Ken Pinto wants dealers to join his campaign to reduce home building costs at least 10% by urging their customers to do three things better: Clarify, cooperate, and communicate.
Pinto, a former chief purchaser and supply chain leader who has worked at four of America’s 10 biggest home builders, argues in a new book that too many builders are hurting themselves by failing to see how purchasing and production improvements can boost their profits, and that dealers need to help point them in the right direction.
He says that getting better begins with clarity: Knowing the price of the materials that go into a house rather than letting that price remain buried in a turnkey contract with a subcontractor. You can’t improve until you know that price, he says, just as you can’t shop better at a grocery store if the cost of the individual bread loaves, eggs, and cookies are presented as one total rather than being broken out. It’s why Pinto’s call for unit pricing is titled: How Much Is the Milk?
But Pinto puts just as much importance on the book’s subtitle: “Uncovering your greatest cost savings in residential construction by listening to your suppliers.” This comes first through builders learning what it is they do that costs manufacturers and distributors the most. Discovering and resolving those pain points in ways that benefit all parties will make for even tighter, cost-effective relations. For example, there’s communication: Builders who identify well in advance what SKUs their job sites will need 30, 60, and 90 days from now make it possible for manufacturers and distributors to eliminate costly guesses when they do their planning.
“Builders really don’t understand that there is a problem,“ Pinto told me in a Jan. 6 interview. “In the big housing boom in the ‘80s and ‘90s … builders lost their core competency of understanding the supply chain. [Now] they do a turnkey, lump-sum contract to the subcontractors, so contractors were responsible for materials, and builders were like ‘Hands off, I don’t need to deal with that anymore. It’s your job.’ I think we blew it
“Now this is where you [building material dealers] come in, because this is important.,” Pinto continued. “You can imagine a skeptical builder who reads the book, is still a little skeptical. The first thing he does is he goes to his LBMer and he asks him, “Have you read this stuff? What do you think about that?” And the LBMer goes, “Yeah, I don’t know. I don’t think it’s that big of a deal. There’s not as much money in it as Ken says there’s going to be.” Whatever they say to poo-poo the idea at all, the builder is quickly going to dismiss it, conclude there’s no value in supply chain management, and it’s out the window.” Thus an opportunity is lost.
Here’s more from my interview with Pinto. The remarks are lightly edited and reorganized slightly.
Craig Webb: I think you said in the book that your standard guarantee to a prospective employer is that you would earn back 10 times your salary. Optimally, starting from zero with a regional sized company, what percentage of savings do you think you could achieve in the cost of constructing a house?
Ken Pinto: Everyone has a different starting point. … In my experience, and it’s big-builder experience, pulling 10% out of the cost of construction was pretty easy. Ten percent on materials equals about 5% to direct costs. That’s 2%-3% to net profit. That wasn’t even a lot of effort; once we started it just kind of fell in our lap. A couple of years after that, you want to get another 10%. That took a little more work but we did that too. So there was a lot of money on the table.
One of the quotes in the industry is “Where there’s mystery, there’s money.” If you don’t know how much you’re paying for the milk, I guarantee you’re paying too much for it. If you know and you’re okay with that, great. But if you don’t know, then you don’t know what’s on the table, and generally speaking, the more the mystery of how much you’re paying for products and services, the more you’re paying too much.
CW: The biggest builders in the country are far, far different than the average builder in the U.S. who might build five, 10, 20 homes in a year. You had some [employers] that were building four houses in a day. How small can you be and have what you recommend still apply?
KP: I think that a lot of smaller builders assume … that because they don’t have a high volume, they can’t add enough value to a distributor or manufacturer to benefit them in pricing and service availability, whatever. It’s not exactly true. It would be if our industry was a sophisticated supply chain, if we were the Toyotas of supply chain management. But the reason it’s not true today is because there’s so much the bigger builders aren’t doing that distributors and manufacturers want, need, desire, crave, that they’re not getting. If the smaller builders were doing it, it would multiply their value to the distributor or manufacturer. And that basically is adding two pieces of information: SKUs and date needed—30, 60, 90 days in advance. And that would magnify the value of the small builder to the supply chain.
