A Six-Step Strategy to Reset Material and Labor Costs

The dramatic run-up of home building costs over the past two years, coupled with rising mortgage rates, has worsened the housing affordability crisis—but maybe not in the way you think or have heard or read about.

I envision affordability as a triangle, where the horizontal axis is the number of prospective buyers who can afford a new home and the vertical axis is the monthly payment (not overall sales price) of a new home.

Where the mortgage payment for a new home is $0, essentially everyone who wants a new home can afford one. But just as the triangle narrows as you go up the vertical (cost) axis, so does the number of people who can afford a home—and right now we’re looking at a pretty narrow triangle.

At some point, either interest rates will need to come down (not likely, as inflation continues to be stubborn) or home builders will need to work with their supply chain, including installing trades, distributors, and manufacturers, to bring material costs down to a level at which the market can support them. While I don’t think the supply chain is ready for this adjustment today, the time is coming when either home costs will drop to a point where the average homebuyer can afford a new home, or the new-home market is in for a real slowdown.

Supplier Engagement: A Tale of Two Tactics

To be certain, home builders will attack the problem from different perspectives.

Some will send off letters to suppliers mandating cost reductions—a tactic I know at least one builder has taken already. For installing trades, distributors, and manufacturers that fail to comply with such a mandate, builders will bid out the category and swap vendors wherever they can save money.

That approach is effective in the short term, but it’s no way to treat trade and supply partners that held cost increases at bay, prioritized your orders, and worked like crazy to take care of you during the boom market.

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But what about those supply chain members that were opportunistic during the boom, raising prices not out of need but out of greed, failing to prioritize your business, and refusing to provide any help in tackling the affordability problem? For those “partners,” I do think it is a purchasing professional’s fiduciary responsibility to bid them out. If they are competitive in the marketplace, OK. But if not, you have a responsibility to replace them with a more competitive option—a partner that will work with you during slow and boom times.

Otherwise, builders that see the long-term danger in cost-reduction mandates and knee-jerk bidding will engage their suppliers collaboratively to reset costs at a sustainable level.

Supplier Collaboration: A Six-Step Strategy

If you choose the path of collaboration instead of price-reduction mandates, here’s a six-point guide to making that collaborative strategy work for you.

1. Start with data analytics. Specifically, compare the current cost for any house plan you built in the same market two years ago. Look at your costs by trade category, and even at a cost code level, and document how and where specific costs have changed.

Too often, builders will send out cost-reduction letters with an across-the-board request without even meeting with supply chain members. But to be fair to your company and your supply chain, your cost-reduction goals should be based on how much a specific supply chain member raised their prices, not an overall average increase per house or even a phase of construction. Get granular with your data!

2. Set up meetings with members of your supply chain. Start with those that have increased your costs the most, based on your data analysis, and ask for their help in rolling back some of those increases to achieve your goals. Keep in mind that you will likely need to help installing trades by including their distributors and manufacturers in the process—a real team effort.

In fact, the trade in question may need to be open to using an alternative distributor or manufacturer for the product they install. Those that do are strategic to your business; those that won’t, aren’t. Consider bidding out their scope of work to see if you can find a strategic trade partner willing to work with you in both the peaks and the troughs of the housing cycle. Identifying strategic partnerships along your supply chain is the end goal.

3. Put everything on the table. Share where you think your costs need to be to generate sales. Be open to working together to eliminate waste. I have seen so much waste and inefficiency on jobsites and otherwise in the past two years because builders were too busy trying to keep up with demand and weathering one supply chain disruption after another.

But now that things are cooling a bit, you need to address material and labor inefficiencies. Meet with your installers in the field, walk homes under construction (as well as the ones before and after that phase), and identify opportunities to reduce costs without reducing quality.

You must be agile to adjust to the ever-changing home building market. The best way to manage change is to involve those closest to the process.

4. Review your specification levels. Are they still suitable for your target market segment? Do a competitive market analysis (CMA) by walking your direct competitor’s products in communities near yours. What are they including that you are not? What are you including that they are not?

Then meet with your sales team—remember, they are closest to your customers and your prospective customers. They hear what buyers are looking for and what they don’t want. If you’re spending money on something your prospective buyers don’t value or spending more for it than the value they assign to it, then consider eliminating it.

To be sure, there are some things you will want or need to include, regardless, such as items required by code or for which the incremental cost is less than the warranty expense for alternative products, and so on. To stimulate sales, you may also need to add new things buyers want.

5. Involve your internal team. Consider creating ad hoc, cross-functional teams to look at all of the changes you’ve made in the past two years to maintain production (or tried to). Some of those processes are worth keeping, while others are not. You must be agile to adjust to the ever-changing home building market. The best way to manage change is to involve those closest to the process. The adage that those who help plan the battle don’t battle the plan is true. People are your biggest asset.

6. Avoid laying off purchasing professionals. I have never understood why a company trying to cut costs would shrink its purchasing team when it needs them the most. A good purchasing professional is worth 10 times their cost. That said, if you have a “paper pusher” on the team who is not adding value, then by all means consider replacing that person with a higher-caliber professional. But generally, layoffs should be a last resort; you’ve worked hard to develop the talent you have, so don’t cut them loose to go work for a competitor.

Be strategic in your approach to cost resetting. A strategic trade should be treated differently from one that isn’t. Do your homework. Pull together the data. Be open to adjusting your specification levels. Engage your team members. Avoid laying off purchasing professionals.

Finally, don’t expect great results until you flush your backlog. While your sales are down, your back-end trades are still very busy.