Katerra: Key Learnings for Building a Healthier Prefab Industry Through Collaboration
Author: Nolan Browne and Lexi Nelson
Vertical integration—the expansion of operations into other stages of the supply chain process—can occur without merging two businesses. When Netflix began to make its own movies, it was vertically integrating.
Vertical integration can also involve acquiring companies in the supply chain and treating them as bought assets. The benefit of vertical integration is that profits between stages of the supply chain no longer matter.
A vertical merger, on the other hand, would result in a manufacturing company and a supplier merging, and agreeing to operate on a co-equal basis.
In the aftermath of the Katerra collapse, it is easy for the Monday morning quarterbacks to tell us how they would have done things… so, with all due respect to the decision makers at Katerra who had no benefit of hindsight when they made their decisions, it is worth exploring the root of what doomed an otherwise excellent senior team — and one of the world’s premiere financiers — into an impossible position.
One major problem plaguing the construction industry is lack of coordination among and between players. Coordinating the supply chain under a unified leadership rather than capturing profit pools is a main reason industry leaders want to vertically integrate, especially in industrialized construction (IC). Yet simply changing ownership of a company does not necessarily fix coordination issues; once companies are acquired and joined, the additional hurdle arises of how to get them to work together.
Getting the value chain to cooperate to deliver a building that can be mass customized takes diligent coordination from the site owners all the way down the chain to the trades who fit out the building and tie it to the site. As such, no amount of acquisitions will help do the hard work to solve the challenge of supply chain coordination. The problem doesn’t go away in a pure vertical integration because you have the same owners; rather, it actually becomes more urgent to solve quickly.
Coordination of the actors around standardized design, assembly and building practices – and the “Model T”-ification of a product line – was a prerequisite for success in automotive manufacturing. Why should it be any different for IC?
Katerra was well-funded, having received over $1B in funding from Softbank and $1.6B in total funding over 12 rounds, making it one of the most highly-funded startups to implode. The company’s leadership was certainly competent, but the coordination was absent: it needed a properly-executed vertical merger.
Katerra’s goal was to mass-produce K3, the name it coined for a volumetric box model of a three-story garden walkup apartment. Despite Katerra’s acquisitions of over 45 companies, the California factory set up to produce K3 was never actually activated. From 2015 to its recent bankruptcy, Katerra mostly constructed buildings designed by others, which compromised on the geometry that allowed its panelized walls and bathrooms to operate efficiently in the first place.
This loss in efficiency in turn compromised revenue, which caused Katerra to lose money or break even on various jobs. And in the words of former employee Brian Potter, they failed to place sufficient focus on facilitating synergies between different business units. On June 6, 2021, Katerra and 32 affiliated debtors filed with the U.S. bankruptcy court.
Just two years prior in 2019, Katerra had claimed to have 8,000 employees, $1.7B in annual revenue and a pipeline of projects worth over $15B — yet revenues had been exaggerated in financial reports, prompting an SEC investigation. Katerra now owes between $1.3 and $1.5B to creditors, with Stiles Machinery, Haddad Plumbing & Heating, and Thyssenkrup Elevator Corp owed between $4 and $6M each. Katerra also owes between $1.4 and $4M to roughly 30 other contractors and suppliers.
Modular companies lose ground because they change tools every time they run a new building type (e.g. houses to hospitals to apartments, etc.) as factories are commissioned to produce whatever companies franchise. Further, varying building and zoning codes create a shifting landscape that works in opposition to standardization. ADL collaborator Colby Swanson, Managing Director at MIG Innovations, compares the current one-off project diet IC manufacturers survive on to feeding twinkies to a starving diabetic. “You don’t starve immediately, but it’s going to wind up killing you,” quipped Swanson, who oversees the Modular Mobilization Coalition of 30+ volumetric offsite factories around the U.S.
The root of the problem has nothing to do with simple asset acquisition; if it were that simple, this would have been solved long ago. Instead, it has to do with getting the assets to seamlessly coordinate their work:
- Architects have to design for manufacturing from a set of practical prefabrication options that factories can reliably supply.
- Manufacturers need to standardize enough that they don’t need to retool their factory each time they produce a kit of parts for a new project.
- All the actors in the value chain need to work together to provide “mass customization” for the downstream owners.
This coordination has been successfully implemented in the electric vehicle industry: for example, you can buy four different Tesla models with custom trim packages and colors. In the end you have to buy an electric car – you can’t get an internal combustion engine motor – so the manufacturer’s compromises are inherently limited.
One would think that “serial builders” constructing hospitals, apartment complexes, and senior living facilities across the United States — Brookdale Senior Living or Marriott, for example — would be interested in buildings with a consistent and reliable color, design, and user experience that IC can provide. In interviews that ADL conducted with IC stakeholders in Massachusetts, we heard feedback that these building types would be especially conducive to designated prefabrication factories, and would allow the entire industries to scale more rapidly and cost-effectively. Look to Chick-Fil-A for an early case study of this model.
Katerra currently symbolizes the present failings of the IC industry as a whole — an industry that is struggling because “it is being fed the wrong food”. Katerra’s bankruptcy can be boiled down to vertical integration without a proper vertical merger. By implementing industry-wide coordination, more uniform housing and zoning laws, and factories standardized to produce specific building types, the industry could learn from Katerra’s failures. These measures would allow the United States to unlock the true potential of IC: immense waste reduction, safer, cheaper and more predictable construction, and a solution to the present housing crisis.
Here at ADL Ventures we are collaborating with the DOE and RMI, among others, on the Advanced Building Construction Collaborative to create this much-needed collaborative ecosystem and link building owners with prefabricators while establishing a standardized national program for design, products, and services.
Just last week on August 17, Volumetric Building Companies (VBC) formally announced that it purchased the California factory in a $25M bankruptcy acquisition. As they begin production in the 577,000 square foot factory in September, we will see whether they can coordinate to set the factory up for success that can change the narrative for IC in the United States.