CW: Let’s talk pricing and supply chain difficulties. I have a feeling that some people will read your book and say, “Yeah, what he says is well and good when we’re in calm times, but these are rough waters.” What’s your response?
KP: If we had better supply chain practices we’d have less of an issue today than we do. Beyond that, supply chain principles are supply chain principles are supply chain principles. It doesn’t matter much what the industry is or whether it’s in good times or bad times. The principles are the same. If you want to increase the production capacity of your supply chain, if you make them more efficient and give them an opportunity to become more efficient, then you get more services out of them. Oh my gosh, we need that right now.
In pricing, it’s the same thing. If we were taking costs—not margins—if we were taking costs out of the supply chain, then that’s sustainable. When you negotiate hard and an LBMer gives a price for a certain amount of material, [after a] time, the price of the material goes right back up. It’s not sustainable. But if you take costs out of their operations, then that is sustainable cost savings, which we hope gets passed down into pricing. Because we’re such a competitive industry, I think it will.
CW: Give me an action plan: Let’s say I haven’t thought that much about supply chain management in my construction company. I’m just worried about when the windows are going to arrive. I think some people would say “I don’t have time to read your book, and I don’t even know what I would start with if I were to start after I read your book.”
KP: It’s important for us to keep sharpening the saw, no matter how busy you are. …. One of things I do recommend is that you pick one or two or three categories. Drywall is pretty easy; it’s a big spend category and there are fewer SKUs in it, so it’s a pretty easy one to start with, and it’s one I detail out pretty specifically. But I recommend they choose the categories that they particularly have core competence in—there’s someone in the company or they themselves, who are really good with roofing, or drywall, or cabinets and paint. Whatever they are good at, start there first. That way, they can gain some confidence in the process. I detail out a process to get started with the drywall and that’s a pretty easy way to get started. Once people get started and find out how easy it is, they’re like “Oh my gosh, why haven’t we always been doing it this way?” And so I love those epiphanies that occur.
Even within the company that I worked for, I had to go from division to division and re-convince the whole team over and over again. They’d say “We’re better than that other division. We’re different. That’s why it worked for them but not for us.” I had to re-prove myself in every division over and over within my own darn company. So I understand the change that happens here and how difficult it is to push it through.
Finding ways to save money through supply chain management was so easy, it was like shooting fish in a barrel. So my job wasn’t finding those. My job was culture change.
CW: One of the editors of Builder [magazine] once said to me, when I talked about the need to improve supply chains, “Builders don’t care because the money is really in the dirt.” I would imagine that, over the course of your time, people said “I make so much more money developing an undeveloped piece of land and selling it that the relative cost of building a house doesn’t matter all that much to me.”
KP: I have two comments on that. First, you just pointed out how we kind of lost the core competency of construction operations in our industry, where our leaders—whether they are CEOs or the president or whatever—isn’t really an operations guy, he’s a real estate guy. So he buys a piece of land, improves it, and sells it. And construction operations are just a necessary evil to get that done so he can do his real estate deals. In our industry, even guys who grew up as operations guy and now are CEOs of the companies have kind of lost that urgency of improving construction operations.
The second part is that I remember walking into a division president’s office and talking about supply chain management strategies, about something I wanted to do. It was a little bit risky, given the time. And he’s like “I don’t think we need to focus that much resources on this because that’s not really where we make our money. It’s the land deals where we make our money.” And so I pointed out to him how the price of a house is broken down.
Forty-two percent of the cost of the house is broken down as direct cost from construction operations. .… You save 10% on your construction materials, you can make a big impact, at 5% net profit impact, to the price of the house. And I think the reason our industry leaders don’t realize that is because there hasn’t been a big movement to prove that that’s true. There have been a few like me who have done some great things, but it hasn’t really caught on and people don’t really understand what we’re doing. So I hope that the book makes some light bulbs go off and people say, “Hey, maybe we should pay some more attention to this.”
