Producing goods and services is typically subject to economies of scale - as the volume of output rises, the unit cost of each thing being produced falls. Economies of scale are common - we don’t find it surprising when a large company like Walmart or Amazon or Borders (rip) can drive a smaller “mom and pop” competitor out of business with low prices that the competitor can’t match, and we’d expect that a giant company like Toyota can produce cars much more cheaply than a small boutique manufacturer like Aston Martin.
The reason for this situation seems pretty straightforward.
Manufacturers achieve economies of scale by investing in expensive capital equipment that increases the productivity of labor. It was expensive to build the early Ford factories, but the completed factories contained sophisticated equipment that made the marginal cost of building one Ford auto cheaper than the cost of an auto built by a boutique manufacturer. So Ford captured market share from the boutique auto manufacturers, and the new equilibrium became a small number of well-capitalized, high-volume car manufacturers dominating the market.
Complex factories are expensive, so firms can only afford to build a few of them and need high output from them to be profitable. This means that the products need to be shipped relatively far from the few factories to their many final destinations.
The obvious issue is that the physical dimensions of a factory’s product have to be small enough to fit within the dimensional constraints of our transportation infrastructure. Roughly speaking, this means that the product needs to be small enough to fit within a shipping container. Any product that’s substantially larger than a shipping container can’t be transported cheaply, so it’s pointless to invest in expensive equipment to build it in a centralized factory.
If you zoom out and look at manufacturing as a whole, defined broadly to include the production of any physical object, you see a sharp disparity in efficiency between the manufacturing of small and large objects. Small things, like cars and widgets, are built in a few expensive, centrally-located factories and shipped. Big things, like houses, skyscrapers, roads, and sewage-treatment plants, are too big to be shipped, so they’re built on-site. But only one of the big items is built in each location, so it’s not cost-effective to install expensive volume-production equipment there. It’s cheaper to use simple, labor-intensive methods.
Based on the above, it makes sense that a 300-unit apartment building isn’t much cheaper on a PSF basis than a single-family house. Although the apartment building is a lot bigger than the house, the relevant factor is not the size disparity between the two but rather the fact that both of them are, unlike a car or widget, too big to fit in a highway lane. So they’re both built at their final locations with similar labor-intensive construction methods, at similar PSF costs.
Based on the above, we’d also predict that discrete building components that *do* fit within shipping containers will be built like cars and widgets, not like buildings. And that’s exactly what we see. The window industry, unlike the home building industry, is highly centralized. Andersen and Pella have huge, expensive factories, ship their windows thousands of miles, and capture large shares of the window market. Likewise for boilers, appliances, etc.
A few years back, I did some analysis of economies of scale while working at a major national homebuilder. We found some evidence of economies of scale *within* local markets: in general, the national homebuilders with larger relative scale in local markets tended to be more profitable. This didn't generalize to national scale. I expect that was mainly due to the many unique aspects of each metro area around land development and entitlement, building codes, relative market power of the building trades, etc.
You are looking for economies of scale in the wrong place. You are asking, "If it costs $X to build a 1,000-square-foot building, shouldn't it cost less than $1000X to build a 1 million-square-foot building?" You should be asking, "If it costs $X to build a 1,000-square-foot building, does it cost less than $1000X to build a thousand 1,000-square-foot buildings?" In a state such as Texas or North Carolina, where land isn't heavily regulated, the answer is "Yes." In a state such as California, the answer may be "No" only because no one can find enough land to build a thousand 1,000-square-foot buildings.
There are manufactured things that have cut the cost of construction, for example, modular rafters, prehung windows, and .metal roofing. These are, however, available to builders large and small. Some of them, like metal roofs, actually increase the cost of construction though they make good sense for the long term.
The problem is that most construction has to be done on site. Once you are on site, being large and doing large projects has minimal advantage. If someone invents a robot that can frame a house, lay an underfloor or shingle a roof, that might give them a cost advantage. Unfortunately, that would only be an advantage in a handful of the many trades involved in building a house.
When we considered building a house, we ran a number of cost estimates. The framing, flooring and roof are roughly linear, but every kink and bend adds to that cost. In bathrooms and kitchens, the plumbing is the big cost. It is more expensive to add a bathroom than to double the square footage of a bathroom.
