17 February 2022
A personal view of the evolving role of real estate in a world of technological, social and business change, by Richard Pickering, Chief Strategy Officer, UK.
The Power of Difference
Welcome to this week’s blog. If you’d prefer to listen to an audio version, click here for the podcast.
Everything in the world is becoming the same. From fashion to furniture, from careers to culture and from clone high streets to toytown housing developments. This huge convergence has happened largely in my lifetime and certainly within that of my parents. And it doesn’t feel great. There are many solid financial and economic reasons why this is happening. However, in the process, are we losing an important part of what it means to be human? I sense a change in the wind, and today I want to discuss the incredible power of being different.
But firstly, what are the reasons for this great homogenisation? We can boil it down to a few economic principles.
Firstly, economies of scale. By putting similar activities under the same roof, an operator is able to exploit considerable efficiencies. If you have a production run of 100,000 units instead of 1,000, you can drive down fixed overheads and increase unit profitability. This simple principle has driven a huge surge in corporate M&A starting in the 1980s, forming an underpinning strategy for many leveraged buyouts. Through the consolidation of many businesses into one, the processes, objectives and deliverables of these businesses over time become the same, leaving the consumer (and the employee) with less choice. In some industries the consolidation is so intense that the nature of competition and power within that industry changes considerably – the most extreme form of this of course being a monopoly.
A second economic benefit to homogenisation comes through standardisation. You may recall Henry Ford’s comment about the Model T: ‘Any customer can have a car painted any colour he wants, so long as it is black.’ Through standardisation of process and outputs on his new ‘production lines’ he was able to drive operational efficiencies and increase profits. Or more recently, Lego reinvented itself around similar principles. In 2004 it had 11,000 suppliers supporting ~14,000 SKUs. By 2007, it had halved the number of colours, cut the number of logistics partners by 85%, radically reduced the number of SKUs and turned a $200m operating loss into a profit. Sure, you could no longer get a pink pirate hat, but it turns out that not many customers cared. And in some cases, this kind of rationalisation is no bad thing for the consumer. For instance, when an IBM-led consortium rationalised computer peripheral connections through the introduction of the single USB standard, everyone was a winner. Particularly now in the digital era, consistency of data and software which enables interoperability and automation of processes deliver huge wins for businesses and consumers alike.
And all of these principles have scaled up through globalisation. In 1970 global trade accounted for ~20% of global GDP; now it stands at ~60%. As companies and products span the world, so the different countries of the world start to look the same. For those of you of a similar age to me (or older), going on a road trip in Europe with your parents in the 1980s was a colourful riot of different cultures, products and foods. Whilst regional differences remain, they are now much less pronounced than they were, and international hotels feel identical. This has on the one hand enabled much less friction and improved predictability. After a week of travelling in Vietnam, there is a comfort to knowing that a Big Mac in Hanoi tastes the same as one in London. However, to me at least, the whole world feels a bit less exciting as a consequence.
And of course in real estate the same principles map over. Housebuilders gain huge cost efficiencies in delivering the same product everywhere, and the bigger ones that have greater influence can drive down procurement costs. Our high streets are full of international chains, because these big organisations have driven down their unit operating costs hardest to be able to afford the rent. And prudent office developers tend not to build highly bespoke buildings targeted to the needs of a single occupier, because if that occupier doesn’t sign, then the risk of that building suiting the wider market is considerably reduced. Finally, the fun and quirky elements of design have largely been engineered out. Look around our cities to the consequences. The interesting looking buildings mainly come from an era before the world became as focussed on efficiency as it is today. Sadly, although today’s buildings are better laid-out, more energy efficient and more functional than those of a former era, not many of them add much to the rich tapestry of our cities; and will I suspect be quickly forgotten.
But I sense changes are on the horizon. Let’s consider why.
Firstly, in the same way that homogeneity favours cost, there are other counterbalancing economic principles on the revenue side which support heterogeneity. This is because the biggest enemy of pricing is similarity. If you are a monopolist, you can charge whatever value you realistically create for your customers. If, however, you operate in a competitive market, your price point is instead more influenced by the pricing strategy of your competitors. And if you operate in a perfectly competitive market, with no barriers to entry, and very similar products, then your price point is almost entirely determined by competitive interaction. In the case of two identical products, the rational buyer will always buy the cheapest one. In such conditions, the dominant competitive strategy is price undercutting, and prices typically converge on the cost of production, plus the opportunity cost of capital. There is therefore a huge discount to revenue between on the one hand a unique product and on the other a commodity that is produced by many competitors. For this reason, being different is a hugely powerful business strategy.
Products can be differentiated in two dimensions. ‘Vertical differentiation’ relies on a difference that is objectively true. It relates to things that are ‘better’, quicker or in other ways objectively comparable; for instance, a processor chip that has a higher computational speed, or a higher quality grade of construction material. Success through vertical differentiation means winning the race. Meanwhile ‘horizontal’ differentiation is subjectively assessed; you might have a product that offers different or alternative features preferred by some consumers and not by others. Success through horizontal differentiation means running a different race. Either method is a defence to competition and price erosion; however, more often than not, it involves injecting more cost.
So what is now happening in real estate and the wider world that might put greater emphasis on these revenue side factors, over the cost factors which have driven corporate decision making for the past 40 years?
Firstly, big data and predictive analytics are taking a chunk of the risk out of creating bespoke products. Deep customer knowledge and the ability to operate ‘unit of one’ marketing strategies drive down the sales risk associated with more unique products. In real estate, the ability to land a particular tenant by accurately predicting and designing around their future requirements is starting to become a reality.
Secondly, new platform business models now provide the scalable infrastructure for product deployment. This allows the product developer to focus on building their point of difference, whilst letting the platform provider bring the economies of scale. You no longer need to be a Nintendo to make millions from Flappy Bird; you just need a few lines of interesting code and access to the App store. In real estate, you no longer need to own the building to create the point of difference; instead, you can supply less costly but differentiating services, technology, fit-out and community offerings to create a pricing differential.
Thirdly, difference is usually a product of accident (someone makes a mistake and finds out that the mistaken route was actually a pretty good one) or innovation (people work deliberately to create something new). If you haven’t been watching, global capital into innovative Proptech topped $21bn last year; that’s more than the total commercial real estate transacted in London in the same period. This capital is being funnelled into organisations whose whole purpose is to be different from the status quo. Change is coming.
Finally, as the digital economy takes over, real estate faces new competition from virtual alternatives. In the long run, with incredibly low marginal costs, these alternatives will win a war waged on price. Rather than competing like-for-like, real estate needs to choose to exploit its points of difference, which hinge around quality of interaction, and human experience. This increases the emphasis on the value chain benefits that real estate creates for corporations (talent, brand etc), rather than being seen as a functional commodity. In this context, weird, exciting, unexpected, non-standardised, beautiful, bespoke buildings and places will increasingly win out over their functional, samey counterparts.
A final thought for today - all of these same principles apply to you as individuals. Those who have a few years’ experience under their belt might point to increased corporatisation, consolidation and homogenisation of the real estate industry over the past 10 years. However, it strikes me that there remains several ‘personalities’ in real estate, and that these people shine disproportionately. Being unique pays. If you are choosing how to differentiate yourself, then consider the nature of your ambition. If you want to be more powerful than others then you need to opt for vertical differentiation; but beware that this is a slippery slope, with only a handful of winners. Being better than everyone else is really difficult. The more intrinsically rewarding route in my humble opinion is horizontal differentiation; choose you own path, create something unique, don’t compete in the same lane, be proud to be different and celebrate difference in others.
Regards,
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