Building Products Market It forms the basis of our economies and yet remains one of the most fragmented – and least digitized – industries in the world. Thousands of product categories include raw materials such as cement, steel and glass, along with finished items such as windows, doors, and air conditioners – plus everything in between. Adding to this complexity, a large pool of market participants includes major manufacturers, specialized players, and one-step and two-step distributors, as well as hundreds of thousands of dealers and contractors who manage the sale and installation of these products. Many of these players continue to rely on handshakes and fax machines to do business.
Meanwhile, the recent epidemic has fundamentally reset the short-term supply and demand relationship of the entire building products industry. Supply chain disruptions, raw material price volatility and labor shortages have led to cracks in corporate operations. Although the market has been able to overcome these cracks through multiple price increases, when the price environment returns to normal, many companies may find that the recent outperformance of their long-term plans turns out to be a mirage. As such, the sector is primed for innovation.
Perhaps not surprisingly, then, industry executives are responding to the current dynamic with a renewed focus on innovation and digital transformation. Even more surprising is the degree of consensus in this regard noted in McKinsey’s 2022 global survey of more than 500 executives in the building products sector.
After validating many of the topics we discuss with our clients, we heard:
- About 70 percent of CEOs plan to increase their investment in innovation and research and development.
- The top three trends in the rating are digital or technically oriented in nature, as are six of the top ten – this is significant in such a stubborn analog industry (Fig. 1).
- Distributors are feeling this pressure on multiple fronts and see major disruption on the horizon, including through more consolidation.
Accordingly, we decided to dig deeper into the future perspectives and plans of two major industry groups: Building Product Manufacturers and Distributors.
Building product players aspire to ‘smartness’
We see a number of areas in which executives are advised to invest and make changes over the next five years in order to remain competitive, and business model innovation is high on the list. In fact, faced with seven choices in our survey, including “regression” for productivity gains, “doubled” in core markets, or “look broadly” to find growth in neighboring markets, executives were clear: building products looking players to “get smart” by increasing its investment in innovation, research and development (Exhibit 2). Furthermore, when we asked CEOs to rate how important it is to see certain changes by their organization, 70 percent rated “Be Smart” as one of the top two choices—more than any other option (see the “Be Smart by Numbers” sidebar).
Digital and innovation-related trends are at the fore in many industries, often rising to the top of the agendas of our building products CEOs. In fact, topics involving digital design tools such as Building Information Modeling (BIM), software solutions such as worksite management, and automation even outperformed the sustainability trends in our survey. Clearly, many people see opportunity in innovation, with executives from every category choosing digital manufacturing as the greatest such opportunity: improvements to tools, processes, and efficiency can boost quality, lower costs, and increase personalization—all changes that benefit the entire value String, and further threaten those who refuse to adapt.
The growing threat of digital disruption: distributors under fire
Another particularly interesting finding in our survey is that despite the market’s perception of the need for innovation, executives still view digital as a threat rather than an opportunity. Making drastic changes to traditional ways of working requires taking uncomfortable risks. Across all four categories of respondents (buyer/contractor, designer/specifier, manufacturer, and distributor) two-thirds of the digital trends were recorded as net threats, with the largest threats considered to be those from supply chain transparency and distribution efficiency (Figure 3).
Distributors will feel the effects of these trends in transparency and efficiency, whose role in delivery and fulfillment is important, but whose margins are under severe pressure as ways to intensify the market. In fact, the only group of respondents who did not choose innovation and research and development as their first priorities were building product distributors; Instead, their preferred option is to “reinvent” themselves, with strategic and operational implications.
The reasons for the need for reinvention are clear: competitive threats from all sides, including new platforms and direct-to-consumer sales channels, the looming shift to modularity, and the expectation of continued consolidation in the industry. Specifically, however, the number one digital threat that distributors recognize is supply chain transparency, especially price discovery. Not surprisingly, those who lose most on price transparency see the biggest threat: contractors, who can command a higher margin when product and labor are pooled, and distributors, whose ability to set prices dynamically is essential. In fact, there are many disruptors seeking their share of the billions at risk in this market: an industry venture capital investor recently told us that they see a “new purchasing platform every week” seeking capital to scale their solutions.
However, we think the biggest challenge will actually be in channel management for manufacturers. As both buyers and distributors adapt to new ways of doing business, manufacturers will need to maintain downstream access and adapt to the changing ways of the market without allowing inevitable channel conflict to impair their business in the near term. In fact, the market agrees that this was the highest-scoring digital threat across all categories (net threat -13 percent). This transition will require bold actions, and involves real risks, to beat the next winning position.
Three ways to build smart product players
What then are the options available to executives for coping with this impending disruption? See the following three methods.
- Set a clear (and bold) ambition for the North Star. It’s hard to innovate in a vacuum, and without a clear innovation goal, leaders often won’t divert resources to pursue the big moves that bring about change. To make progress, it is important to articulate innovation goals with bold but reasonable ambition. These goals can range from achieving net new growth, improving customer experiences, or operating and value chain improvements. One of our clients set an ambition to achieve top-five total shareholder returns (TSR) over five years, but then realized that this meant expanding the performance of its largest division far beyond anything achieved by any player in the industry. The gap between what can realistically be achieved through routine interventions (cost programmes, marketing and sales initiatives, etc.) and bold ambition is what we call a “green box” (Figure 4): this identifies and sets a clear goal for innovator and disruptive growth.
- Keep your focus downstream. Great innovation concepts come from the intersection of three lenses: customers, technology/capability, and business model. At the end of the day, they must fulfill a clear end customer need. For manufacturers, this means understanding use-case applications and developing solutions that can alleviate contractors’ major pain points (such as qualified labor challenges or price volatility). A roofing manufacturer, for example, can choose between investing in a different grain technology or developing an easy-to-install shingle design. While both directly improve the product, one of them is likely to have a much greater impact on contractors, thus ultimately creating more value in the ecosystem. For distributors, this means understanding and meeting contractors’ evolving ways of working, including the expansion of value-added services such as pre-assembly, and greater integration with technical tools such as job site management platforms.
- Adjust your investment portfolio approach. A traditional product development approach that provides significant investment dollars based on milestones may not work in a rapidly changing environment that requires more iteration and additional steps for expansion. When we recently looked at a manufacturer’s product portfolio, we saw that less than half of the products “earned the right to grow” through accelerated investment. The rest will benefit from cost improvements or market repositioning in order to maximize value creation. Some even justified the outright abolition, given the inefficiency of the capital expenditure required to maintain their position. Managing this wide range of concepts, each with a different approach to investment, requires a more flexible approach to resource allocation.
Getting smart — investing in innovation, research and development — will be the key defining factor in the market over the next three to five years. Building materials players who do not adapt to these trends will be left behind, but those who embrace the future through innovation will succeed in turning the experiences of the past three years into a new growth path.