Nothing but net

HEADNOTE

As Internet mania sweeps through the industry many wonder when and how hidebound home builders will enter the digital decade.

TO DOT.COM OR NOT TO DOT.COM THAT IS THE QUESTION. With each passing day, the

Internet threatens to take over even the most conservative businesses, including home building. Long known for its aversion to change, home building is haplessly caught up in the World Wide Web mania that is taking America by storm, making millionaires out of computer nerds who launched money losing Internet business es that nonetheless find willing investors. Industry watchers are waiting to see how abruptly builders will adapt to this brave new world, or whether they will at all.

"The last technological change that came to home building that was accepted, for all practical purposes, was the telephone," notes Joel Orr, editor of Extranet News and a leading technology consultant to the home building industry. "Home builders have not been known as the most technologically advanced folks out there." Greg Brooks, a general partner with The Construction Supply Group in Centerville, Va., agrees that builders are loath to make changes but believes they will eventually "get on board once they realize the Internet will not change the underlying construction process a bit."

The inescapable lure, says Brooks, is the cost savings the Internet can provide. "Since home builders are so dependent on off-the-shelf products, they could save a lot of money and time using the Internet to get supplies instead of calling around to check prices or get bids. The potential savings for those who rely on the Internet are 15 percent to 25 percent on the final end price of the product."

INTERNET START-UP FRENZY

Seeking to cash in on the dot.com craze, several major home builders have either signed on with Buildnet.com, a new e-business and project management software provider, or have joined forces to launch their own Internet play, HomebuildersXchange.com. The latter will provide builders with business-to-business (B2B) services, including purchasing supplies. This site was launched not long after the large home builders announced the formation of Homesite.com, a Web site that will offer what is billed as "the most comprehensive listing of new homes available throughout the country." The new company is being formed for the home builders by their financial advisor, Salomon Smith Barney.

According to Orr, some 117 providers or collaborative and market Internet services are already available to the home building industry, including such leaders as Buildnet, Homesite, BuildScape. corn, and USBuild.com. Most are new, and many will fail, but the sheer number of such start-ups indicates the strong interest Internet entrepreneurs have in the $200 billion-plus U.S. home building industry (see the "Residential Home Building EBusiness Marketplace," page 194).

BuildNet's aim is to become the e-community of the construction sector. "It exists to allow builders to seamlessly buy, sell, and exchange building products, services, and information online," says Paul Brandeis, vice president of equity research at Banc of America Securities in New York. Users will be able to organize, schedule, and conduct most building operations, such as tracking job processes, exchanging information, verifying inventory or orders, and ensuring delivery and billing-all via the Web.

Two other services, BuildScape and USBuild, offer project management capabilities centered around their procurement systems, a much scaleddown approach.

BuildScape plans to enable builders to schedule projects online via its BuildScapePRO site. Using automation, the system will centralize and track purchasing, essentially building a platform where builders can manage all project management and procurement operations. The company also will offer an interactive scheduling and procurement process between builders and subcontractors in an effort to centralize the market for services.

USBuild, too, is developing an integrated supply chain service through which the company will gather and ship building materials, matching a builder's exact project specifications. Builders will be able to supervise, order, track, and revise all processes and operations.

But some in the industry are wary of such services. "While these groups might start out well, their value might be short-term," Brooks points out. "They represent an added cost in the channel as a middleman. I expect we'll see buyers and sellers begin dealing more directly, as they do in other businesses. Simply facilitating transactions will not be a viable plan for very long, I don't think."

SMALL BUILDERS LEFT OUT?

While the nation's largest home builders have moved quickly to align themselves with one or more of these Internet launches, small-to-medium-size builders are worrying about what their own place in this new marketplace will be. "I am very nervous about these Internet plays," admits Paul Estridge, CEO of The Estridge Cos. in Carmel, Ind. "It concerns me and builders like me, who build 500 or less homes a year, that there might be a two-tier access to products. Prices will be lower and the supply much quicker for the largest home builders."

Whether or not that happens depends on how alliances between big builders and suppliers and manufacturers develop, Brooks says. "Those groups could link up and work out a process they don't really want to share with others. These alliances will start out and make the appropriate investments in technology-but the thing to remember is that the technology changes so quickly that smaller builders like Estridge might well find themselves positioned to join such an alliance down the road."

What bothers David Hill, CEO of Chicagobased Kimball Hill Homes, is that home builders are focusing on making money on the Internet like venture capitalists instead of using the new technologies to make themselves better builders. "Builders are acting just like everyone else," he says. "We now have the largest five or six builders starting their own B2B Internet services-and ignoring the rest of us. Everyone is seeking to get the best advantage rather than learning how to make themselves more effective."

