Built Not to Last

I want to build a business that won’t last.

In the world around us, many things come to a natural conclusion and end. Then why do we expect businesses—and all of their component parts—to last forever?

Imagine a business founded with an end date. After two years, the stakeholders come together, ask what the company would look like if they founded it today, and then form that company. The new business retains the good elements, sheds the bad, and moves forward with a fully-committed team.

By introducing an end to its constructs and practices, a business forces itself to evolve to the best possible design. It meets customer needs with a proactive, forward-looking operating structure, and not one rooted in the past. 

The problem of inertia

Research shows that most companies allocate the same resources to the same business units year after year. A review of over 1,600 U.S. companies between 1990 and 2005 found that inertia was the norm, with one-third of the businesses allocating capital almost exactly the same as in previous years.[1]

Studies have shown that anchoring—a form of cognitive bias where previous information influences decision making—contributes significantly to organizational inertia.[2] But the problem extends beyond budgets and resource allocation. Business leaders are also anchored to last year’s business practices, org charts, marketing messages, role definitions, technology initiatives and sales practices. That anchoring leads to incremental thinking year after year.

In their 2008 book Nudge, Richard Thaler and Cass Sunstein discuss the idea that choice architecture, or the design of environments in order to influence decisions, leads to both good and bad outcomes. Defaults are the building blocks of this architecture.[3] A default option is the option the chooser will obtain if he or she does nothing.

The push to evolve often goes against the grain of corporate culture, where the default path is maintaining the status quo. Change is uncertain, uncomfortable, and many times unprofitable. As Larry E. Greiner states in “Evolution and Revolution as Organizations Grow,” management problems and principles are rooted in time. Attitudes become more rigid, more outdated, and more difficult to change. While business leaders must be prepared to dismantle inefficient structures, evolution does not occur effortlessly.

More often than not, a businesses default path—the one taken if no decision to the contrary is made—is to continue without change. But what if the default path forced an ending?

The evolutionary concept

Evolution is the process of heritable change over time, whereby advantageous traits are preserved and bad ones rejected.[4] This process occurs over multiple generations—which is key. In nature, this means organisms need to have an end. When applied to the business world, it means business practices and constructs also need to have an end to evolve.

This intense feedback cycle creates an efficient system of improvement over time, which produces the best possible design for the current environmental conditions.

When a new product is launched, business unit created, or team started, it is designed with a start in mind, but rarely an end. By default, it’s assumed that it will carry on forever (or until specific but unspecified action is taken to modify or end it). 

Evolution is a powerful concept that results in improvement over time. Bringing this concept to work in practice requires two key principles:

  • Define an end date up front. Whether it’s a business, business unit, product, marketing plan, sales plan, or a staff position, create an end date at inception and only bring people along who are comfortable with the journey. Something can’t evolve when it continues on indefinitely.
  • Change the default. On the specified date, the default action becomes an ending. It’s not a review, discussion, or theoretical exercise. It ends, and if it’s decided to continue on, a new structure is born. A rebirth occurs with a forced ending, and with this we keep the good, ditch the bad, and end up with the best design possible.

4 ways businesses can put evolution into practice

1. Reinvent the business

The fundamental, key concept in this process is asking the following question: “If we were to start a company that does [whatever the company does] today, how would we do it?” Then start that company. (In the unlikely event that the answer is “exactly how we’re doing it now,” you’re not trying hard enough!)

By definition, the new business will be the one that is best designed and best positioned to succeed in the market at that time. Old practices that don’t work need to be killed, quickly and completely.

SpaceX started as an answer to the question, “If we were to launch a space flight program today, how would we do it?” In a classic illustration of the Innovator’s Dilemma, it led to significantly improved designs, processes, goals, and systems that the incumbents weren’t capable of undertaking—at a significantly lower cost.

2. Hire employees for fixed periods of time

Sports teams hire athletes for a fixed period of time. They do this because an athlete’s skills and the team’s needs vary over time. What works today might not work in three or five years. Are the needs of a business so different? 

It’s unrealistic to think that a business’s needs are going to remain constant for several years. It’s equally unrealistic to think that an employee’s skills, abilities, and desires will also remain constant.

As much as possible within the local labor laws, a business should only hire employees for fixed periods of time. At the end of that term, the business should reevaluate the position and the candidate to ensure the best possible fit.

A manager should ask the following key questions:

  • Is the job that needs to be done exactly the same as it was 12 or 24 months ago?
  • Is this position still needed?
  • Is the person the right fit for what we need today? 

3. Rotate senior managers

The CEO—and the entire leadership team in general—sets the tone and pace of the organization. Their leadership will impact the company more than anything else. That’s why they should be replaced on a regular basis (think of it as term limits rather than being fired).

In practice, this means signing all senior managers and executives to fixed-term contracts. At the end of that term—just like a fixed-term employee—the business should reevaluate exactly what’s needed in the position and then conduct interviews to make sure it ends up with the best possible candidate for the job.

