After years of relative stability, the homebuilding value chain in North America is poised for disruption. A combination of six forces—including persistent shortages of skilled labor, digitization, and ongoing consolidation—will demand innovations in materials, techniques, and even operating models. In this sped-up, digital-dominant world, incumbents that do not adapt to frequent shifts will lose market share and industry position to technologically savvy newcomers.
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Although ongoing pressures present many risks to industry incumbents, they also represent transformative opportunities to create value. A rapidly changing environment will demand new responses and ways of thinking. Leaders in the building-products industry that have traditionally excelled at operational and technical disciplines, such as engineering, will need to reframe their approaches to the industry—and themselves—and become nimble strategists.1 We offer a series of strategic considerations for the North American residential building-products industry to help companies evaluate their position amid significant changes and understand what is required to thrive.
Internal and external forces create pressure and opportunity
Because of the speed and breadth of the changes occurring both in and outside the industry, incumbents have a critical need to respond. The first step is understanding the factors setting the stage for industry transitions.
Skilled-labor shortages create an innovation imperative
Labor availability is the primary concern of homebuilders, significantly ahead of factors such as lot availability, environmental regulations, and prices.2 Due in part to a 70-percent decrease in new housing starts from 2009 to 2011, a large number of skilled workers left the industry. Demographic shifts, from an aging population to a lack of interest from young workers, are also reducing the pool of skilled workers. To compound the challenges, productivity growth in construction has been flat over the past 20 years, compared to 3.5 percent for the manufacturing sector and a global average of 2.8 percent.3
These intersecting realities leave many companies no choice but to implement significant innovations (often digital) to their products and processes. One such innovation is off-site homebuilding. An analysis of 14 leading modular (off-site) builders reveals more than $2 billion of disclosed funding in the market—not including investments by incumbents—led by private equity funds and large technology firms. While structural differences between markets such as degree of urbanization and consumer preferences have led to lower market penetration for off-site construction in the United States, the significant gaps suggest that there is room for the US market to grow (Exhibit 1).4 Incumbents should consider the potential impact on their business and how they can position themselves more favorably if off-site penetration does increase significantly.
Incumbents are also starting to innovate: building-products manufacturers have created products that save on labor by combining process steps or lowering the skill level required to install appropriately, and distributors are experimenting with new digital selling tools for contractors.
Digitization finally starts to gain traction in construction
Although large portions of the economy have already digitized, the construction industry is still in the early stages of the process. According to the McKinsey Global Institute Industry Digitization Index (Exhibit 2), construction is the second-least digitized industry surveyed, with low levels of digitization in assets (such as digital spending), usage (such as digital and automated business processes), and labor (such as digital spending on workers).5
Venture-capital funds recognize that the industry’s low level of digitization translates into vast opportunity and have funded hundreds of construction technology companies. Indeed, investment in construction technology has doubled over the past decade, from $9 billion in the 2008–12 period to $18 billion in the 2013–18 period (Exhibit 3).6
The inflow of investment has supported a number of construction technology innovations such as digital project management tools, aerial imaging, and building-information modeling. While currently concentrated in large commercial and infrastructure construction technology companies, investments could increasingly flow to residential homebuilding technology providers. As the homebuilding construction tech industry grows, companies will redesign key customer journeys and touchpoints—and the impact could be meaningful. For instance, we estimate distributors will see a 2–3 percent improvement in return on sales from network operations thanks to decreased costs and increased productivity.
Continued consolidation will alter how companies operate
Building-products players have undergone a wave of consolidation over the past decade. The number of M&A transactions in the North American building-products industry has increased by 10 percent per year, from 118 in 2011 to 207 in 2017.7 As scale remains a reliable way for building-products companies to increase margins through synergies and other operational efficiencies, we expect this trend to continue. An analysis of the financials of building-products companies indicates a positive correlation between revenue—a proxy for company size—and margins.8
The potential for further consolidation varies by product category. For instance, the top five manufacturers of framing materials hold 80 percent of the market, but other product categories such as millwork are much more fragmented and may be available for consolidation as market and technological conditions change.
Consolidation is already placing pressure on classic manufacturer and distributor business models. Consolidated entities that provide additional offerings have made reliable, professional service even more critical. In part because of larger companies’ offerings, customers increasingly demand value-added services such as vendor-managed inventory and just-in-time delivery. In addition, consolidation in one part of the industry increases pressure throughout the value chain, changing established negotiating dynamics and industry structure. It can also change local market dynamics if agreements between national parent companies replace purchasing patterns that were previously set through local relationships.
Environmental and regulatory pressure and consumer preferences will spur change
Outside the industry, increasing environmental awareness, increasing regulatory stringency, and changing consumer preference (tied to demographic shifts) are compounding the need for a strategic reevaluation.
The consumer and regulatory impetus for more environmentally friendly products is changing the mix of products sold and their marketing. Consumers, especially young ones, are likely to peg their purchasing behavior to environmental concerns; 70 percent of millennials surveyed said that they take companies’ stewardship of the environment into consideration when making purchasing decisions. Companies in diverse industries have responded by increasing their green offerings, in part because consumers are often willing to pay a premium for green products and services.9
As consumer values have changed, regulators have responded with increased oversight of homebuilding. For example, California’s cool-roof regulations require new roofs to have solar-reflectance properties.10 Regulatory trends have increased the number of construction regulations from 463 in 1970 to 5,198 in 2017, introducing additional costs associated with compliance and occasionally disrupting supply chains.11 Increasing regulation is also a key driver of product innovation, as new products are developed and old ones modified to satisfy changing standards.
