to take Lean process nationwide. That notion was quickly squelched, however, when presidents of other operations launched a strategy of systematic denial of the results. I had seen this pattern many times in my career, but this was the first time I actually overheard two executives plotting the sabotage, unaware that I was within earshot. The fear of looking bad in front of the company CEO when millions of dollars of waste were uncovered in their own operations was a larger concern than the desperate need to improve their meager profit margins. The disappointment in Ryan’s voice was palpable the day he called some weeks later saying, “Scott, the forces against me are too strong. If I push this any further, I will lose my job.” I wondered how long Ryan would last, and if he did, under what circumstances.
What Happens When All You Hear Is Price
Fast forward now to January’s International Builders’ Show where I met up with an old industry friend for some late-evening commiserating at the bar. “Joe” was now president of a large, multi-state trade company and was ruminating about the state of things. He described a meeting the previous week in which a regional purchasing director from a national builder opened the gathering with a strong declaration, “Let me state this clearly before we begin: We are bidding this to four companies and there is a single criterion for selection: bid price. We don’t care what you have to say about delivery, quality, capacity — none of that. All we want to hear from you is price. If it’s the lowest, you get the job. Period. So let’s have it.”
The strange thing, Joe observed, was that this purchasing director was clearly uncomfortable, adding, “His bravado seemed in inverse proportion to his commitment. He avoided eye contact.” Joe, an experienced and savvy industry vet (meaning he is almost as old as I am), concluded that he was dealing with a guy who was mouthing the party line, yet didn’t believe a word of it. His heart was just not in it. His name? Ryan. I told Joe the rest of the story and all we could do was order another round.
Twenty-two years working with builders, suppliers, and trades in a myriad of combinations have taught me one inviolate rule: The only thing that purchasing on bid price alone guarantees is that you will never operate by lowest total cost. This is not a supposition or an ideology. This is a cold, hard business fact, and a broad understanding and acceptance of this would literally change the industry. Although it became obvious to me 20 years ago, over the past five years, my colleagues and I have engaged more than 1,500 suppliers and trade contractors in Lean process implementations with more than 10,000 of their personnel. Instead of mere observation, there is now inarguable data.
So ... How Do You Reduce House Cost?
Ask yourself a simple question: What would be the best, most productive way to reduce house cost by $10,000? A) Have your suppliers and trades bring it to you in a way that leaves their margins intact, or B) hammer it out of their bid price?
If you answer “B,” go no further because you do not believe “A” is even possible. But you have a huge problem — you are now on your third or fourth round of demand letters calling for unilateral price reductions, and that well is dry. Of course, rebids were an obvious and immediate stop-gap measure in the early stages of the recession. After all, the customers rebid the builders multiple times and I don’t fault any builder who took that route in the beginning. But there was and is a better way, and a few builders have found it. Ironically, it has been the past five years of the housing recession that has opened both doors and eyes, enabling the best builders, suppliers, and trades to finally see what they were leaving on the table. They have learned how to improve their margins through significant cost reduction — without collateral damage — by understanding all aspects of cost.
This requires a literal change in thinking, which is no easy task with purchasing managers’ feet held to the fire daily for immediate results. I will state this unequivocally: There is no such thing as a “commodity buy.” Whether you are purchasing plywood, shower bases, trim carpentry, or cleaning services, “all else being equal” does not exist in the real world. There are always differentiating factors. If you don’t believe that, you simply have not yet learned how to measure. This simple, observable, and measureable fact has profound implications. The goal is not cheapest bid price. The goal is lowest total cost of operations.
The frustrating part is so many purchasing managers and directors really do get it. The problem is they, like Ryan, are handcuffed, forced to work under directives from someone above or in an office 500 miles away, that does not.
What would I have them “get”? What follows are the things I hear from senior purchasing and operating managers in the best companies, the ones who are growing and making good margins even in this lousy market. These represent basic tenets of purchasing that a builder must practice and internalize that enable lowest total cost.
The Basic Tenets of Purchasing
- Initial bid price is very important, but is just one of many factors we consider in choosing and maintaining supplier and trade relationships. We operate by defining and measuring lowest total cost of operations. Using bid price alone is fiscally and operationally irresponsible.
- A preeminent goal is to help our suppliers and trade contractors become more successful. We do this because it helps us become more profitable.
- A dollar saved is a dollar saved, and that counts, no matter who it goes to initially. If we show no interest or reject an improvement that generates greater margin for our suppliers and trades, we will find far less for ourselves.
- We have to harness the brainpower of all contributors. For each of our people there are at least 20 others in our supplier and trade base who supply labor and materials for our homes, only a fraction of which are the managers.
- Frequent mass-bidding means our suppliers and trades simply cannot take the time to do good takeoffs and bid effectively. The result is the exact opposite of what we intended.
- The only way to get the bids right and do apples-to-apples comparison is to get the plans and specifications right, in detail, up front. Any money spent there pays 10 times in execution.
- We do our own takeoffs, then sit down with our suppliers and trades and compare. The numbers virtually always get better, not by beating them down, but by dealing with accurate quantities, the right products, and using preferred methods.
- We find the very best suppliers and trades by total cost, build solid relationships, and get them involved all the way back in the design process, then every step of the way.
- We continually evaluate our suppliers and trades and give them feedback via our total cost model. This has required much more discipline than we had imagined.
Evaluating Total Cost
The companies that are leading the way in purchasing do not always have their total cost model written down, but they always think in these terms. Yet there is tremendous power in getting it formatted on paper and sharing it with your people, as well as the suppliers and trades. Here is a list of elements to consider adding to your total cost evaluation model:
- Bid price
- Capability and capacity
- Participation in product development
- Process integration (with builder)
- Pre-close rework
- Post-close warranty
From personal experience, I can share that supplier/trade reaction to the introduction of total cost criteria ranges from fear to cautious-yet-interested to outright enthusiasm. For the best outfits, builders who genuinely consider everything their suppliers and trades have to offer represent pure opportunity. Using a total cost model quickly sorts the wheat from the chaff.
There is so much more that I can say about all 10 of these total-cost categories, and you have to clearly define your metrics to use them effectively in purchasing. We will do that in detail in the June issue. In the meantime, challenge yourself. Sit down with your people, read aloud the list of “overheards” above and see how you stack up. What do you believe and what do you practice? And what would your suppliers and trades say if I asked them off-line?
Meanwhile, if you’re another Ryan, hang in there. Fight the good fight. I understand you need to keep your job, but don’t give up your ideals. The new world order of purchasing is on its way.