When Pulte Homes Inc. last month announced it has entered a 50/50 joint venture with its largest trade contractor in Arizona and Nevada, eyebrows went up across the American housing industry. A high percentage of them belonged to GIANT production builders who compete head to head with the Bloomfield Hills, Mich.-based colossus.
Pulte and Phoenix-based carpentry trades mogul Ron Pratte are equal partners in the new company, Pratte Building Systems, formed to replace Pratte Development Co., one of the nation's largest wood framing and concrete foundation companies. Financial details of the transaction were not disclosed.
The old Pratte company worked for many of the largest builders in Phoenix; Tucson, Ariz.; and Las Vegas. The new Pratte works only with Pulte.
Pratte now provides materials and labor for concrete foundations, concrete flatwork, and wood framing and trim on the 8,000 to 9,000 homes to be built this year under the Pulte and Del Webb brands in Arizona and Nevada.
In a cryptic announcement of the deal, Pulte president and CEO Richard J. Dugas Jr. shed little light on the specifics Pulte has in mind for its new desert operations:
"This venture advances Pulte's stated goals of improving its operating and financial performance through the implementation of advanced supply chain strategies. Over the years, Ron Pratte and his team have been great business partners helping Pulte deliver superior product quality while reducing construction cycle times and related building costs. We expect this venture to enable Pulte to further reduce its cycle times while lowering costs through enhanced value engineering, manufacturer-direct purchasing and greater regional operating leverage."
However, a clue of the deal's nationally high importance can be found in the assignment of Alan Laing, Pulte's erstwhile vice president of customer satisfaction and construction support, to move to Arizona and work directly with Ron Pratte to "lead the integration and optimization activities associated with the new venture."
Initially, the joint venture is focusing on delivering materials and labor related to concrete foundations and associated flatwork, framing, exterior sheathing, roof trusses, exterior and interior doors, and trim packages. In Phoenix, the new company also provides materials and installation services for underground plumbing. It's not lost on Pulte's competitors that this amounts to the vast majority of both the time and the cost in home construction.
"This joint venture is part of Pulte's broader strategy to develop innovative building programs that support efficient delivery of high-quality homes," Dugas says. "Through efficient house designs, tightly controlled specification and purchasing processes, and strict adherence to production scheduling, Pulte Homes can deliver a house of unmatched quality and value to our customers while realizing increased returns for our shareholders."
Industry Buzz
This public stance triggered a multitude of questions across the country. Here are just a few we heard from industry insiders:
Is this a new form of industry consolidation?
"Public builders like Pulte have to continue to grow to please Wall Street," Hearthstone Companies chairman and CEO Jim Pugash says. "They are running out of viable candidates for acquisition among other builders. Vertical integration of trades and suppliers is another consolidation strategy. I can't imagine they're going to do it only in Arizona and Nevada."
A private builder offers: "A lot of the public builders are moving toward vertical integration through panelization. This looks like vertical integration without the investment in a panel plant. It's where this can go that's intriguing. At least if the market crashes, they don't have a plant to worry about."
Will Pulte take Pratte to other markets?
Phoenix is widely recognized for having the largest and most professional trade contractors in the housing industry, many of them larger and better managed than most of the builders for which they work. It must be tempting to consider what Pratte could bring to other markets where Pulte builds, such as Denver and Dallas.
"A key question is: What's in this for Pratte?" says one builder who asked for anonymity. "Other than the ability of Ron Pratte to get some of his money out of his company, it has to be Pulte sponsoring his entry into new markets, perhaps even the opportunity to grow into national operations."
Is this a roundabout way for Pulte to control materials costs in markets where turnkey trades dominate?
All public builders have long expressed consternation that turnkey operations, in which trades price materials and labor in a package, dominate Western markets from California to Denver. The largest public builders want to exercise their buying power to drive down those materials costs, but without separating materials from labor, they can't do it.
"This is certainly one way to get control of materials cost," says an executive of another GIANT operating in the Phoenix market. "Del Webb had its own framing operation when Pulte acquired them, but it was a disaster [in terms of efficiency], and they disbanded it. It's a different business. But Ron Pratte knows how to run it. And the part I like best is adding the concrete company to the mix. It should have a real impact on cycle times to have concrete and framing integrated."
The Inside Scoop
To answer as many of these questions as possible, we went to Laing.
"We've been looking at vertical integration as a strategy to drive lower costs, improved cycle times, and better quality and customer satisfaction," he says. "As a second-tier initiative, we have the Pulte Home Sciences effort, which involves product differentiation by building a better home using different materials so that we can charge a price premium for it. But what's guiding us in the Pratte deal is our DiVosta Homes operation in Florida, which is vertically integrated - completely.
"They have their own manufacturing and assembly, even including kitchen cabinets. They do their own 'kitting' in plumbing, electrical and HVAC, and a lot of their trade labor activities are done by employees - not all, but most. DiVosta is one of our most successful and profitable operations. They are a leader in cost, cycle time, quality and customer satisfaction in our company."