CW: When it comes to unit pricing, say for a framing material take-off, the dealer does provide it. The complaint I hear is that they’ll take it to the builder or the subcontractor, and the builder or subcontractor will blow right past that and go to the bottom page, look at the total, and make a decision based on that. And the dealer complains in two ways: One is that they aren’t looking at the unit prices. [The other is that] they’re also not looking at the work involved, the service provided by the dealer, to help figure out the best and safest way to build a home. The thing that concerns me is that you’re saying in the book that people really don’t understand the supply chain process. What I wonder about is whether builders, to a certain extent, don’t understand how to build a house.
KP: Yeah, core competencies are being lost. … In different parts of the country, builders understand different pieces of the supply chain. Nowhere in the country that I found, at least for large production home builders, do they understand the whole supply chain and are involved in making it better.
The one question that I asked that made it better in all the supply chains was “Hey, what is it that we do that costs you money?” And oh my gosh did I get an earful from every single entity that I asked that question to. And I learned so much. That’s the goal: To get builders and LBMers to talk to each other and say, “Hey, what can we do to lower each other’s costs?” That’s where the magic happens.
I have methodologies in there about consolidating distribution upstream, that’s cool, and kitting, that can work well in some areas, and sometimes buying direct works really well. But nothing’s better than getting two entities working together to lower each others’ costs—continually, so it never stops. And you become really close partners working together. That creates great relationships and people on both sides of the table start loving their job because that’s a great way to work and that makes retaining and attracting good employees easier. It just makes you love your job a lot more.
So it’s important we get the right message out to the right people. And I know some builders—especially my Texas guys—they’re going to go “Aww, we really know all our costs.” Well, they do and they don’t. There’s a lot they don’t understand that I hope they take advantage of.
CW: There have been so many changes in who owns what in the supply chain. … When you were working at your big builders, companies like ProBuild were the kings of the hill. ProBuild doesn’t exist any longer. And yet at the same time, the impression I get from your book is that long-lasting, trusting relationships are crucial. Can we have such long-lasting, trusting relationships in an era in which builders are being bought and sold and dealers are being bought and sold?
KP: I am optimistic about the consolidation. I think our industry is a little too fragmented, and that is part of the obstacle to bringing greater supply chain sophistication to our operations. Part of that sophistication includes better software. Typically, our industry doesn’t spend much money on software. It’s why SAP and Oracle, we just don’t have their attention. The consolidation has the potential to increase the capacity for the whole industry, from builders to manufacturers, to collaborate better together.
If you do a better job of collaboration, when the company changes hands or changes names, there should be a pretty good handover to that [new entity]. And in a lot of mergers and acquisitions that are happening, the key people are staying. So yes the volatility does make it a little bit more difficult, but I think better processes are recognized by both buyer and seller and that those processes will stay in place after the M&A.
CW: I have to confess there were times in the book when the solutions seemed too easy. Such as when you said we asked people to put in unit pricing and everyone lowered their prices. I think you basically concluded “Well, the jig was up and they couldn’t pad those prices any more.” Maybe. Another might be that maybe subcontractors are bad at figuring out how to improve their processes as well, and so consequently they didn’t know where to put the padding anymore. … Did they lower their prices because of honesty or incompetence?
KP: The quote that we thought we had caught them at something and gave us a fairer sense of what they thought the pricing should be came from them. I didn’t make that up. We were befuddled. We just couldn’t believe it. We thought this was an administrative exercise, just changing lump sum to unit pricing and everything would be the same. We had no expectation of reducing costs and every single one of them dropped their costs. So yeah, it was a surprise to all of us. In every division I did it, it happened over and over again.
CW: Of course, one of the reasons why they had been raising the price is because they had administrative costs. For you to take over that meant that you would have administrative costs. So I could see some builders would say, “Well, I can see myself getting into purchasing but I don’t want to have to hire a whole staff of purchasers.”