Brian, these are interesting facts, particularly relating to the business models of the largest homebuilders. It would be very interesting to see an international perspective on this. For instance, looking at other countries' approaches for fee-simple single family homes, what kind of value is delivered e.g. in Japan or Western Europe? And how does this cost per unit compare to multi-family condo purchase?
Economies of scale are like gravity, and are determined by either scale (in mass production) or technology (for specialized or customized widgets). Additive manufacturing (3D printing) may be the tech that changes the equation for construction. Mass production will always have a role, but market niches currently occupied by some or many manufacturing firms may be replaced by new production technologies based on BIM, linking localised digital fabrication facilities with online design databases.
The commercialisation of 3D concrete printing is happening, with two types of systems available. One using a robotic arm to move the print head over a small area, intended to produce structural elements and precast components, the other a gantry system for printing large components, walls and structures. The Additive Manufacturing Marketplace has 34 concrete printing machines listed, ranging from desktop printers to large track mounted gantry systems that can print three or four story buildings.
Many of these printers could be used to produce fixtures and fittings for buildings. Producing components onsite from bags of mixture avoids the cost of handling and transport, and for large items avoids the load limits on roads and trucks. There are also printing services and additive manufacturing marketplaces being set up. These link designers to producers with the materials science, specialised equipment and print farms capable of large production runs and manufacture on demand.
The combination of digital twins and digital fabrication would be transformational if it allows onsite and nearsite production of some or many building components, by fundamentally altering existing economies of scale in the industry. As well as 3D concrete printing, other materials like steel and plastic can be used to make components and fittings on or near the building site. A modular fab in a container customised for construction, or even a specific construction project, can be set up onsite to produce components as the schedule requires. Large sites might need a nearsite fleet of fabs. Restorations and repairs can be done with replacement parts made onsite from scans of the original.
If onsite and nearsite production becomes steadily cheaper the industry would, perhaps slowly, reorganise around firms that best manage onsite and offsite production and integration of digitally fabricated parts. Contracting firms would become more vertically integrated if they are fabricators as well. This effect of economies of scale is discussed here https://www.constructioneconomicsresearch.com/post/3d-concrete-printing-and-digital-construction
Hope you are differentiating between building construction and, say, road construction in this series (or be clear about it if you are only addressing building construction). My intuition from being in the industry is that road construction is somewhere in between building construction and mining. There are some big companies that own their own heavy equipment and can do better than a local road contractor in terms of $/m3 dirt moved, or $/m2 road built. But only on big jobs and they don't take small jobs because it just doesn't work out for them - can't use the economies of scale - thus still a market for small contractors fixing up a bit of road for the local government.
The comparison between factories and home building does not work on one level because if one is making widgets or cars, one doesn’t move one’s equipment and workforce miles and miles away with each production run. In construction, this is what happens, even if the work is subcontracted to a local company that does the actual building.
Great post. I would be interested to know how the ratio of labor to material costs in housing construction costs have changed over time. Perhaps the total project haven’t benefited from economies of scales but the various materials have relatively decreased in price due to manufacturing learning curves. What would be the learning curves of various material manufacturing that could lower construction costs?
Summary: to what extent are non core physical construction costs - permits/fees/taxes, sprinkler systems, insurance costs, etc. locked into per sq ft (or close to that rates), so that for at least that part of the project cost, there's no hope of economies of scale? And maybe these effects are bigger than one might realize?
...
In some areas, various fees and taxes are a non-trivial part of the cost of delivering (or renovating!) a structure, and at least in WA state they are sometimes flat rate per sq ft.
So while a say 5c per sq ft permit fee for adding insulation to a warehouse (I kid you not) shouldn't be a deal breaker, it by definition does NOT go down with scale. It scales 1 for 1, period.
Noted by Jim is things like code compliance - well, once you start adding sprinklers (say) the cost per sq ft is essentially linear - twice the floor space, twice the sprinklers, twice the piping.
I suspect the same or worse with things like utility fees, assessments for road and sewer building, etc.
I'll also note being told that for some crane operations, the insurance is per operating hour, no discounts for scale. There's no "insurance economy of scale". I wonder if other sorts of insurance and bonding have the same anti-economy-of-scale - twice the sq ft so twice the materials so twice the insurance bill, twice the completion bond, etc.?
