Prefabrication of Buildings Resilient, High Margin Business Models for a Cyclical Industry

This article describes Blackhorn Ventures’ strategy to address the capital-intensity and resiliency challenges of prefabrication in construction, an industry plagued by lumpy short term micro-demand and by severe swings in regional and national macro-demand across business cycles.

Construction is one of the largest industrial sectors globally, yet its productivity gains lag behind other sectors. Modular construction through prefabrication is one promising solution to this productivity challenge, but three factors restrict its growth: market cyclicality, market fragmentation, and demand for customization. Blackhorn is backing a new generation of companies in prefabricated or modular construction that take one of two differentiated approaches to mitigate the above challenges.

Disrupting the Construction Industry

Construction firms assume significant risks of cost overruns and delays, but most general contractors still earn an operating margin of less than 5 percent. Furthermore, construction is one of the highest emitting and most dangerous sectors, accounting for 39 percent of carbon emissions and more fatal work injuries than any other industry.

Prefabrication offers a compelling opportunity to make construction more efficient, profitable, sustainable, and safe for workers.

Why Prefabrication Has Failed in the Past

Despite prefabrication’s potential, past U.S. attempts at prefabrication, including the ambitious Operation Breakthrough experiment during the 1970s, failed spectacularly, largely because their capital-intensive and vertically-integrated approaches did not account for market cyclicality, demand for customization, and both vertical and horizontal industry fragmentation.

Cyclicality

The market demand for new construction is highly responsive to changes in macroeconomic conditions and resulting changes in interest rates and the availability of debt. The industry’s cyclical nature is highly problematic for prefabrication businesses that must assume significant debt or make large capital investments. Modular firms that participated in Operation Breakthrough, for example, invested heavily to build plants that required large amounts of equity and debt. When demand unexpectedly fell and interest rates simultaneously rose due to “stagflation” in the late 1970s, the plants became stranded capital assets. And “stagflation” may be coming back now! Integrated prefabrication business models have been successful in some European housing markets, where demand for homebuilding is driven by long-term government investment in affordable “social” housing, but this model does not work for the U.S. market.

Customization

A high level of customization is needed to accommodate the significant differences in building design caused by divergent local building codes, climate conditions and variations in material and labor supply and cost in different housing markets. So, conventional modular construction fabricators have found it challenging to scale production while supporting customization.

Fragmentation

Construction is a highly fragmented industry composed of many small firms across more than 15 trades. So, systemic innovations that cut across multiple trades or “swimlanes" diffuse more slowly than innovations within a single trade’s swimlane. Both Operation Breakthrough and Katerra failed to recognize the stickiness of traditional fragmented processes and business models across value chain partners.

Investing in the Next Generation of Prefabrication

To address these pressing challenges, Blackhorn has developed a differentiated investment strategy. 

We invest in firms that adopt one of two capital-efficient and resilient business models:

1. a fractional prefabricator approach; or

2. a supply chain orchestrator approach.

Fractional Prefabricator Business Model

Fractional Prefabricators target just those parts of a single trade or a small number of related trades that:

1. face a skilled labor shortage;

2. can be automated with a modest capital investment; and

3. generate high gross margins.

The offsite, fractionally prefabricated solution is faster and cheaper than traditional onsite construction. Automating the skilled labor part of the work helps address skilled labor shortages. And the modest capital investment that the fractional approach to prefabrication requires can be paid back in months rather than years or decades, so this approach is more resilient to industry downturns than high cost, more vertically integrated, multi-trade prefabrication of entire modular rooms or entire houses.

Three Blackhorn portfolio companies demonstrate Blackhorn’s fractional prefabricator approach.

• Agorus transforms 2D or 3D architectural BIM files into machine and human instructions for manufacturing custom wall, floor and roofing panels for homes.

• Hyperframe has developed a prefabricated, snap-in, steel framing kit-of-parts system; front-end software that ingests BIM models to automate frame element manufacturing; and a back-end, hardhat-mounted, augmented reality application to show installers where each stud or lintel snaps into its track, enabling 10-15 times faster on-site installation.

• Toggle is automating just rebar cage assembly —not cutting and bending of rebars. Rebar cage assembly onsite is error-prone, fatigue-inducing, expensive, dangerous, inefficient, and hampered by labor shortages.

Supply Chain Orchestrator Business Model

Companies pursuing the supply chain orchestrator approach design a system of modular components while outsourcing the production, assembly, and final installation of their elements. This allows companies to take a lifecycle perspective to cost management without assuming all the debt necessary to own each element of the supply chain. This is in direct contrast to Katerra’s business, which sought to control the supply chain by acquiring and owning every part of the value chain, making it highly vulnerable to the market’s cyclicality.

Blackhorn’s portfolio company, Modulous, serves as a good example of this approach. Modulous has created a digital platform to synchronize the site and building design, approval, procurement, and logistics of multi-family homes, shortening the delivery lead time by general contractors to typically one week from order.

What Our Portfolio Companies Share in Common

Whether through the fractional prefabrication business model or supply chain orchestrator model, Blackhorn’s portfolio companies set their growth trajectories based on deep understanding of the fragmented construction market, avoiding the risk of horizontally and vertically integrated prefabricators—a lesson learned from Operation Breakthrough.

Our portfolio company founders focus on specific pain points instead of trying to “solve them all.” This allows them to develop capital-light, agile business models. While most traditional VC investors have shied away from investing in manufacturing/service enterprises that prefabricate buildings, Blackhorn is aggressively stepping into this underinvested niche in the construction sector, and we have seen strong initial results.