KP: I would agree with that. When you find an opportunity to buy direct, it needs to be so easy that you don’t have to hire extra people. There are cases in the book where I talk about buying HVAC, and we got down to the end and we were ready to cut the deal, we decided not to. There just wasn’t enough benefit based on the additional resources we were going to need. I want builders to get to that decision-making point, which you can’t do unless you invest in it fully. Once you investigate it fully, no matter whether you decided to buy direct or not, you’ve done a great job on your decision-making process and that’s what I’ll be happy with.
CW: One of the things that intrigued me that I hadn’t read in the book is that a common recommendation that dealers make is that they make fewer deliveries. I saw you talk about combining deliveries and bringing things in. But dealers would love to find a situation in which, instead of coming to the site five times they come two times. I would presume dealers made those requests to you.
KP: So I identified less tire tracks as an opportunity to reduce costs, not margins, through the supply chain. And it’s never been more true than today when truckers and trucks are a scarcity and if you have them, they’re quite expensive. So if we can increase the capacity of the industry by reducing the amount of tire tracks on the job site, whether that’s through consolidating distribution or buying more of the product line from one distributor, or whatever. The key principle is reducing tire tracks at the job site. Costs go down and capacity goes up.
CW: There had been a day when builders had their own distribution yards. Do you ever see that coming back?
KP: No. I try to imagine in my head what it would look like for builders to regain that competency of both managing materials and managing employees who work on job sites. I can’t envision a way which we get back to that point. We’re very efficient being inefficient in our industry. It would be difficult for a builder to justify that. The reason we changed in the ‘70s was because although you have a bunch of plumbers working for you, it’s very difficult to keep them busy every day. Whereas your plumbing subcontractor—I can think of a company I used to use in San Diego that had 800 employees. They kept those plumbers busy all day long.—I think it would be challenging unless you had a kind of job where you are doing four houses a day every single day, very consistent, and you’ve got years and years of pipeline of land ahead of you where you can make sense out of that.
CW: What do you think is the future of just-in-time philosophy?
KP: Just-in-time is what I used to preach for many years. In today’s market, I don’t think that’s a good strategy. Purchase in advance of need is the best strategy for today, just because of the scarcity. But that scarcity will be solved, and in a couple of years we’ll be back to having ample supply of products that we need, and I think we could approach just in time, so that we’re reducing the amount of time and resources for manufacturers and distributors to get products to the job site.
CW: And letting them know further in advance of what you expect to need is one way to help that happen.
KP: It’s a vital part of making that happen.
CW: You say in one part of the book, “In my experience in supply chain management, about 15% of subcontractors are really good at managing materials and negotiating excellent pricing.” Could the problem not be with the builders but perhaps with the subcontractors, and what we really need to do is figure out how to get the subs some education?
KP: It would be helpful, but not a total solution. I was amazed at the pricing that some of my subcontractors had when we really drilled down and got open book visibility to what they were doing. I was shocked that they weren’t buying better than they were. These guys have been in business for 20 years and we were under the impression that they buy very, very well. And I could beat their prices with two to three months’ worth of work. I didn’t expect that to happen.
The reason they aren’t better is that their focus isn’t materials. Buying isn’t the core competency of a subcontractor’s work; it’s the installation of those materials. So they don’t put enough focus on supply chain management to make that better. And some of them are so small that they really don’t have the bandwidth to do better than what they’re doing today. So I’m not sure that could happen. On top of that, these solutions I’ve put together--like consolidated distribution, where the carpenter’s and the plumber’s materials are put together on one truck--will never happen when individual subcontractors are managing all of our materials. It’s going to take a bigger, whole-house view of the supply chain to really pull out all of the efficiencies.
CW: I wonder whether the constant changes in prices work in favor of your book in the sense that, because pricing is so volatile, it makes people more aware of the price of the product and thus perhaps makes people more aware of the need to go to unit pricing.
