Business Models: Coworking
 
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The Future of Work: Aligning work with office space and economics

When coworking leader WeWork announced in April 2018 that it was pursuing enterprise clients, analysts were supportive.

In our office, we said, “What took so long?”

WeWork’s business model of taking on long-term liabilities of office leases in exchange for increased short-term rents from small companies and solopreneurs was a gamble from the start. Fortunately, no economic recession left them stuck with liabilities during a mass exodus of customers. Their success spawned countless imitators and a boom of local coworking offerings.

But in 2015, three years ago, we analyzed the business model of coworking for a large professional services client with 1200 employees and about 37 offices around the world. We looked at the sustainability and the need to focus on enterprise companies, those that would benefit most as knowledge-based organizations if they were to put some of their people into coworking spaces.

SITUATION: To illustrate savings and other benefits to our client, we used PwC as an example. In our example, we showed that PwC could save as much as $379 million annually if they put 30% of their workforce into coworking locations, and they’d also benefit from idea exchange and front-line exposure to new ventures.  

In this analysis, we also examined the coworking business model and determined that it wasn’t sustainable unless they focused on large enterprise clients with offices in multiple metro areas.

2015 Analysis Highlights

Cost Savings

Office real estate evaluated on a per-square foot basis is outdated now that knowledge workers can work off-site and have no need for space when they are not at the office. Thus, dedicated office space is an underutilized asset, which decreases margins.

For example, a manufacturing plant or a warehouse using 24/7 space for equipment or to store products in transit makes financial sense for an operational or supply chain model.

The knowledge supply chain is almost 100% virtual and electronic. Large, fixed-cost dedicated space for a knowledge worker is a mismatch. We evaluated PwC and determined that if they put 30% of their workforce into coworking spaces, they would save $379.5 million per year just in lower rents. This doesn’t include other savings and financial benefits, including lowering the debt ratio by decreasing long-term liabilities, among other benefits.[1]

Some knowledge-based companies had been looking for creative ways to manage how they use office space to address the inefficiency. In 2015, Charles Schwab, Square and Rocket Fuel Inc. vacated parts of their San Francisco offices to streamline operations and lessen a heavy footprint.

Scheduling changes and other tactics, such as subleases for shared business incubators, are models emerging from Microsoft, Trulia, Salesforce, SoftBank and Dreamworks. Real estate analysts expect other companies to pursue similarly creative ways to exit long-term real estate liabilities and to become more agile and nimble.[2]

Coworking spaces could be attractive to thousands of similar companies and get them out of inflexible long-term leases that are a sunk cost on corporate balance sheets.

Shift a fixed cost to a variable cost

By putting employees in a coworking space on month-to-month rents, large organizations can decrease long-term liabilities and fixed costs. Converting some of the expense to flexible or variable, makes the organization nimbler, enabling faster responses to market changes.

Separately, staffing decisions are mirroring this trend as companies balance their headcount of full-time, contract, part-time or project-based hiring.

Other benefits

·       Increase worker productivity

·       Road warrior access

·       Front row seat to innovative new companies and startups that use coworking spaces

Future of coworking

Coworking has started to catch on and is appealing to a workforce that is increasingly made up of freelance and independent workers. In essence, the developer (coworking business entity) takes on long-term liabilities in office structures and subleases at increased rents to small entities and individuals on month-to-month basis. The margins are good, but the developer does risk exposure if a recession were to hit.

The future of coworking is likely a mix of independent workers and enterprise knowledge workers, particularly with an enterprise workforce that is more mobile and has a greater number of freelancers and independents already. Large knowledge-based firms will see the benefits of using coworking spaces, which will create a more stable client base for the developer.

Although our focus was mainly on the client side, we studied the coworking business model in detail and determined that if coworking wanted to survive a recession, it would need to focus more on enterprise clients (e.g. PwC, Deloitte, HP and Microsoft) and put in safety nets to protect against the risk of losing a huge percentage of tenants in a bad economy.

Considering this analysis, WeWork would still be exposed to shocks in the economy with its long-term liabilities, but it could create safety nets in contracts with enterprise clients, including HP or other national accounts, that couldn’t be part of a contract with small operators. This lessens their risk significantly and makes sense for a wide range of services and knowledge-based industries.

OUTCOME: In discussions with this client, we suggested the company move part of its workforce into coworking spaces to reduce long-term liabilities and overhead cost per employee. The CEO thought the gilded appeal of downtown, luxury office spaces was more important to the company brand, even though offices were never more than 30% filled to capacity.