Oh, and at least WA state has at least some rules, that surely raise costs, that only apply to buildings above a particular size, or to housing developments with more than a small (2 ???) number of houses.
Various groups have tried (not sure if they succeeded) in requiring that any development with more than 2 houses put sprinklers in them all! Regardless of the merits of sprinklers, such a rule is anti-economy-of-project-size.
1. highly labor-intensive relative to capital-intensive means constant cost-per-time and constant productivity-per-time
2. very low barriers to entry for new firms (because of #1)
3. inconsistent market - construction is very roughly speaking a second derivative of the size of the economy. I.e. the market for construction services is highest when economic growth is faster and construction is hit really hard in a downturn. In addition, demand is highly inelastic and impervious to marketing. No one is gonna decide to build a building because you have a really cool commercial. The precludes capital investment, thus enforcing #1. This also makes construction employment much more susceptible to recessions etc, creating regular openings for new competitors, enforcing #2.
Couple more thoughts - residential construction is manufacturing done in the open - subject to weather. Many of the components are heavy and bulky, and not so easily stocked by the manufacturer (builder). And in many cases, the final touches end up being close to custom construction - choices of tile and fixtures and cabinets - with the attendant delay from buyers. These add to costs as well as time. Certainly there are regulatory delays and code issues that add to costs, but most of us don't really want to eliminate those. The Chinese way does eliminate many time delays and cost elements. Project completion is with windows and a unit entry door installed and electrical and plumbing connections stubbed in at a wall. Buyers pay for all finishing on their own schedule. Developers mostly do not have to deal with wood or drywall or brick or any interior finishes at all, unless they are separately contracted to do that work. Concrete and concrete block are the main building cost elements. Building inspectors are not a problem; nor is code compliance in many cases. Codes don't require fire sprinklers in many situations where they would be required in the US, and (in the south of China) there are no costs at all for HVAC work since a couple of wall hung units provide all heat and air conditioning. Only one exit is required from an apartment unit and building common area finishes aside from exterior landscaping are non-existent, even in higher end buildings (no hallway or stairway work). I have a few related posts at chinareflections.com
What about manufactured housing? That should benefit from economies of scale. Does it in reality? How does it compare to site built homes? As per the comment below, manufactured homes are built in central locations and transported to site.
The reason for this situation seems pretty straightforward.
Manufacturers achieve economies of scale by investing in expensive capital equipment that increases the productivity of labor. It was expensive to build the early Ford factories, but the completed factories contained sophisticated equipment that made the marginal cost of building one Ford auto cheaper than the cost of an auto built by a boutique manufacturer. So Ford captured market share from the boutique auto manufacturers, and the new equilibrium became a small number of well-capitalized, high-volume car manufacturers dominating the market.
Complex factories are expensive, so firms can only afford to build a few of them and need high output from them to be profitable. This means that the products need to be shipped relatively far from the few factories to their many final destinations.
The obvious issue is that the physical dimensions of a factory’s product have to be small enough to fit within the dimensional constraints of our transportation infrastructure. Roughly speaking, this means that the product needs to be small enough to fit within a shipping container. Any product that’s substantially larger than a shipping container can’t be transported cheaply, so it’s pointless to invest in expensive equipment to build it in a centralized factory.
If you zoom out and look at manufacturing as a whole, defined broadly to include the production of any physical object, you see a sharp disparity in efficiency between the manufacturing of small and large objects. Small things, like cars and widgets, are built in a few expensive, centrally-located factories and shipped. Big things, like houses, skyscrapers, roads, and sewage-treatment plants, are too big to be shipped, so they’re built on-site. But only one of the big items is built in each location, so it’s not cost-effective to install expensive volume-production equipment there. It’s cheaper to use simple, labor-intensive methods.
Based on the above, it makes sense that a 300-unit apartment building isn’t much cheaper on a PSF basis than a single-family house. Although the apartment building is a lot bigger than the house, the relevant factor is not the size disparity between the two but rather the fact that both of them are, unlike a car or widget, too big to fit in a highway lane. So they’re both built at their final locations with similar labor-intensive construction methods, at similar PSF costs.