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Finally, homebuying preferences are changing because of urbanization, migration within the United States, and changing consumer preferences linked to demographic changes (including aging populations and maturing millennials). From 1992 to 2017, the share of US residents living in urban areas increased from 76 percent to 82 percent and is expected to continue increasing.12 As the population has urbanized, its composition has also changed. For instance, there were six million senior-renter households in 2010; that number is projected to double by 2030.13 Meanwhile, millennials have delayed homeownership, increasing the demand for rental housing and supporting strong growth in multifamily units in recent years.
Changing consumer preferences can also affect building-products choices. One example is the rise of smart-home technologies intended to meet homebuyers’ demand for convenience. Such shifts have led to the development of new product categories and pockets of high demand for building products in high-growth metro areas. Meeting these demands effectively and promptly requires companies to closely monitor consumer preferences.
Six strategic considerations for industry leaders
In an industry with traditionally glacial change, the impact of the forces named above are a significant challenge. Incumbents risk losing market share to substitute products and being forced to change business models if they don’t act effectively. Since bold thinking and decisive actions are required, we’ve developed six diagnostic questions incumbents can use to challenge their current strategy and develop a powerful response. Only by determining the impact of market forces can building-products companies develop effective strategies to increase their resilience and thrive by capitalizing on the opportunities that these forces create.
1. How well does your product portfolio integrate innovations and withstand disruption?
Building-products manufacturers should assess how diversified their product portfolio is relative to disruptions and innovations in the market, after which they can consider steps to diversify their portfolio organically or inorganically (usually through M&A). Distributors, for their part, should consider whether their most profitable product categories are vulnerable to replacement by substitutes and new products and build relationships with innovative suppliers to mitigate the risk of product changes. To do this, incumbents need to be more informed about innovations and disruptions both in and outside the industry, including from start-ups and digital attackers. From there, incumbents can formulate plans to defend their positions.
2. How can you protect your competitive position?
Consolidation and technological trends are shifting opportunities and risks in the industry value chain. In fact, digital technologies are causing some steps of the value chain to be bypassed entirely. Executives should therefore reevaluate their industry segment and use scenario planning to counter significant threats to their companies’ position. Scenarios include one in which an incumbent’s customers consolidate their buying to a handful of market leaders or one in which a supplier uses digital tools to capture an incumbent’s customer relationships.
The next act for private equity in US residential building products
For companies affected by consolidation, options include further consolidating within their own value-chain step, offering innovative products or services to strengthen their competitive position, or improving their operational efficiency to protect profit margins. To protect their customer base from digital intermediaries, companies must reconsider the ways in which they offer value to their customers. To keep pace with competitors and digital disruptors, leading players can learn from innovations in business processes such as automated warehouses, artificial intelligence, and advanced analytics, which are becoming sources of competitive advantage in other industries.
3. How can you incorporate digital technology for maximum gains?
Building-products companies have an opportunity to use digitally enabled efficiencies to provide more cost-effective service. Digital solutions tend to have payback periods of only one to two years (if successfully implemented), thanks to their benefits and declining costs. In an industry that is currently underutilizing digital solutions, early adopters stand to gain a competitive advantage. Industry leaders can both adopt digital platforms for sales and also use them to reshape the customer experience. Before prioritizing digital investments, incumbents should consider their current level of digitization and estimate the value they can derive from different digital capabilities.
4. Do you know your customers and markets in enough detail to benefit from demographic shifts?
Demographics and consumer preferences vary considerably across North America. Combined with the local nature of building-products manufacturing and distribution,14 these variations create micromarkets among which growth prospects for the residential building-products industry also vary. For example, the southeastern United States contains many high-growth micromarkets. To accommodate different customer preferences in diverse micromarkets, companies may vary the mix of product offerings in different markets. For instance, green products can be emphasized in areas where consumers value environmental sustainability. Companies need to take a granular view of the markets and segments that represent the best opportunities for their product portfolio and network—and of how well they are positioned to benefit from shifts.
5. Are you in a position to effectively respond to or benefit from cyclicality and volatility?
Economic cyclicality and commodity-price fluctuations are major challenges for the building-products industry, as seen during the 2007–09 recession. Building-products companies should consider strategies to reduce their vulnerability to those forces. For example, some industry incumbents have acquired businesses tied to “repair-and-remodel” spending (such as roofing) because such businesses tend to be more resilient and less volatile during economic downturns. For companies with capital to spend during a recession, acquiring repair-and-remodel businesses can be a way to insulate themselves from future economic shocks for below-market values.
6. How does your talent strategy help you become and remain successful?
As the industry transforms, leaders will need to institute thoughtful talent strategies. Ongoing challenges include recruiting effective operators to run their businesses and staffing new functions to support growth. For example, as construction digitizes, industry leaders will need data scientists and digitally savvy analysts to provide internal capabilities. Recruiting and maintaining this talent pool means competing with technology companies—rather than other building-industry companies—for talent.15 Meanwhile, manufacturers will need to increase investment in R&D and innovation labs to foster product innovation.
Owing to intersecting competitive, technological, social, and regulatory forces, the potential for disruptive change in the building-products industry is greater than at any time in recent history. As incumbents update their strategies, the industry will diverge into leaders informed by market forces and laggards caught unprepared. Industry executives will need to objectively assess their companies, creating a scorecard of areas in which they are well positioned or vulnerable. Armed with these insights, industry leaders will be better equipped to take the bold actions that may be required to stay competitive as the market transforms.