"I don't think HomebuildersXchange or Homesite are going to work as planned, but only time will tell," Hill notes. "Everything is changing so quickly. Can they roll with the changes? The jury is still out," he adds.

Whether or not a two-tier system does develop, the US. housing industry has more than adequate market size to allow for such substantial e-commerce start-ups. One of the nation's largest industries, home building represents up to is percent of the gross domestic product (GDP) and employs one out of every six people in the country. In May, a study released by Forrester Research titled "B2B Information Warfares" found that e-commerce in the construction industry alone will account for $.4 billion in 2001, $2.2 billion in 2002, $11.6 billion in 2003, and $43.7 billion in 2004.

A Banc of America Securities report released in March, "B2B E-Commerce," estimated the overall U.S. B2B market at $50 trillion, five times the current GDR So the prospect of opportunity for those that can provide e-business, e-commerce, and supply chain automation is considered huge by most in the home building industry, as most B2B industry transactions are not currently handled via the Internet.

Another study, "The Internet and the Building Industry," released by Salomon Smith Barney in October 1999, projected that within three to five years "the Internet will handle virtually every aspect of the home building process, including the purchase of materials, scheduling of labor, marketing of homes, choice of options, and origination of mortgages." Further, Salomon found that over the next several years the Internet will make the "real estate broker virtually unnecessary for the larger builders and could result in a corresponding cost reduction to home buyers." Other studies, however, have found that Realtors will still be needed to provide the human touch to the consumer's purchase.

INDUSTRY PAYOFF

In March, New York-based Sidoti & Co. released its study, "Bricks and Mortar Online," analyzing the impact of the Internet on the home building industry. According to Ian Jacobs, senior equity analyst for home building and building materials at Sidoti, the payoff for becoming Internet-savvy is immense. "In our opinion, the race to build an electronic infrastructure for home builders certainly is worth running," he says. "This $216 billion-plus market is ripe for restructuring. We calculate [huge potential cost savings ... through helping the supply chain achieve peak efficiency."

Indeed, Jacobs sees Internet solutions as the answer to many of the industry's problems. "Home building gets no respect from Wall Street today," he says. "Even as earnings soar, valuations plummet. In this cyclical industry, a secular profitability expansion brought on by cost savings achieved through technology is what the doctor ordered."

Stephen Kim, a New York-based building analyst with Salomon Smith Barney, agrees. "Investors are overlooking the Internet's impact on home building," he says. "There is ample skepticism that the Internet will have any material impact on [home building] because the industry is so fractured." But it's precisely because home building is so diverse and unwieldy, Kim believes, that it's a natural to reap huge benefits from the consolidation Internet systems offer. "The cost savings potential is staggering. But because the industry is so fractured it's hard to see anyone being able to quickly develop a system that can produce savings very quickly."

The biggest winner, predicts Jacobs, will be the home builders. "They are the ultimate winners as they stand to gain from increased productivity and material cost savings," he says. "The industry could see dramatic improvements in profitability."

Others, however, believe most of the lowered costs realized would just be passed along to home buyers. "Home building is such a competitive enterprise that whatever advantage a builder can get in pricing he's going to use," Brooks says.

Either way, costs should fall, Jacobs asserts. "We see home builders saving between $17 billion and $28.5 billion from increased lot turnover. In an industry with net margins in the 2 percent to 4 percent range, cost savings could have dramatic ramifications for builders' profitability."

INTERNET CONSOLIDATION?

Because both the Sidoti and Banc ofAmerica studies indicate that the nation's largest home builders will be among the first to realize benefits,Jacobs believes accelerated industry consolidation could be on the horizon. "Within the next five or 10 years you'll see that the nation's 20 largest home builders will be doing all their purchasing online," he says. "The cost savings is too high to ignore. Just remember that is years ago, no one in the industry had fax machines. Now, everyone does. The same will be true of Internet systems that enable builders to buy direct from manufacturers and the large regional suppliers."

Composed of more than 140,000 builders, 400,000 subcontractors, 4,000 manufacturers, and about one million real estate agents, the industry needs an all-encompassing Internet solution. Consider that the building of just one house often involves more than 50,000 products and 20 teams of subcontractors. An excessive number of forms, records, and processes used by both the construction and real estate industries inflate administration costs. Automating those transactions and processes will save time and money, but the automation must serve multiple players in a mutually beneficial system.

"But whether or not the Internet can help consolidate this business is unclear at this time," Brooks says. "In an industry where there's such demand for customization, there is not a great push to consolidate. Fragmentation exists to handle the great need for customization. Instead of consolidating, I think we'll see the industry polarize between the mega high-volume builders and the largest high-end custom builders, with some smaller ones in between."