KP: I would not have wished this supply chain crisis on anyone. I could not have designed a better time for my book to come out. So I think it’ll be a little easier to get acceptance and adoption from people who may not have read a book like this in the past and might pick it up and read it now. These are tough times. Our industry is cyclical; we’ve seen good times and bad times. In 2004-2005 we had a hard time getting our houses built. We could sell every single thing we could possibly build, so every builder was trying to build faster-faster-faster. It’s very similar to what we’re doing today. And those who won are those who had the best relationship with their suppliers.
Pricing goes up and there’s justification for why those prices go up. Trucking costs more. Raw materials are costing more. Employees on assembly line are costing more money. [An employer might say:] ”I had to do a $40,000 upgrade to my break room in order to retain my employees.” And those are real costs.
I think what happened all the way down the supply chain is that there’s an opportunity to put a little padding on each one of those increases so that everyone is making a little bit more. You can see when you look at reports that margins are pretty darn good right now.
CW: You talked about zero-dollar purchase orders and how that alone could cost prices 5% to 15%. What’s your understanding today of the relative popularity of those?
KP: They’re extremely rare. I don’t know anyone who’s ever done it besides myself. The reason for the zero-dollar purchase orders was that I needed to communicate SKUs and needed data up the supply chain to entities I was not buying materials from. I was buying materials directly from the sub as part of a turn-key, but I needed the distributor and manufacturer to have visibility to those SKUs and when they’d be needed on the job site so that they could do better demand planning. And zero-dollar purchase orders wasn’t the most ideal situation, but it worked, and some of the distributors and many of the manufacturers absorbed electronically that information so that they could use it in their demand planning. While the zero-dollar purchase order is not a solution, it was a work-around to communicate the SKU data needed.
CW: I remember years ago, when I covered the banking industry, JPMorgan had electronic hookups with many of their major customers where they were seeing in real time what was going on with their major customers so that, if the CFO decided he wanted to issue bonds or do a funding deal, JPMorgan had instant access to all the info and thus could put together all the documents far faster than they could otherwise.
KP: A lot of industries have adopted that technology in order to electronically connect buyers and sellers. I’d love to see our industry get to that point. One of the things I did at [Standard Pacific] was to put together a door hardware deal where I was buying directly from the manufacturer. He was assembling a box of locks for me and we used Hyphen Solutions software to pull info out of the builder’s back office and get it to the manufacturer’s MRP. So we really did have computer-to-computer communication with no humans involved. And that’s ideal.
CW: Some of the builders have been changing the pace with which they sell and build in response to lumber prices, to demand, and to other things. They’re making decisions faster, maybe a little more abruptly than in the past. That’s my outsider’s opinion. What’s your feeling?
KP: The purchasing department—and most builders don’t call it supply chain management, they call it purchasing, which is the wrong term—most purchasing departments don’t get a lot of attention. They are considered the administrative arm of the construction department and they’re not considered to be decision makers except for the largest home builders that have a big team that at least helps the divisions with that work. And when you’re not getting a lot of attention, nobody wants to hear when you’re raising the flag.
Today? Oh my goodness, the flag is so big and so red that everyone wants to see it and know about it. They’re talking about it on their earnings calls. I don’t know how long that attention lasts, but right now the attention is on the purchasing departments because they control so much of the profitability and production capacity of getting homes built. And so that’s where decisions are happening faster.
CW: To conclude this, imagine that you're standing at a podium talking to dealers. And I’m standing next to you and say “Ken’s got a message.” What do you want them to remember to think about right now.
KP: At the beginning of this interview I talked about small and medium-sized builders magnifying their value to the supply chain by providing information that big builders are not giving them—the SKUs and the date needed data, 30, 60, and 90 days ahead of time. If they do that, they can become much more valuable to the supply chain than they are today. They need that. Right now they can do it and get competitive advantage. In the future they’ll need to do it just to stay alive. I would compel them to get control of their SKUs and date-needed info and learn how to communicate it up to their supply chain managers. And please ask the question, ‘What is it we do that costs you money?” And then work together with them to lower each other’s costs.