A less extreme version of this, especially if a business has great talent it doesn’t want to lose, is to rotate senior managers between different business units. Large companies like GE use this system to force evolutionary thinking while keeping great talent inside a business. The concept also works with employee rotation as a form of retention and renewal. (For more on senior manager rotation, see “Rotate the Core” on the Harvard Business Review web site.)

Huawei, the largest telecommunications equipment manufacturer in the world, has a rotating CEO system. Three deputy chairmen act as the rotating CEO for a tenure of six months each, while sitting on a board of seven with four standing committee members. The system, inspired by U.S. presidential elections, is a great example of evolutionary thinking principles in practice.[5]

4. Implement zero-based budgeting

Zero-based budgeting is a process that allocates funding based on opportunity and necessity rather than history. As opposed to traditional budgeting, no item is automatically included in the next year’s budget by default. It’s a powerful concept that, when properly implemented, can liberate a business from inertia and entrenched thinking.[6]

It is the mindset shift, and not necessarily the methodology, that makes zero-based budgeting an effective tool. It resets the discussion in favor of actively thinking about ways to make things better (forward-looking) rather than asking why it is the way it is (backward-looking).[7] Compared to other cost-cutting measures, the focus is squarely on what activities and resources are needed in the current environment.

Zero-based budgeting is a process that can work in any sized company, at any stage of growth. While it may be challenging to implement, when done correctly it successfully reduces organizational inertia and incremental thinking through a more accurate expenditure of resources. (For more on implementing zero-based budgeting in your organization, see “Five myths (and realities) about zero-based budgeting” on the McKinsey & Company web site.)

Concluding thoughts

New Zealand’s national museum, Te Papa, is ranked as one of the world’s best. It is currently undertaking a renewal program of all of its major exhibitions. It’s not simply an update with incremental change, but a total reimagination where leadership effectively asks, “If we were to have an exhibit about [whatever the current exhibit is] today, how would we do it?” By specifically ending the current exhibits, museum staff are forcing an evolution that is not anchored to the status quo.

The way businesses think about strategic planning leads to incremental thinking and incremental results. Instead of being a passive observer to change and evolving by incrementing, businesses should adopt a more proactive posture and force endings. There are many changes that any sized business can make to effectively force evolution and stay relevant in a changing, fast-paced world. It all starts with defining an end.

 

Footnotes

[1] See Stephen Hall, Dan Lovallo, and Reinier Musters, ”How to put your money where your strategy is,” March 2012.

[2] See Dan Lovallo and Olivier Sibony, “Re-Anchor Your Next Budget Meeting,” March 2012.

[3] See Daniel G. Goldstein, Eric J. Johnson, Andreas Herrmann, and Mark Heitmann, ”Nudge Your Customers Toward Better Choices,” December 2008.

[4] See Ker Than, “What is Darwin's Theory of Evolution?,” May 2015.

[5] See David De Cremer and Tian Tao, “Leadership Innovation: Huawei’s rotating CEO system,” November 2015.

[6] See Zero-Based Budgeting: Zero or Hero?, Deloitte 2015.

[7] See Matt Fitzpatrick and Kyle Hawke, “The return of zero-base budgeting,” August 2015.

Zillow: Killing the golden goose?

Over the past week, real estate has been dominated by news of Zillow Group’s Instant OffersThe new program, which allows prospective home sellers to receive instant offers on their homes, has been covered across the industry, with the reaction – as one would expect – largely negative.

A thought-provoking article in VentureBeat rhetorically wondered whether Zillow could “Uber-ize” the hundred-billion-dollar real estate brokerage business. The author claims that Zillow is well-positioned to disrupt the industry and capture an even larger share of the brokerage market.

All up, there’s an immense amount of interest related to Zillow disrupting or displacing the traditional real estate industry structure. It’s a huge opportunity, but one fraught with risk.

I’m going to approach this situation from two angles: my own time as head of strategy for a publicly-listed, multi-billion dollar business, and what the data tells us.

Instant Offers: offensive, defensive, or opportunistic?

The key strategic question in all of this is whether Instant Offers is an offensive, defensive, or opportunistic move by Zillow?

If Instant Offers is an offensive move and amounts to Zillow’s first salvo against the real estate industry, it’s a strange one. It’s just too far removed from the endgame of displacing real estate agents. The risk doesn’t match up with the reward.

Or, perhaps it’s a defensive move against the rapid rise of Opendoor and its growing list of national competitors. With Opendoor raising over $300 million U.S. and valued at more than $1 billion U.S., it’s difficult to ignore. But, even a disruptive operation such as Opendoor still needs to sell houses, and those houses will appear on Zillow. And with a two-percent market share in the Phoenix market, it still has niche appeal – not exactly an existential threat to Zillow.