COMMUNICATION IS KEY

Many industry-watchers see changes occurring simply in improved communications. "With the Internet, you can post messages, sometimes automatically, letting subcontractors know that you're off schedule or that the floor plan has changed," points out Orr. "No longer will everything run off orders given by phone. Just having a written record of transactions should help reduce communication problems." Problems, he adds, that cause huge cost overruns.

"The object is to decrease the average building time from 90 days per house to 60 or even less," says Brandeis. "Doing so would reduce the builder's outof-pocket costs on floating the construction loan and would enable him to build more units in a year."

Jacob's study for Sidoti & Co. showed that manufacturers and distributors who use the Internet's strong communications platform and accurate forecasting tools could over time move from a just-incase inventory system to a just-in-time system. This would reduce their inventory levels between 30 percent and 60 percent, Jacobs found. The resulting lower capital requirements could save between $1 billion and $2 billion annually.

"Similarly, smooth interaction between all the various parties has the potential to increase housing lot turnover 25 percent to 50 percent, lowering the builder's capital requirements significantly, with savings of $3 billion to $6 billion annually,"Jacobs says. "Even more important, the resulting labor savings could range from $ 14.5 billion to $22.5 billion. Add to that, reductions of $2 billion to $4 billion from procurement savings, savings of $500 million to $1.5 billion from capturing redundant transportation costs, and savings of $4 billion to $9 billion from more efficient material utilization methods, and you come up with potential annual savings from $25 billion to $45 billion-no small change."

Such huge cost savings, Brandeis believes, will prompt builders to accept today's technology and put aside tried-and-true methods of supervising construction. "More and more you'll begin to see builders walking around homesites with Palm Pilots," he says. "Compare that to today's average contractor walking around with a yellow pad, making notes. Half the time he's going to forget to do everything he noticed. With a Palm Pilot, he makes a note, sends an immediate e-mail, and it's done."

In countless little ways like that, the Internet is fundamentally changing everything we do, Brandeis continues. "Home builders might be among the most resistant to such change, but sooner or later they'll get on board and start doing everything via the Net."

E-PROCUREMENT BECKONS

Builders will also be drawn to the Internet as manufacturers and major suppliers begin using it, adds Jacobs. Online cataloging, for instance, would allow manufacturers and suppliers to update their product offerings, inventory, and pricing in real time. Buyers could search for products electronically rather than hunt through outdated buyers guides.

Making purchases online would be the next logical step. The buyer would send price requests over the Internet, and suppliers would respond with bids. He would then issue online purchase orders to the suppliers. Then a virtual invoice would be sent to the purchaser.

Doing all of this via the Internet "will reduce paper and human error and improve time management,"Jacobs points out. Add to this the electronification of all data involved in the home building industry, and considerable cost and time savings can be realized. "For instance, if an engineer changed a floor plan, the system would amend any outstanding purchase and work orders, update the total cost, and send the updated order to a supplier, who would send it to the manufacturer along with a new estimated job schedule, and the system would accept and pay the new invoice- all without human interaction."

Automation would also eliminate much of the guesswork involved in the building process. "If a problem arose at the manufacturer and created a delayed arrival of a product, the system would automatically reschedule all the affected areas to account for the bottleneck," says Jacobs.

Not to mention that performing all these procedures via the Internet would enable the manufacturers to develop online profiling of each home builder. Recording purchase size and payment history would allow the manufacturer or supplier to offer real-time customer pricing. Tracing the history of how the job progressed could help suppliers more accurately determine scheduling needs for the next job. Banks could use this to make instant credit decisions.

PREJECT MANAGEMENT IMPROVEMENTS

Another area ripe for improvement is project management. Currently, subcontractors handle anywhere from 75 percent to too percent of the actual construction of a house. Often, the builder oversees several projects at once. Thus, according to the Banc ofAmerica study, an efficient system that automates and streamlines processes, such as record keeping and inspection status of each project, would reduce costs.

"But at present, most project management in home building is handled manually or on a spreadsheet through the back-office operations of builders, subcontractors, manufacturers, and distributors," Brandeis notes. "All scheduling, coordination, and record upkeep is generally done off site by an administrator far away from the actual building process. The administrative process, therefore, is laborintensive and error-prone. Paper-work proliferates from an array of memos, faxes, and forms. Plans or ideas are shuffled among participants and sometimes lost or forgotten."

