Tuesday, March 10, 2020

Has the Time Arrived for Vertical Modular Factory Integration?

With the dwindling of the once strong modular home “Builder Base”, the modular housing industry appears to have limited options for future success including vertical integration.
It’s not the first choice for many factories but with no training to found for “new to modular” home builders, the number of true independent home builders will continue to diminish. There are two types of vertical integration, forward and backward, and the modular housing industry has seen both. Vertical integration in the modular home industry is when a factory controls more than one stage of the supply chain. That's the process all businesses use to turn raw material into a product and get it to the consumer. There are four phases of the modular home supply chain: sales, manufacturing, distribution, and finish. A company vertically integrates when it controls two or more of these stages. Forward integration is when a modular factory at the beginning of the supply chain controls stages farther along. Examples include companies Homeway Homes and Volumetric Building Companies that own "downstream" activities including everything from selling the project to final finish. Backward integration is when a modular builder at the end of the supply chain takes on activities "upstream." Express Modular Franchising is an example of one such company. It has just about the only real training program for “new to modular” builders. There are many distinct parts to any new modular home sale to the customer:

  • Marketing - done by both the factory and the builder
  • Sales - done by both
  • Engineering - done by the factory
  • Manufacturing - done by the factory
  • Land prep and excavation - done by the builder
  • Freight - modules can be delivered by independent companies or the factory
  • Crane - Usually done by the builder
  • Set Crew - done by the factory or an independent company
  • Finishing the home - done by either the builder or the factory

This article will focus on the Pros and Cons of the completely Vertically Integrated Modular Home Factory.

Five Pros of the Vertically Integrated Modular Home Factory
Any of these five advantages of vertical integration gives a modular factory a competitive advantage over non-integrated companies. Consumers are more likely to choose this company’s homes as their first choice. Either the costs are lower, the quality is better, or the product is tailored directly to them. The First advantage is that the company doesn't have to rely on many outside contractors. They are less likely to face disruptions from those that aren't integrated. Since they control all or most of the areas mentioned above, the reliance on subcontracted work means that every home will be under the factory’s control from start to finish. The Second advantage, modular factories can cut ties with demanding builders. Factories benefit from vertical integration when one of its builders becomes too big and begins dictating terms such as unreasonable discounts, preferential production scheduling and service issues. If the company can go around these big single family home builders that become very demanding, it reaps many benefits. It can lower internal costs and have better scheduling. The Third advantage, vertical integration gives a company economies of scale. That's when the size of the business derived from being fully integrated allows it to cut costs. For example, it can lower overall pricing lower by keeping set crew and finish work within its control. These services become a cost item rather than a profit item for subcontractors. Another way is to make the manufacturing process itself more efficient. Vertically integrated companies eliminate overhead by consolidating management. The Fourth Advantage, a modular factory with vertical integration is popular. It usually has several model homes on display at their factory and possibly sales centers strategically located within their sales territory and knows what is selling well. They are unwilling to risk losing distribution through the builder. With the lack of new modular home builders getting into the business, that risk will diminish over the next 10 years. The Fifth advantage is most obvious to consumers. That's lower prices. A modular home factory that's vertically integrated can lower costs. It can transfer those savings to the consumer at lower prices.

Four Cons of the Vertically Integrated Modular Home Factory

The First and biggest disadvantage of vertical integration is the expense. Modular factories must invest a great deal of capital to set up vertical integration. They must keep the plant running to maintain efficiency and profit margins. The Second disadvantage is that it reduces flexibility. Vertically integrated companies can't have integrated sales that take them too far from their factory. If an integrated home is sold more than 100-150 miles from the factory it will mean that a lot of the factory employees will be traveling more than 4 hours a day round trip to the job. This makes them less productive. If the factory pays their overnights, it means a lot of added expense. The Third disadvantage is a loss of focus. Running a successful retail business, doing the set and finish work for example, requires a different set of skills than running a profitable factory. It's difficult to find a CEO that's good at both. If top management can’t work together effectively and efficiently, vertical integration just might cost them the business. It's also not likely that any company will have a culture that supports both retail stores and factories. A successful retailer attracts marketing and sales types. That culture isn't responsive to the needs of factories. The clash of cultures can lead to misunderstandings, conflict and lost productivity. A non-integrated company can even use cultural diversity in the workplace to compete against the vertically integrated one. The Fourth disadvantage is loss of existing business. When a modular home factory switches from being a manufacturer of modules only to a fully integrated modular home supplier direct to the buyer many of their existing builders within that 100 mile radius of the factory will leave, taking their millions of dollars in yearly business with them. When the factory owner(s) decides to vertically integrate, a plan has to be in place to quickly replace that lost revenue.

Gary Fleisher is a housing veteran, editor/writer of Modular Home Builder blog and industry speaker/consultant.

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