41-How the High End Company is Vulnerable
The housing market is in a shambles, especially the new home construction market. In partial response to this horrible market, some of the home building industry’s largest competitors, including Toll Brothers and Hovnanian Enterprises, have entered the custom home market. Their entry illustrates the strengths of companies at the high end and exposes their vulnerability.
In the custom home market, small builders design and build homes for customers who own their own lots. These customers go to these high end builders because of Function. The builders will design and build exactly what the customer wants. The Features and Functions of the home are precisely built to the customer’s specifications. (See “How Customers Buy” in StrategyStreet.com/Tools/Perspectives.) We call companies at the high end of the product spectrum Performance Leaders. These companies usually offer Functions that the industry’s largest competitors, whom we call Standard Leaders, do not offer. (See “Success Under Fire: Policies to Prosper in Hostile Times” in StrategyStreet.com/Tools/Perspectives.)
There is not much of a market for the Standard Leaders in home building today. New home construction rates are near historic lows. In search of some market, then, these Standard Leader builders have begun offering custom-built homes. There are two types of these homes: semi-custom homes, which are developed from the builders’ pre-drawn plans; and custom homes, which are built to the buyer’s specific specifications. The Standard Leaders are entering the Performance Leader’s territory with both semi-custom and custom homes.
Why would a custom home customer buy a Performance Leader product, such as a custom home, from a Standard Leader company? There are three answers to this question. The first answer is that the customer wants Reliability. These customers want to be sure that the project will be finished as promised. These Standard Leader builders have more resources available to them and have a proven capability to complete a project, where sometimes Performance Leader builders might falter. Second, the customers for the custom home buy on Convenience. Some of these customers have found that the Standard Leader builders can produce a custom home in half the time it takes for the Performance Leader builder to complete the project. Finally, these custom home customers also buy on Price. The economies of scale that the Standard Leader builders can bring to the Performance Leader product category enable them to offer lower prices, per square foot of home. In fact, these prices can be as much as 25% below those of the Performance Leader custom home prices.
Performance Leaders are usually strong on Function. But Standard Leaders can attack their market, offering better Reliability, Convenience and Price. The Standard Leaders’ high-end product is “almost as good as” that of the Performance Leader company’s product, but it is much cheaper.
This Standard Leader attack from below pattern has recurred many times. Another example is the Lexus line of automobiles offered by Toyota. In the early years of Lexus’ debut, Toyota priced the Lexus at a breathtakingly low price compared to its competition from Mercedes and BMW, among others. This price advantage shot Lexus into the market. Today, the Lexus enjoys a much higher price level but it is still less expensive than BMW or Mercedes.
Both Toll Brothers and Hovnanian were successful in entering the Performance Leader product line. These 2 homebuilders are the middle of the pack among the larger national homebuilders in 2022. The industry leaders, DR Horton and Lennar, also offer a complete line of products, including Performance Leader products. These Standard Leader competitors use their superior economies of scale and national reputations to succeed in the Performance Leader category.
In 2020 DR Horton led the industry with $21.6 billion in sales, followed by Lennar at $20.8 billion. There is a big drop off to number 3, Pulte group, at $9.9 billion in sales. Toll Brothers is number 5 at $6.9 billion. Hovnanian is not in the top 10.
Here is a bit more explanation on Performance Leaders. The second type of Price Point, Performance Leader, sits at the high-end of the product price and performance range. These products offer more benefits for higher prices than do the Standard Leader products. Examples of Performance Leader products include first class airline travel, combination PDA phones, specialty beers, and laptop computers. The term Performance Leader can also refer to those companies that specialize in selling products at the higher end of the product marketplace. These companies would include BMW, Nordstrom, Restoration Hardware, and Bose. Each Performance Leader company would gather at least 50% of its revenues from Performance Leader products.
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