More Trouble Ahead for Builders

Today, customers have a lot of options, and the threat of substitutes remains high for builders. There is a glut of existing-home inventories, and rental apartments and houses are often more affordable across the country. In some communities, builders selling new homes are facing competition within their existing communities from buyers looking to sell a version of an identical home purchased a year ago.

All of these substitutes obviously hurt builders with their pricing power.

Force Four: Buyer Power

Buyer power "allows customers to squeeze industry margins by compelling competitors to either reduce prices or raise the level of service offered without recompense," Ghemawat, the Harvard professor, writes in his book.

Open up a newspaper in Florida and California and you'll see builders offering price cuts and incentive deals to move a home.

In short, buyer power is huge right now in most markets, and customers are exerting this influence -- sometimes by just waiting on the sidelines until a deal emerges.

Force Five: Supplier Power

Here is the one area where builders might have some advantage right now. Barron, the JMP analyst, says several homebuilder management teams have talked about extracting 5% price cuts from certain material suppliers.

Then again, if housing prices are dropping 30% on new orders -- like at Lennar -- that gain doesn't help much, he says.

Even if material costs drop, land costs remain a huge piece of the puzzle that builders will have trouble controlling.

So as a whole, the homebuilding industry is facing intense competition, strong buyer power and the high threat of substitutes (such as rental apartments and existing-home inventories).

As an investor, ask yourself if this looks like an attractive industry to be in now.

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