Deep integration of hardware and software creates efficiencies that are hard to measure or match. It also creates unique risks.
The iPhone’s user experience set the standard for the mobile industry. WeWork has been doing the same for the modern workplace. Both companies take an integrated approach, using software and services to differentiate hardware and, increasingly, designing their own hardware components.
Apple’s focus on consumers allowed it to fend off competitors and maintain both premium pricing and market share. As WeWork shifts to provide solutions to larger corporate clients, it is instructive to compare the dynamics governing the two company’s evolution.
A phone is not a phone
When Steve Jobs introduced the first iPhone in 2007, he initially described it as three different products: “an iPod, a Phone, and an Internet Communicator”. Back then, mobile phones were differentiated by their hardware features — their shape, weight, battery life, keyboard size, camera megapixels, and network speeds. “Software on mobile phones”, as Jobs put it, was “like baby software.”
Apple expected users to pay a higher price for a device with substandard battery life, no keyboard, fewer megapixels, and no 3G connectivity. But with software that offered something other phones did not provide including the ability to flick through the artwork of your favorite music albums, a disappearing keyboard that makes room for full-screen videos or web browsing, using one’s fingers to pinch or zoom or resize photos, and the general flexibility to evolve with its user’s needs. Hardware specs were secondary; the experience was everything.
The value of Jobs’s vision was far from obvious. Microsoft’s Steve Ballmer dismissed it as a hopeless gimmick, and the father of Disruption Theory, Clayton M. Christensen, predicted that established handset makers such as Motorola, Nokia, and RIM will quickly catch up to Apple’s UI innovations and pull further ahead.
In the ten years that followed, Apple sold more than 1.2 billion iPhones worth $736 billion while consistently capturing over 80% of the mobile industry’s profits. Apple doubled-down on its original integrated approach, expanding its software offering into services and payments and its hardware designs into silicone graphics chips and AI neural engines.
An office is not an office
In 2011, Adam Neumann, WeWork’s co-founder and CEO told an interviewer that “The ’90s and early 2000s were the ‘I’ decade. iPhone, the iPod — everything was about me… The next decade is the ‘We’ decade, where collaboration is the future of innovation.”
The company was barely two years old, and everyone was talking about its refreshing approach to workspaces: shared desks, beer on tap, pool tables, industrial design, and an online companion that enables members to trade and interact with each other. “What separates us”, said Neumann in that early interview, “is community. It’s not a trend for us. It’s a way of life.”
WeWork relied on these “soft” and software features to differentiate its buildings from those of other landlords. While traditional offices were priced based on square footage, WeWork charges per desk or per (private) office. This allows it to decouple its revenue from the direct cost of the underlying real estate: In Manhattan, for example, WeWork charges around a $1,000/month for a one-person private office. Assuming an office size of no more than 40 sqf, this translates into an annual rent of around $300 per sqf, about 5 times higher than the average rent for Manhattan.
That margin then absorbs the cost of furniture, partitions, community managers, beer, coffee, common areas, access to online services, and Manhattan’s infamously high loss factor, and is trimmed to a still impressive 33% for locations open 6 months or longer. But wait, 40 sqf for an office? That sounds tiny. It is. The average space per employee in traditional offices is just above 150 sqf, down from over 220 sqf a decade ago. WeWork gets away with offering much less.
How does WeWork achieve this? The floor plan across is from a location in Charlotte. The total area is around 22,000 sqf and includes nearly 400 workstations. This means 55 sqf per workstation, including the common areas, staircases, elevator shafts, landing, and mechanical rooms. WeWork designed its own glass partitions, wallpaper, furniture, and acquired companies that specialize in design and virtual modeling, construction management, and visitor management.
This ability to design dense floor plans and operate them in a way that creates a pleasant and productive experience is WeWork’s key competitive advantage. It is not about the “sharing economy”. It is not even about flexibility. It is about being able to deliver a complete product that creates a superior experience for end-users. In a recent interview, Neumann acknowledged as much: “We used to say we are a community company, but we are starting to figure out now that we ourselves are discovering what is the best kind of company that we should be”.
WeWork discovered that becoming the “best kind of company” begins with integrating software and hardware, and culminates in changing the way the hardware itself is designed and developed. This allows it to operate whole buildings, for large corporate clients, for longer periods (3–5 years), and potentially achieve similar margins. It also means the company can grow even faster, securing large deals with enterprise tenants, as it recently did with IBM.
This is very different from the company’s initial reliance on small, short-term tenants, who joined WeWork in order to be part of an entrepreneurial community. WeWork was never an aggregator like AirBnB or Uber, and sharing was never going to become a enduring source of value. Enterprise deals that cater to larger groups already account for 30% of the company’s new revenue and are likely to become the company’s main source of revenue.
An office is not a phone
Remember when Clayton M. Christensen predicted the iPhone would fail? It’s important to understand why. The Harvard professor was relying on research from a variety of young industries that showed that during the early stages, “when the functionality and reliability of a product isn’t yet adequate”, the winner was almost always the company that offered an integrated solution that “knit[s] all the pieces together in an optimized way.”
But with time, the technology matures and a set of industry standards emerge. The existence of standards allows different companies to specialize in creating different pieces of the product. The product then becomes modular — made of interchangeable pieces made by different specialized providers. “At that point,” says Christensen, “the competitive advantage of the early leader dissipates“. The integrated approach is great in the beginning, but ultimately loses out to more flexible, modular competitors.
But that’s not what happened with the iPhone. As the mobile industry matured and standards emerged, most mobile phone makers adopted the iPhone’s UI conventions and attached them to superior hardware components at a lower price. But they were not able to unseat the iPhone. Apple, meanwhile, became even more integrated. How could this happen?
The best explanation comes from tech strategist Ben Thompson: Disruption Theory relies on examples from enterprise clients that have a rational procurement process — taking into account measurable specifications and price. When a large company needs an ERP or Cloud Computing solution, it receives offers from IBM, SAP, and Oracle and conducts a proper comparison.
The iPhone, meanwhile, is a consumer product and its buyers are driven by experiential and emotional factors that are difficult to measure and compare. Most iPhone buyers, for example, don’t care about the fact that the latest Samsung model has a better screen, more RAM, more megapixels in its camera, or costs $50 less.
Back to WeWork. The company redefined the workplace with an integrated approach, combining hardware, design, software, and services. Providing a consistent experience and having a strong brand that members are passionate about allowed it to stay ahead of direct competitors.
Now that WeWork is shifting towards enterprise clients, it can tap into a much larger opportunity. But it also creates an opening for new types of competitors who can adopt the industry’s new standards and develop “good enough” solutions that compete with WeWork on price and specification. Enterprise clients are more likely to make a rational decision and switch. At least that’s the theory.
Dror Poleg is a real estate and technology executive, public speaker, and author. He helps companies develop and fund the products and business models that will shape tomorrow’s property markets. Follow @drorpoleg on Twitter or Dror Poleg on LinkedIn.