So, the most likely answer is that Instant Offers is an opportunistic move by Zillow. It wants to capitalize on the growing consumer demand for instant home offers, and sees it as a potential new revenue stream, whereby it can collect and monetize seller leads.

This fits well with Zillow’s existing business model: It continues to operate as a marketplace, monetizes leads, and sells those leads to real estate agents. It’s a natural extension, rather than a radical disruption.

Real estate websites versus agents

Real estate websites around the globe have the same problem: a love-hate relationship with their biggest customers – real estate agents. The top sites are fighting a constant battle to extract more money from their customers through regular price rises and value-added services.

On the other hand, real estate agents pay the sites for advertising, exposure, and leads, because of the clear return on investment, but do so begrudgingly and with a sense of fear. Most agents are afraid of these sites gaining too much power, continually raising prices, and perhaps even replacing them with an online-only offering.

So, while real estate sites are best positioned to disrupt the real estate industry by displacing agents, they’re also the least likely to do so, because agents are their biggest customers and source of revenue.

Case in point: The Trade Me Property price rise. While I was at Trade Me, New Zealand’s dominant horizontal, we initiated a modest price rise for agents. It was a change from an all-you-can-eat model with a flat subscription fee towards a pay-per-listing fee. It was not well-received.

Real estate agents across New Zealand were angry. They did not take kindly to a price rise and organized themselves around our rival and No. 2 on the market, the industry-owned RealEstate.co.nz. The impact was a material narrowing of the traffic gap between both sites – arguably the most important performance indicator for a real estate website (see Network Effects for more on that). 

 
Source: Properazzi

Source: Properazzi

 

Trade Me Property’s traffic lead went from five times to three times the traffic of the No. 2 rival, a huge drop. Increasing prices for real estate agents – let alone disrupting them – isn’t easy.

(Zillow’s traffic is approximately three times higher than its top competitor in the U.S., namely Realtor.com.)

I believe there are a number of critical preconditions for a real estate website to truly disrupt real estate agents:

  1. A monopoly on traffic. Ideally, there is no major No. 2, but if there is, the top site needs to have a massive traffic advantage.
  2. Revenue diversification. The less reliant the site is on revenue from agents, the better able it will be to withstand a revenue hit.
  3. A strong brand. It should be well-known in the market and be seen as a leader in the field, the equal of any strong brokerage.
  4. Online tools to disintermediate brokers. A site needs to offer all the tools and capabilities that a brokerage offers, including CRM, document signing and management, marketing and promotional tools, lead capture and management, and inventory management.

Revenue diversification and risk

Most real estate platforms capture their revenue from agents. Whether spending their own money to promote themselves or buy leads or spending their vendor’s money to advertise a property, the agent controls the purse strings.

In the case of Zillow, around 70 percent of its revenue comes from real estate agents. While not surprising, it’s still a big number that reflects a poor level of diversification. Furthermore, as we can see below, that number as a percent hasn’t changed over the past four years. Zillow does not look like a business trying to diversify its revenue.

 
 

Zillow fully believes it is at the beginning of its journey, not the end. It sees plenty of runway left to grow its revenue even higher as more spend goes online. And the numbers prove it: revenue grew 31 percent from FY 2015 into FY 2016, higher than any of its global peers.

In other words: Zillow is making a ton of money with its current business model and sees plenty of growth left. Why put that at risk and kill the goose that lays the golden eggs?

We can also see that Zillow’s revenue share from agents is on par with its global peers. Most of the major players illustrated above receive between 65 percent and 75 percent of revenue from agents. 

 
 

Zoopla, the single exception, has taken a proactive strategy to diversify its revenue streams away from agents. In 2015, it acquired uSwitch, a price comparison business, for £160 million and the acquisitions have continued at a brisk pace since then, all in an effort to expand along the value chain and become a one-stop-shop for consumers and real estate professionals.

As opposed to Zillow, Zoopla looks like a business that is diversifying its revenue streams. With that clear strategy in place, revenue diversification has followed.

 
 

Of all the major real estate websites in the world, Zoopla is best positioned from a revenue diversification standpoint to disrupt the industry.

Given what we know about its strategy and what the data shows us, I consider it unlikely that Zillow is making moves against the industry. The existing business is just too lucrative with plenty of growth left to put it all at risk.

Rather, Instant Offers is about giving consumers choice, expanding the existing lead marketplace, and a new source of revenue with seller leads. It’s also just a test.

Zillow is not well-positioned to make a big move against the industry. Its revenue is not diversified and there is a strong No. 2 on the market.

Regardless, Instant Offers should be instantly interesting to all of the major real estate websites around the world. It’s capitalizing on a pro-consumer offering that can make these sites more valuable to consumers around the world. I guarantee many – myself included – will be watching this test with great interest.

 

This article was originally posted on the AIM Groupwhere I am a senior consultant and principal.