Compared with its competitors, Laing says, Pulte has an advantage in knowing that vertical integration will work because it has a living, breathing model of the strategy operating in Florida.
Is this another consolidation play?
Probably not. If you listen closely to Laing, the Phoenix and Las Vegas markets have special characteristics that make the Pratte deal work and are hard to duplicate in most other Pulte markets.
"In Arizona, between Pulte and Del Webb brands, we'll build 4,500 to 5,000 homes this year, and we're growing rapidly," Laing says. "But half of that volume is concentrated in two communities, Sun City Grand and Anthem. So we have remarkable velocity in those two locations. There's a lot of labor efficiency possible when you've got that kind of concentrated production. It's almost a manufacturing environment."
In Nevada, Pulte will build 3,700 homes this year, with similarly concentrated operations. "We're on our way to 5,000," Laing says. "This is unprecedented production. I don't know of anyone that has ever built 5,000 homes in a year in one market.
"The other thing about the markets in Arizona and Las Vegas is that the trades here are enormous. And it's not just concrete and framing. Ampam Plumbing in Phoenix, for example, does 12,000 homes a year. Chas Roberts does 25,000 units a year of HVAC. These companies are very profitable. There's not a lot of options as a production builder. You do business with the big trades, or you don't build. We're concentrating on the shell of the house because that's where most of the cost and cycle time is concentrated."
In Ron Pratte, Pulte found a trade contractor with the same vision for integrated operations that the home builder has. "He wrote a strategic document on how to optimize these trade categories - from design right through to service - that Bill Pulte could have written," Laing says. "That's what triggered the formation of this new company. The operating agreements have been in place for more than a year. The transaction just didn't close until recently."
Is panelization involved?
No. "Ron's cycle times are as fast or faster than anybody who panelizes," Laing says. "They don't throw away a piece of wood unless it's under 4 inches long."
Does this solve the "turnkey" problem?
You bet. "We're getting what we want in the way of control of materials costs," Laing says. "Pratte as a business has capabilities in estimating, budgeting and cost management that home builders can only dream of. I've been in the business for 20 years, and we lack the capacity to even think about the level of understanding costs that Pratte already employs."
The story on cycle time is much the same. "We see our cycle times going down as much as five to seven days on the shell of the house," Laing says. "I'm not prepared to put a number on cost savings, but we wouldn't be doing this if it couldn't be measured in several points of growth in margin improvement.
"The quality side of this is reason enough to do it," Laing adds, citing the risks associated in big builders' "warrantable 10-year backlogs of product."
Laing also believes that Pulte can eliminate some costs associated with liability insurance by self-performing much of its previously contracted construction operations.
Will Pulte take Pratte elsewhere?
Laing says the only viable candidate is California, especially Southern California. "I don't know if this will work there, but it's a potential opportunity," he says.
Most other markets lack the concentrated production and velocity necessary. "It takes a lot of sales per community to set this up," Laing says. Dallas would require 50 communities to reach 2,000 houses of production, he says. "If you sell more than four houses a month in a Dallas community, you're doing good, and that would create a logistics nightmare."
However, Laing holds out hope for the future. "As we do more Del Webb communities around the country over the next several years, we will change a lot of those production dynamics. Our goal is to get to 20% market share in every market."
Will Others Follow Pulte's Lead?
Not right away. Pulte always has been a bold leader in production innovation. Companies such as D.R. Horton, Lennar and Centex will watch Pulte's grand experiment in the desert closely to see if the firm realizes cost and construction time improvements that affect earnings. In the meantime, the risk is probably too great for them to jump.
What this amounts to is Pulte putting its money where its mouth is in terms of the economic cycle, which is what got builders out of the business of employing their own trade crews.
Large builders have been saying for five years that the bad old days of housing's cyclical nature are gone for good. Many Wall Street analysts say never say never. "I have a real problem with Richard Dugas saying Pulte is going to grow units 29% in '04 from the high end of their range," one analyst says. "Why accelerate unit growth in what could be a more challenging year? They feel comfortable that demand will be there. They are very aggressive and counting on a continuation of a strong market."
Craig Steele, president and CEO of Schuck & Sons Construction, one of Phoenix's other large framing contractors ($100 million in 2003 revenue), doesn't foresee a rush of other GIANTS heading for his door to talk about a similar deal.
"If cyclicality comes back into the market, this experiment will die very quickly," he predicts. "I think the other public builders in this market value the efficiencies that the bidding process brings. The danger of this is that the competitive nature of the bidding process is gone."
Asked if he would talk to the others about a similar deal if asked, Steele replied, "Of course we'd talk. I don't expect to get a call like that, but I guess everybody is for sale for the right price. But our company is an ESOP, so it would be harder for us to do a deal like Pratte's."
The jury remains out on this deal until Pulte proves the bottom-line value of taking the trades in house. But if that happens, watch out. The largest public builders are so competitive, they can't allow Pulte a clear advantage in the desert (and perhaps California), even if a return of the cycle would murder such deals on the spot.
Laing clearly loves the dilemma the other public builders now face: "We think there's a sustainable competitive advantage to be achieved, and we really hope nobody else does it."