September 2019 Update

As WeWork scrambles to push through its IPO, I’d be concerned about the business model as it seems they could be trying to complete their IPO before any potential recession that might be looming hits. We don’t know how We Co. (WeWork’s parent company) will ride out a recession and that seems to be the big question about their business model. It’s very likely that our earlier analysis underestimated the consequences of a recession, even if they had significant enterprise clients.

Another issue, at least in California, is the passage of a law that will make many contract workers in the gig economy reclassified as employees with rights to typical employee benefits. Could this impact We’s client base, particularly among those enterprise clients that would otherwise put contract workers in WeWork’s office spaces? If other states follow, could the business model be impacted?   

[1] Calculation: Average company savings per employee is $6,487.20 per year to use a coworking space over a full-time office or cubicle (200 sqft). The savings are made up of cost savings across lease, janitorial, office equipment, office supplies, and utilities. It doesn’t include sunk costs from buildout or IT infrastructure, which would increase the savings further. PwC has 195,000 employees. If 30% of their employees used coworking spaces, they would save $379.5 million annually. This doesn’t include financial benefits from a reduction in fixed costs or long-term liabilities.

[2] San Francisco Business Times article, “Charles Schwab, Square, latest companies to unload SF office space,” (May 26, 2015) highlights this trend. The SF Business Times wrote several articles in 2015 recognizing this trend.

How To Become Visionary
 
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So, as senior executives, what can we do to overcome our own biases that prevent us from seeing possible futures for our organizations and markets? In essence, how can we become visionary.

We have to become better at sensing by creating systems and routines to dismantle our biases, to put them in check, in order to see reality better. We have to disconnect ourselves from the way we have framed the world, from the way we understand the world, and try to glimpse the future through fresh eyes.

John Cage was an experimental composer born in 1912. He was a leading figure of the post-war avant garde movement. Like many artists, he constantly challenged his understanding of things and his own expertise. He questioned the very nature of what music was or what it could be. He said of himself, “I’m trying to check my habits of seeing, to counter them for the sake of greater freshness. I am trying to be unfamiliar with what I’m doing.”

Every executive might take Cage’s words to heart.

If you want to see better, to sense, to be able to see around corners like Jack Welch, you need to put your habits in check. Unlearn what you know. Try to overcome some of your cognitive biases in order to see reality better and then, try to look forward and extrapolate possible futures.

This is not about data analysis, which breaks information down into smaller and smaller bits. This is about synthesis, about unifying, bringing everything together into the whole. This is about becoming visionary.

When we synthesize a pattern and feel the wholeness of it, we experience harmony or kalos. Our awareness is not defined by the rational, by analysis, but by a complete, emotional and intuitive understanding. This is the moment of having a vision, of recognizing truth. This is sensing.

Sensing the future starts by becoming open to possibility, by setting aside our attachment to current patterns and ways of understanding, and then, by recognizing the many human biases that surround you and your organization.

Any executive in any industry can develop routines and activities to see better and to foster values that support a dynamic sensing mindset and culture throughout the organization. Learning to sense better, becoming visionary in the face of uncertainty, is the first step toward organizational agility.

Arms race to zero margins
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In a recent survey by PwC, CEOs said the biggest internal projects they implemented last year or plan to implement this year are cost-reduction initiatives. CEOs are tightening their belts, doing what they know how to do in order to survive: decrease costs and increase efficiencies.

This is a game that cannot be won. The faster costs are decreased, the faster an organization and market will become extinct unless it looks inward and develops a sustainability strategy to grow and thrive. As you decrease costs, so does your competitor, and ultimately, the gains become increasingly smaller and smaller, driving margins down until there’s no more juice to squeeze out of your organization.

Technology is great at cost reduction and it’s often necessary. All your competitors are using it, so you have to as well. But, it won’t provide long-term competitive advantage on its own, unless you’re Amazon or Apple or Google. Only the biggest firms have the means to use big data for long-term competitive advantage and realize true productivity gains. For the rest of the world, technology has only sped up the competitive cycle. It’s an arms race to zero margins and it’s a zero-sum game in the end.

So, on the one hand, CEOs know they need to transform their organizations (we hear them speak about this need daily), but on the other hand, they fall back to a position of trying to increase their efficiencies and failing to develop medium- and long-term growth strategies that are actually sustainable and provide real competitive advantage.

Why is this?

Fear, perhaps.

Uncertainty.

Not knowing what to do.

Not knowing how to get there.

Not understanding how customer interests are changing.

Aversion to career risk.

Blinded by the headlights of today’s rapidly changing markets

The list goes on.