Based on the above, we’d also predict that discrete building components that *do* fit within shipping containers will be built like cars and widgets, not like buildings. And that’s exactly what we see. The window industry, unlike the home building industry, is highly centralized. Andersen and Pella have huge, expensive factories, ship their windows thousands of miles, and capture large shares of the window market. Likewise for boilers, appliances, etc.
A few years back, I did some analysis of economies of scale while working at a major national homebuilder. We found some evidence of economies of scale *within* local markets: in general, the national homebuilders with larger relative scale in local markets tended to be more profitable. This didn't generalize to national scale. I expect that was mainly due to the many unique aspects of each metro area around land development and entitlement, building codes, relative market power of the building trades, etc.
You are looking for economies of scale in the wrong place. You are asking, "If it costs $X to build a 1,000-square-foot building, shouldn't it cost less than $1000X to build a 1 million-square-foot building?" You should be asking, "If it costs $X to build a 1,000-square-foot building, does it cost less than $1000X to build a thousand 1,000-square-foot buildings?" In a state such as Texas or North Carolina, where land isn't heavily regulated, the answer is "Yes." In a state such as California, the answer may be "No" only because no one can find enough land to build a thousand 1,000-square-foot buildings.
There are manufactured things that have cut the cost of construction, for example, modular rafters, prehung windows, and .metal roofing. These are, however, available to builders large and small. Some of them, like metal roofs, actually increase the cost of construction though they make good sense for the long term.
The problem is that most construction has to be done on site. Once you are on site, being large and doing large projects has minimal advantage. If someone invents a robot that can frame a house, lay an underfloor or shingle a roof, that might give them a cost advantage. Unfortunately, that would only be an advantage in a handful of the many trades involved in building a house.
When we considered building a house, we ran a number of cost estimates. The framing, flooring and roof are roughly linear, but every kink and bend adds to that cost. In bathrooms and kitchens, the plumbing is the big cost. It is more expensive to add a bathroom than to double the square footage of a bathroom.
Brian, these are interesting facts, particularly relating to the business models of the largest homebuilders. It would be very interesting to see an international perspective on this. For instance, looking at other countries' approaches for fee-simple single family homes, what kind of value is delivered e.g. in Japan or Western Europe? And how does this cost per unit compare to multi-family condo purchase?
I like the shorter post. cliffhanger!
Economies of scale are like gravity, and are determined by either scale (in mass production) or technology (for specialized or customized widgets). Additive manufacturing (3D printing) may be the tech that changes the equation for construction. Mass production will always have a role, but market niches currently occupied by some or many manufacturing firms may be replaced by new production technologies based on BIM, linking localised digital fabrication facilities with online design databases.
The commercialisation of 3D concrete printing is happening, with two types of systems available. One using a robotic arm to move the print head over a small area, intended to produce structural elements and precast components, the other a gantry system for printing large components, walls and structures. The Additive Manufacturing Marketplace has 34 concrete printing machines listed, ranging from desktop printers to large track mounted gantry systems that can print three or four story buildings.
Many of these printers could be used to produce fixtures and fittings for buildings. Producing components onsite from bags of mixture avoids the cost of handling and transport, and for large items avoids the load limits on roads and trucks. There are also printing services and additive manufacturing marketplaces being set up. These link designers to producers with the materials science, specialised equipment and print farms capable of large production runs and manufacture on demand.
The combination of digital twins and digital fabrication would be transformational if it allows onsite and nearsite production of some or many building components, by fundamentally altering existing economies of scale in the industry. As well as 3D concrete printing, other materials like steel and plastic can be used to make components and fittings on or near the building site. A modular fab in a container customised for construction, or even a specific construction project, can be set up onsite to produce components as the schedule requires. Large sites might need a nearsite fleet of fabs. Restorations and repairs can be done with replacement parts made onsite from scans of the original.
If onsite and nearsite production becomes steadily cheaper the industry would, perhaps slowly, reorganise around firms that best manage onsite and offsite production and integration of digitally fabricated parts. Contracting firms would become more vertically integrated if they are fabricators as well. This effect of economies of scale is discussed here https://www.constructioneconomicsresearch.com/post/3d-concrete-printing-and-digital-construction
Hope you are differentiating between building construction and, say, road construction in this series (or be clear about it if you are only addressing building construction). My intuition from being in the industry is that road construction is somewhere in between building construction and mining. There are some big companies that own their own heavy equipment and can do better than a local road contractor in terms of $/m3 dirt moved, or $/m2 road built. But only on big jobs and they don't take small jobs because it just doesn't work out for them - can't use the economies of scale - thus still a market for small contractors fixing up a bit of road for the local government.
