Monday, November 27, 2017

Pros and Cons of Vertical Modular Factory Integration

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.

There are two types of vertical integration and the modular housing industry has seen both.

Forward integration is when a modular factory at the beginning of the supply chain controls stages farther along. Examples include companies Homeway Homes and Homes by Keystone that own "downstream" activities including everything from selling the home to final finish.  Backward integration is when a modular builder at the end of the supply chain takes on activities "upstream." There have been examples of this mostly before the 2008 housing recession when new home sales dried up forcing those backward integrated companies to fold.

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

In this article we 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 its 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 as 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 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 integrate, a plan has to be in place to quickly replace that lost revenue.

Switching from being a manufacturer to a fully integrated retailer is not for the faint of heart.

1 comment:

Anonymous said...

Coach, I see this happening in the western part of the US with Clayton leading the way. They do everything from supplying lots, to selling the home, financing it, manufacturing it all the way to turning the keys over to the new homeowner.

The East modular factory is more interested in making the sale and watching it leave the yard. Few deliver their own homes and fewer set or finish their homes. They advertise their companies on Facebook but quickly turn any lead that actually comes into them over to a builder simply because they don't want any part of being responsible to the home buyer other than building it and shipping it out the door.

Then they brag on Facebook about the beautiful homes they build and in a lot of cases never mention the actual builder. Talk about a group that is very egotistical.