Turn up the volume

There has been a trend towards volumebuilders over the last decade – an increased number of larger firms expandingmarket share at the expense of small building companies.   A similar trend hasbeen evident in other areas of business – supermarkets and department stores,for example.   We believe the trend towards volume builders has further to go,with tighter regulations and the desire to keep building costs down both factorsthat will give larger players an advantage over their smaller rivals.

Squeezing out the little guys

In the year to March 1997, there wereonly six construction firms with over 100 new dwelling consents (excludingapartments), accounting for 6.9% of the total residential building market.   By2006, that number had risen to 17 firms with 18% of the total market share.

Graph 1.1 shows total market shares fordifferent size building firms over the last ten years.[1]   While the proportion of total constructionwork undertaken by builders of 80 or more dwellings per annum has risen, almostall other segments of the market have shrunk (the exceptions are owner buildersand builders of 40-79 dwellings per annum, both of which have been flat).

Graph 1.1

The residential building sector has gonethrough 2 ½ cycles since 1997.   The larger firms have tended to hold their own(in terms of market share) during the downturns, and expanded their marketshare during the upturns.   Large established firms are able to lift theirproduction relatively quickly in response to increasing demand, so it isunsurprising that they reap the benefits of a building boom.

Over time, this trend squeezes thesmaller players out of the market.   The number of construction firms buildingthree or four new houses per annum has fallen from 559 in 1997 to 444 this year(despite a higher overall level of building activity for the last 12 monthsthan in the year to March 1997).   Table 1.1 shows the ten biggest residentialconstruction firms in 1997, 2001, and 2006.

Table 1.1

Figures from the Housing IndustryAssociation in Australia show that in 2002/03, the 100 largest constructionfirms built around 45% of all new detached houses.   By comparison, the marketshare accounted for by the 100 largest firms in New Zealand in 2005/06 was 32%(up from 22% in 1997).   The biggest Australian company, the Alcock/Brown-NeavesGroup, enjoyed a 2.5% market share, which is similar to the size of the largestfirm in New Zealand.

Keeping costs down

Graph 1.2 shows the gap between averagenew dwelling consent values and average improvement values (hereafter referredto as the building price gap) over the last 30 years.[2]   During that period, building a new house hasalways been more expensive than buying an existing property (excluding the landcost).   It cost 14% more to build a new house than buy an existing property in1984, and a whopping 66% more in 1981.   If builders can keep their costs down,it helps reduce the building price gap.

Graph 1.2 also reveals a looserelationship between house price inflation and the building price gap – whenreal house price inflation is strong (e.g. 1981-2), the building price gapshrinks.   The reverse is true when real house price inflation is weak.   Thehouse price boom since 2003 has reduced the building price gap, but perhaps notby as much as might have been expected.   With the building price gap still ataround 33%, the implication is that the gap could become quite large over thenext few years as the housing market goes through a slow patch.

A continuation of the trend towardsvolumes builders over the next five years could help limit the expansion in thebuilding price gap.   There are two cost-associated reasons for ongoing growthin the number of volume builders.

Graph 1.2

The first factor relates to materialcosts.   Building a large number of dwellings simultaneously impliesthe need for large quantities of fixtures and fittings.   A firm purchasing 250door handles at once, rather than ten, will presumably be able to negotiate amore favourable price with suppliers, and pass some of those savings on to itscustomers.   In dealing with larger quantities, there is even scope to importthe products directly and cut out the costs of the middleman.   The ability ofvolume builders to keep material costs down has probably been one of the mainfactors behind their growth over the last decade.

The second reason is the increasedlevel of regulation of the building industry.   The need for allbuilding work to be overseen by a licensed builder will push up the labour costassociated with construction.   For a small building firm with three workers,for example, the percentage cost increase will be much larger than for a firmwith 50 employees, where the licensed builder will be able to spread hisincreased cost of supervision over a large number of projects.   Thus theincreased compliance costs will tend to work against smaller building firms.

[1] "Owner builders" are defined as builders of a single dwelling in a12-month period that have not been identified as commercial builders.

[2] The average improvement value is the average house price less theaverage section price.

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