If you don\u2019t understand the math, you just don\u2019t understand<\/p>\n
A number of years ago, when I moved from California to the East Coast, I struggled to understand why the builders seemed to think so differently about their projects than I was used to.<\/p>\n
I expected the numbers to vary by price point, but the business\u2019s actual approach was different. To someone from California, it was unfathomable that a builder would pass on buying good lots because they didn\u2019t have product that would fit, or that they would put a house on really good lots without taking advantage of local features, or be unconcerned about selling two homes a month.<\/p>\n
In California, we had a saying: \u201cfour per month is making real money, three is weak but okay, and two is a problem. One model, not four.\u201d <\/p>\n
The list of operational differences was long.<\/p>\n
One day in investment committee, we were discussing a deal in California. Good location, not great. The small lots were about 50% of house price \u2013 direct costs were 25% of house price. I had a deal following it where the lots were 20% of house price \u2013 direct costs were 55%. And it hit me:<\/p>\n
When we designed new product in California to take advantage of those lots, if we screwed up the direct cost estimate by 10%, that was 2.5% out of margin. Not good, but not tragic.<\/p>\n
In Atlanta, where my project was, a 10% direct cost miss was 5.5% out of the margin. More than half the projected margin. Tragic. So being cautious on new product, overly cautious in my mind, was not without merit.<\/p>\n
Because 50% of the money was spent up front in California, inflation was our best friend. Half our costs were locked in, so the spread between cost and revenue inflation could be huge.<\/p>\n
In Atlanta, only 20% of the cost was locked in. Inflation could be helpful, but not nearly as much.<\/p>\n
With 50% of the spend up front in California, the internal rate of return (IRR) was doomed if the project went slowly. The capital was eating a hole in the pro forma<\/em>. In Atlanta, with 20% up front, much less so. So, the benefit of going fast was less. Note, I said less, not that there was no benefit.<\/p>\n If the benefit of better velocity is less (again, less, not nonexistent), then you might think differently about whether you should have four models.<\/p>\n There were other differences, but the lesson was clear: the math of the business was so different that it led to different behavior.<\/p>\n I\u2019d still argue there are significant benefits to SG&A leverage, capital recycling and overall returns from increasing velocity. Those arguments remain valid. <\/p>\n However, understanding why rational people behave differently than you expect requires analyzing the math of their business, not yours.<\/p>\n This is just one example of what I call \u201cyellow pad math\u201d \u2013 the discipline of working through a problem with basic numbers before reaching for a spreadsheet. The exercise above taught me more about my new business than the most detailed model could have. <\/p>\n If the behavior you\u2019re seeing doesn\u2019t make sense, don\u2019t assume the other person is wrong.<\/p>\n Do their math. You may find they\u2019ve been right all along.<\/p>","protected":false},"excerpt":{"rendered":" If you don\u2019t understand the math, you just don\u2019t understand A number of years ago, when I moved from California to the East Coast, I struggled to understand why the builders seemed to think so differently about their projects than I was used to. I expected the numbers to vary by price point, but the…<\/p>\n","protected":false},"author":0,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"inline_featured_image":false},"categories":[1],"tags":[],"_links":{"self":[{"href":"https:\/\/mk.gen.tr\/en\/wp-json\/wp\/v2\/posts\/47846"}],"collection":[{"href":"https:\/\/mk.gen.tr\/en\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/mk.gen.tr\/en\/wp-json\/wp\/v2\/types\/post"}],"replies":[{"embeddable":true,"href":"https:\/\/mk.gen.tr\/en\/wp-json\/wp\/v2\/comments?post=47846"}],"version-history":[{"count":0,"href":"https:\/\/mk.gen.tr\/en\/wp-json\/wp\/v2\/posts\/47846\/revisions"}],"wp:attachment":[{"href":"https:\/\/mk.gen.tr\/en\/wp-json\/wp\/v2\/media?parent=47846"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/mk.gen.tr\/en\/wp-json\/wp\/v2\/categories?post=47846"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/mk.gen.tr\/en\/wp-json\/wp\/v2\/tags?post=47846"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}