Evolutionary theorists might tell us that members of a species will minimize the use of energy in the face of uncertainty. Scanning the periphery for signs of change and developing a strategy for change takes a lot more energy than maintaining the status quo. It’s easier and safer to hide in the middle of the herd than be on the lookout for change (threats/opportunities) at the edge of the herd.

As these executives refine operational efficiencies and cut costs, the ground is eroding from right under their feet. If they don’t act, they will most certainly be caught flatfooted when their industries get upended by volatile and seismic forces.

Fast innovations reduce investment risk
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Firms have been moving away from large internal R&D operations and are using incubators and accelerators to develop and scale new products and services much faster.

Success comes more from the speed of these incubators and accelerators than from the initial quality of ideas offered for consideration. By making a small investment to test a large quantity of ideas in the incubation phase, a company reduces its risk when it chooses to make a bigger investment to build out and scale an innovation to bring to market or deliver new value propositions.

An incubator team made up of about 6-10 people (a mix of both intrapreneurs from inside the firm and entrepreneurs from outside) can iterate on up to 50 product ideas in three months, quickly moving from one idea to the next and killing off bad ideas early in the process before the company makes a larger investment to roll out a product.

The innovation team will engage both customers and people across the organization, soliciting rapid, continuous feedback.

The idea is to generate lots of ideas, weed out the bad ideas quickly, refine the business models for the winning ideas, and pass those winning business models onto the accelerator stage to go through a similar process to roll out and scale quickly.

A corporate incubator can derisk investment by building value propositions through the process of engaging the customer and people throughout the firm before a big investment to commercialize is made.

Severin Schwan, CEO of Roche, one of the world’s largest pharmaceuticals, says it’s important to establish stage gates early in the process to minimize investment risk: “Our aim is to find things that will one day be breakthrough innovations,” said Schwan in an interview with McKinsey Quarterly, “and to ‘derisk’ them during the early stage, to the point where they are not big gambles if they get to the late stage.”

At each stage-gate hurdle, the innovation team can:

• Stay the course with the design

• Pivot the design/business model

• Kill the project

When a project is killed or fails during these early stages, it’s a victory for the company. The firm hasn’t lost tens of millions of dollars by investing in an untested product.

Perhaps just as important, the company has learned something about what the customer wants. By killing the project, the organization is able to take what it learned and apply that knowledge toward finding a different value proposition for the customer.

Every step of the innovation process is an opportunity to learn more about the customer and market. This knowledge will help the company ultimately deliver better products and value propositions to the customer. And it will help guide the company’s strategic vision.

Importance of corporate values
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Customers are increasingly discerning about the products and services they buy. They want to purchase products made by companies that share their values and that are invested in the betterment of the world.

Customer values are important to the innovation process. In many ways, innovation is about finding the common ground between corporate and customer values.

We can’t guess what the customer wants. Products and services cannot be created in a vacuum. They need to be created with an enlightened understanding of the customer and, even more, with the customer’s direct participation in their development.

The success and popularity of startup methodologies in corporate environments is based on developing rapid feedback loops with customers to guide the innovation process and kill projects early that don’t engage the customer with a wanted value proposition. Lean practices articulate the importance of the customer.

Disruptive innovations may or may not serve a company’s current customers in the long run, but they should be consistent with the company’s core values. A company may shift and create new products and services for new markets, but its core values will provide consistent guiding principles for innovating.

An innovation project should be easily articulated by anyone on the innovation team in terms of the firm’s strategic vision and core values. These are the guiding principles of the project. An executive should be dubious if any member of the innovation team cannot articulate a project in these terms.

Further, innovation isn’t only about product engineers and customers. It’s also about engaging a team across the organization and soliciting regular input from business developers, marketing managers, supply chain managers, accountants, and finance managers.

The value proposition needs to converge these viewpoints into a product or service, or even a better understanding of what the customer wants. If an engineer develops a product the customer wants, but the business development team can’t sell it or the marketing team can’t market it or the accounting department says the support costs are too prohibitive, the product isn’t an innovation. Innovations need to find support across the entire business model and with all the stakeholders who will play a role in its success.

Innovation is the exploration and discovery of value propositions that customers want.

It’s not just about customer and corporate values. Employee values need to align as well. How can CEO’s engage employees around the firm’s values and strategy as well as develop a talent pipeline? Prospective employees are discerning in where they choose to work, seeking out organizations that share their own values. If CEOs can’t find common ground, they won’t be able to grow an engaged, committed workforce and will struggle perpetually with the disconnect between corporate and employee values.