Because current project management systems have no real-time flexibility, unexpected events can't be mitigated and costs related to schedule interruptions are considered inevitable. "The ongoing development of new Web-based systems," Brandeis says, "should greatly enhance adaptability across the industry." He sees project management systems migrating to Web-based vertical hubs that provide full visibility to all relevant parties in the construction and procurement process.

As the use of automation increases, Brandeis remarks, we'll see more adaptability, reduced laborintensive efforts, and fewer human errors. Information will be readily available on a per-project, realtime updated basis, allowing builders to reassign and reapportion materials as needed. "We expect cost savings of about 15 percent to 20 percent from the use of such Web-based systems."

Internet procurement systems like Buildnet's should help streamline the high-volume purchasing process, Brandeis adds. "Instead of buying products from subcontractors and paying the subs' mark-up, the home builder can buy directly from a supplier or the manufacturer and, in some cases, realize volume discounts. This could generate an additional savings of 5 percent to io percent annually" Some $roo billion a year is currently spent on the purchase of building materials.

Subcontractors would then have to modify their business approach: give up building materials revenue but save the administrative and carrying costs associated with materials procurement, diminish business risk, and build more homes. In his study, Jacobs found subcontractors to be the "least technically inclined link in the supply chain." Yet subcontractors purchase the vast majority of building materials. "This is a crucial part of the puzzle," he says. "Connecting the largest manufacturers, distributors, and home builders will be an extraordinary feat-but in our view hooking up the tens of thousands of technically backward subcontractors is the real challenge."

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Residential Home Building E-Business Marketplaces

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HOT WIRED

Internet services lure many tech-savvy home buyers to today's most wired housing developments.

The biggest builders are getting their Internet act together quickly. Not only have they created HomebuildersXchange.com and Homesite.com, but they've also hitched their wagons to new telecommunications technology that will ensure their buyers are ready for ramped-up digital offerings.

Ian McCarthy, president and CEO of Beazer Homes admits he was both excited and skeptical when first approached by DTE, a new telecommunications company that wanted to install highspeed Internet connections bundled with local and long-distance phone service and a cable TV service. But he decided to take the plunge and sign up for the services for all of his new developments.

Bruce Karatz, chairman and CEO of Kaufman and Broad, made the same decision after trying for years to discover "a way for builders to capitalize on the trusting relationships we build with our customers." Signing up for high-tech Internet access, he believes, ensures that his company is .providing our customers with the enhanced telecom services and savings they are demanding."

Dynamic Telecom Engineering (DTE), based in Olmstead Falls, Ohio, near Cleveland (www.dtelle .com), has been beta-testing an electronics package of high-speed Internet access and phone service in a subdivision developed by Whitlach & Co. The 100-megabit access speed blows away its competitors. By charging only $37.95 per month, DTE is $20 per month less than what similar companies charge for slower service.

The company eventually plans to offer an array of services, including cable television and security services to new housing developments. In addition to Beazer Homes and Kaufman and Broad, it has agreements with The Ryland Group, NVR, and the K. Hovnanian Cos. to install their electronic packages in their new subdivisions around the country.

DTE has the support of such heavyweights because it plans to share the income it receives from each housing development with the home builder or developer for the first 20 years.

According to R. Chad Dreier, president of The Ryland Group, signing up with DTE has given his company "a competitive advantage with a new long-term revenue stream. What more could we ask for?"

The result could be big bucks for home builders, says Eli Asher, DTE's president. Over the next 20 years, the company expects to extend services to 600,000 houses a year. "At that rate, we would raise about $11 billion in revenues for the home builders," Asher estimates, adding that Kaufman and Broad alone could realize about $350 million in that 20-year period. "That's like found money, as home builders and developers are traditionally done with a client after they sell a house. This gives them a revenue stream for another 20 years for which they have no capital expenditures. We take care of all that."

After the 20-year period expires, Asher says DTE will probably install a completely new system to keep up with the changing technology. But you never know. The circuit switching the nation's phone system uses today was developed more than 100 years ago."

OTE expects to gradually add a series of additional broadband services, including movies on demand and other as yet undeveloped services. "For instance, we would like to be able to offer people in Cleveland the chance to take a college course taught at the University of California at Berkley in real time," Asher says.

SIDEBAR

BUYERS UNITE?

Fact: More than 40 percent of today's home buyers conduct their initial home shopping on the Internet. One interesting, but as yet unrealized, trend is that those same consumers could easily form mini-buying cartels. Using an Internet technology called "hot," a consumer could find other people looking to buy a home in the same area.

"Once they locate each other, they could unite and present themselves as a buying group to the builder, who would be forced to cut a deal with them to get their business," says Greg Brooks, a general partner with The Construction Supply Group in Centerville, Va, "This hasn't happened yet, but it's on the horizon."