Addressing Rising Lumber Prices. A Case Study for Smarter Building Material Sourcing. katerra.com

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1 Addressing Rising Lumber Prices A Case Study for Smarter Building Material Sourcing katerra.com

2 Summary In recent months the price of softwood lumber has skyrocketed more than 30 percent, adding pressure to a building market already challenged by labor productivity issues and cost overruns. Builders face a difficult choice: pass the added costs onto customers, cut costs by choosing lower quality materials and/or reducing product offerings, delay projects indefinitely while monitoring prices, or cancel projects altogether. The unprecedented rise in construction materials costs, including softwood lumber, steel and concrete, due in large part to new import tariffs, underscores how conventional buying of building materials leaves developers exposed to unnecessary risk. Katerra s innovative, end-to-end construction process, which offers a fixed price per project for materials in advance, provides developers increased project certainty and competitiveness. Rising Costs Pinch Suppliers, Builders and Customers Over the last 12 months, the cost of softwood lumber a key material in wood-frame construction has risen. According to Bloomberg¹, The price of lumber has surged 31 percent in the past 12 months, and it s trading at the highest level in at least 32 years. This increase can be attributed to multiple factors, including rising demand, new tariffs averaging 21 percent imposed by the U.S. government on imports of Canadian softwood lumber², and weather impacts, such as last year s devastating wildfire season³, which contributed to tighter U.S. supply. Price of for Lumber Futures Futures Contract Contract Source: Bloomberg $600 $500 $400 Feb 2017 Apr May Jun Jul Aug Sep Oct Nov Dec Jan 2018 Feb Mar ¹ Skerritt, J. (2018, March 5). Trump s Tariff Is Forcing Homebuilders to Cut Costs. Bloomberg Businessweek. Retrieved from ² Emrath, P. (2017, December 7). Impact of the Canadian Lumber Duties on the U.S. Economy in NAHB Eye on Housing. Retrieved from ³ (2018, January 4). Softwood Lumber Outlook for 2018 Shaped by Wildfires, Tariffs. NAHB Now. Retrieved from 02

3 The rapid rise in softwood lumber prices presents a real challenge for builders who must manage the difference in costs from when a project is quoted to when materials are purchased. The National Association of Home Builders (NAHB) estimates a 6.9 percent increase in the price paid by U.S. customers for softwood lumber in 2018, or an increase of $1,360 for an average single-family home 4. For larger, multi-family projects, the overall cost impact is approaching a two percent increase in the sales price. Prices for commercial construction are also increasing. National Real Estate Investor (NREI) recently reported a 10 percent increase in the price of steel since the new tariffs were announced. NREI cites one real estate developer who said that the price to construct a similar building had increased 25-30% in just the last two years. 5 The Status Quo: Inefficient and Risky According to McKinsey Global Institute, because of inefficiencies in today s construction procurement and supply-chain practices, companies can overpay by up to 15 percent for materials and services, while poor supply-chain management typically accounts for 10 to 30 percent of cost and time overruns 6. In multi-family construction, a market where Katerra is largely focused, a rule of thumb is that over half a building s cost is materials; therefore, managing the supply chain is as critical as optimizing labor. In the current construction model, contractors make local material purchase decisions, based on specifications from licensed design professionals. This one-off approach is inefficient because it always results in less purchasing power for the buyer. Once a project is planned and costs are budgeted, invariably unforeseen expenses arise and are accounted for by contingency fees, which are typically charged upfront above the quoted rate, or change orders, which are ultimately passed on to the buyer. If builders cannot pass on those cost increases, it pushes them to look for lower-priced alternatives at the risk of sacrificing quality and customer satisfaction. The Katerra Model: End-to-End Building Services Katerra has introduced an entirely new model for construction, which integrates expertise in development, design, technology, material sourcing, manufacturing and construction, within a single offering to deliver superior, fullycomponentized, energy efficient buildings. Katerra applies a systems approach to remove unnecessary time and cost from building development, design and construction, to dramatically improve productivity and enhance value. Katerra s end-to-end construction model is fully integrated, design-led, technology driven and sustainably focused. 4 Emrath, P. (2017, December 7). Impact of the Canadian Lumber Duties on the U.S. Economy in NAHB Eye on Housing. Retrieved from 5 Diduch, M. (2018, March 20). Tariffs Already Putting Pressure on Commercial Construction Pricing. National Real Estate Investor. Retrieved from 6 Barbosa, F., Woetzel J., Mischke J., João Ribeirinho, M., Sridhar M., Parsons, M., Bertram N., Brown, S. (2017) Reinventing Construction: A Route to Higher Productivity (McKinsey Global Institute). Retrieved from 03

4 Katerra s approach is grounded in the development of a revolutionary end-to-end software solution one that encompasses site selection and configuration, building design, optimization for manufacturing, price quoting, and project tracking from concept through completion. Automating these functions as well as financial modeling and zoning and building code compliance analysis most of which are manual today unlock new opportunities for speed, collaboration and assurance for all parties. This platform is made possible through Katerra s vertically integrated model, supported by a robust technology infrastructure that includes global enterprise deployment of SAP, linking design and construction activities directly to their manufacturing and supply chain operations. Vertical Integration: A Smarter Way to Source Katerra is changing the dynamic of material manufacturing and purchasing. The company recognized early on that vertical integration can reduce waste, risk, lower costs and accelerate project delivery. For example, Katerra acquired an LED lighting manufacturer and proprietary cabinet component sets to significantly reduce their base cost of components. Lower costs, less inventory, and tighter controls result from control of the supply chain from design phase to the bulk purchase of raw materials across all Katerra projects. Without Katerra Manufacturers Distributors Dealers / Retailers Subcontractors General Contractors Owner / Developers With Katerra Suppliers & Manufacturers Material Partner Owner / Developers Material cost savings achieved with Katerra s vertically integrated model 04

5 Katerra has established sourcing and quality control offices in Scottsdale, AZ, Guadalajara, Mexico and Shenzhen, China. These direct relationships with suppliers, together with advanced transportation logistics, contributes to minimizing costs. Katerra embraces a Just-in-Time (JIT) inventory strategy, leveraging SAP enterprise software, to increase efficiency and decrease waste by receiving and delivering goods only as they are needed in the production process, thereby reducing inventory costs. Inventory controls allow for more efficient pre-stocking of building materials as the structures are erected. This increases worker productivity in the field because workers are not having to search for missing parts or tools required for installation. Unlike the traditional approach of on-site material stockpiling and crew fluctuations, Katerra s consumptionbased scheduling ensures factory production is carefully aligned with field consumption. This optimizes job-site crew sizing to complete work based on timely delivery of materials from Katerra warehouses or factories. Katerra s Fixed-Price Per Project Offering: Less Risk, Greater Certainty As a result of these innovations, including automation, efficiency, and buying power, Katerra can commit to offering fixed prices up front without charging contingency fees, something that is not typically seen in the construction industry. Regardless of price changes, the company keeps its commitment to its customers. As such, Katerra s customers have protection from sudden price increases in materials that is not possible when purchasing the traditional way. Katerra s unique fixed price offering provides significant benefits to developers, including cost and time savings, project certainty, and better quality assurance. Conclusion The conventional method of procurement in the construction industry is disjointed and inefficient at best. When compounded by price spikes, as occurring presently with lumber, steel and concrete, a high degree of uncertainty is added, leading to undesirable outcomes for builders and consumers alike. Katerra s innovative, end-to-end construction process with direct materials sourcing and fixed pricing enables developers to reduce risk and costs, while increasing project certainty and competitiveness. 05

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