The comparison between factories and home building does not work on one level because if one is making widgets or cars, one doesn’t move one’s equipment and workforce miles and miles away with each production run. In construction, this is what happens, even if the work is subcontracted to a local company that does the actual building.
Great post. I would be interested to know how the ratio of labor to material costs in housing construction costs have changed over time. Perhaps the total project haven’t benefited from economies of scales but the various materials have relatively decreased in price due to manufacturing learning curves. What would be the learning curves of various material manufacturing that could lower construction costs?
Summary: to what extent are non core physical construction costs - permits/fees/taxes, sprinkler systems, insurance costs, etc. locked into per sq ft (or close to that rates), so that for at least that part of the project cost, there's no hope of economies of scale? And maybe these effects are bigger than one might realize?
...
In some areas, various fees and taxes are a non-trivial part of the cost of delivering (or renovating!) a structure, and at least in WA state they are sometimes flat rate per sq ft.
So while a say 5c per sq ft permit fee for adding insulation to a warehouse (I kid you not) shouldn't be a deal breaker, it by definition does NOT go down with scale. It scales 1 for 1, period.
Noted by Jim is things like code compliance - well, once you start adding sprinklers (say) the cost per sq ft is essentially linear - twice the floor space, twice the sprinklers, twice the piping.
I suspect the same or worse with things like utility fees, assessments for road and sewer building, etc.
I'll also note being told that for some crane operations, the insurance is per operating hour, no discounts for scale. There's no "insurance economy of scale". I wonder if other sorts of insurance and bonding have the same anti-economy-of-scale - twice the sq ft so twice the materials so twice the insurance bill, twice the completion bond, etc.?
Oh, and at least WA state has at least some rules, that surely raise costs, that only apply to buildings above a particular size, or to housing developments with more than a small (2 ???) number of houses.
Various groups have tried (not sure if they succeeded) in requiring that any development with more than 2 houses put sprinklers in them all! Regardless of the merits of sprinklers, such a rule is anti-economy-of-project-size.
Reasons coming to mind:
1. highly labor-intensive relative to capital-intensive means constant cost-per-time and constant productivity-per-time
2. very low barriers to entry for new firms (because of #1)
3. inconsistent market - construction is very roughly speaking a second derivative of the size of the economy. I.e. the market for construction services is highest when economic growth is faster and construction is hit really hard in a downturn. In addition, demand is highly inelastic and impervious to marketing. No one is gonna decide to build a building because you have a really cool commercial. The precludes capital investment, thus enforcing #1. This also makes construction employment much more susceptible to recessions etc, creating regular openings for new competitors, enforcing #2.
Couple more thoughts - residential construction is manufacturing done in the open - subject to weather. Many of the components are heavy and bulky, and not so easily stocked by the manufacturer (builder). And in many cases, the final touches end up being close to custom construction - choices of tile and fixtures and cabinets - with the attendant delay from buyers. These add to costs as well as time. Certainly there are regulatory delays and code issues that add to costs, but most of us don't really want to eliminate those. The Chinese way does eliminate many time delays and cost elements. Project completion is with windows and a unit entry door installed and electrical and plumbing connections stubbed in at a wall. Buyers pay for all finishing on their own schedule. Developers mostly do not have to deal with wood or drywall or brick or any interior finishes at all, unless they are separately contracted to do that work. Concrete and concrete block are the main building cost elements. Building inspectors are not a problem; nor is code compliance in many cases. Codes don't require fire sprinklers in many situations where they would be required in the US, and (in the south of China) there are no costs at all for HVAC work since a couple of wall hung units provide all heat and air conditioning. Only one exit is required from an apartment unit and building common area finishes aside from exterior landscaping are non-existent, even in higher end buildings (no hallway or stairway work). I have a few related posts at chinareflections.com
What about manufactured housing? That should benefit from economies of scale. Does it in reality? How does it compare to site built homes? As per the comment below, manufactured homes are built in central locations and transported to site.