October, 2007

Growth for Growth’s Sake

Insights into the megabuilder meltdown from an unexpected source.

By Greg Brooks

Here’s an interesting take on homebuilder consolidation from the back cover of a recently-published book on the history of the industry: “The rationale for the growth in national firms is analyzed. The conventional explanation of economies of scale is rejected; instead, the stock market is found to play a key role both in facilitating acquisitions and in demanding growth from its constituent companies.”

In other words, publicly held builders— and the same logic can apply to builders backed by private equity capital—don’t grow because size gives them a competitive advantage. They do it because growth attracts investors and once you’ve got them, they demand more growth.

That may sound familiar if you’ve been following the performance of publicly held builders this year, and it should. Except that Fred Wellings, author of the book British Housebuilders: History and Analysis (Blackwell Publishing, 2006), isn’t talking about American megabuilders.

He might as well have been, though, because the parallels are striking. In both countries, less than 1% of builders hold roughly 50% market share. The U.K.’s top-10 builder executives also tend to be engineers, accountants, or attorneys rather than tradespeople. And on both sides of the Atlantic, the shakeups caused by severe downturns have hit the biggest builders the hardest.

The U.K. has gone through two downturns since World War II, in 1974 and 1990. Both times, five of the top 10 builders were ultimately acquired, broken up to become regional or local players, or went out of business altogether. The last major downturn in the U.S. occurred from 1989-92; only 16 of the top 100 builders in 1985 were still on the list in 1997.

But one of the most interesting aspects of Welling’s book is his analysis of the competitive landscape between megabuilders and independent builders.

There are 16,000 homebuilders in the U.K. versus roughly 75,000 in the U.S. The top 10 American companies hold around 25% market share versus 45% in Britain. It’s no surprise that builders in the U.K. are more concentrated; land is the controlling factor in consolidation, and the entire British Isles, including Ireland, would fit neatly into Colorado with room to spare.

The surprise is that British builders aren’t more consolidated. Just like the U.S., the U.K. has a strong base of independent production builders who have been able to hold their own just fine against national competitors. Wellings cites three reasons for this:

First, a megaplayer’s greater ability to build entire subdivisions doesn’t necessarily translate into a competitive advantage. “The housebuilders themselves have only limited control over the size of their operational units; even if there were economies of scale on site, there is little that management could do to obtain them,” Wellings writes.

Second, the marketplace muscle that a bigger company theoretically wields is “offset not just by organizational diseconomies but also by the dissipation of entrepreneurial flair, particularly in the land buying which lies at the heart of the development process.” As of July, the 19 publicly held U.S. builders had reportedly taken $7 billion in land impairments, with more to come.

Most important, the technological advances that yield a lasting competitive advantage—from manufactured components to time- and money-saving products, more efficient building methods, and tools to manage job sites more effectively—are equally accessible to large and small builders.

Megabuilders aren’t going away by any means, but the downturn has erased their aura of invincibility.

Smart independents will see that efficient, high-quality construction gives them an edge, and should feel encouraged about their ability to compete in the next boom.

You should, too.