As recently as three months ago, WeWork was a high-flying startup headed for an IPO with a $47 billion market cap. Since then, they have suspended IPO plans indefinitely, sold their private jet, fired their CEO, laid off thousands of employees, and suffered a valuation drop of 80%.
According to SoftBank, the majority shareholder, WeWork is now worth $4.9 billion. By some estimates, the paper worth of their property and equipment ($6.7B) is greater than the valuation. With Adam Neumann’s corporate malfeasance dominating the headlines, it’s easy to overlook the fundamental reason for their downfall: WeWork and its investors miscalculated the size of their market. All the cost cutting in the world won’t earn WeWork’s shareholders a return on their investment. The only way to save WeWork (and SoftBank’s shirt) is to find a new market big enough to warrant such an enormous valuation.
WeWork Miscalculated Its Market Size
Even before WeWork published its S1, Wall St analysts were asking how WeWork was different from any other commercial real estate landlord. IWG/Regus, for example, had more space, more revenue, and, wait for it, profit. Yet, IWG currently has a market cap of $3.56 billion. So what made WeWork different?
WeWork's S-1 devotes a lot of space to explaining the company's high valuation. To summarize there were 3 key points: 1. Technology; 2. Employers are willing to spend a lot on office space and there are a lot of employees; 3. WeWork wasn’t just about commercial real estate it was about building a community. This means they can enter new markets such as their nascent forays into housing and education.
Here are the problems with those justifications for WeWork trading at exorbitantly higher multiples that IWG. Let’s start with the technology statement.
Technology is not a market. Nobody wakes up in the morning thinking “gee, I need more technology.” As Theodore Levitt famously said, “Nobody wants a quarter inch drill; they want a quarter inch hole.” The same is true for technology. Nobody wants the tech itself, they want to get something done and tech helps them do it faster. As a result, technology cannot increase how much the world is willing to pay for a place to work. Technology can help provide a better customer experience and decrease the cost of delivering that great experience for people who need a place to work. But all that does is enable WeWork to potentially capture a larger share of the same market. It doesn’t increase the market itself. This is how Wall St viewed WeWork’s coworking spaces. They asked ‘in what way is the market bigger than what we’ve seen from IWG?’
This brings us to point number two, how WeWork calculates its market size using product price * number of buyers. In the S-1, WeWork estimates there are 255 million people with desk jobs in their 280 target cities. They then cite a data point from CBRE and Cushman Wakefield that employers spend a weighted average of $11,700 per employee for occupancy costs. 255 million * 11,700=approximately $3 trillion. There is a huge problem with this formula. The willingness to pay for office space exists on a curve, with a small number of companies willing to pay a lot and a large number of companies willing to pay a lot less. Taking an average number rather than the area under the curve, inflates the market value tremendously. To use their data to calculate a much more accurate market size, we'd have to see the distribution of spend/employee.
In any case, Wall St evidently didn't go along with this and continually compares WeWork's underlying metrics and Market Size to IWG.
If you can’t justify the valuation in co-working or office space, then you have to expand the mission. In this way, it makes sense that WeWork tried to characterize itself as a "community" company and enter other markets: residential housing and education. Unfortunately, they failed to demonstrate ways of delivering in those markets that were significantly better than what customers get today. If the solution is not better than the competition, people will not switch and growth will not happen.
A Historical Aside
From early 2011 to late 2013, I worked at Patch, AOL’s hyperlocal news network, now owned by Hale Global, a private equity fund. I was the Director of Consumer Product during a proxy battle that saw activist investor Starboard Value try to gain sufficient AOL board seats to shut Patch down. AOL won the battle but lost the war, selling Patch to Hale Global. Coincidentally, Artie Minson, current Co-CEO of WeWork, was the CFO of AOL at the time.
Much ink has been spilled on AOL’s large investment in Patch. Here’s my take: the size of AOL’s investment in Patch led shareholders to demand growth that was incongruent with the size of the only market in which Patch was successful: local news. On the inside, we didn’t discuss the problem in these terms, but we reacted to it as such. Our internal traffic and revenue growth goals were ambitious and had to be in order to justify the investment to the board and The Street.
When our local news traffic and ad revenue fell short of the goals, we looked for other areas of expansion: photo sharing, blogs, social networking groups, classifieds, crowd funding...a Patch Credit Card was even in development. We didn't get enough traction in any of these areas and Wall Street didn’t buy the story. Patch was sold to Hale Global.
Since Hale acquired Patch they have re-focused on news and ads, and have reported profits. With a lower investment and a lower valuation, Patch’s expectations outside the eye of Wall St are right-sized for the market in which it performs well. I don’t know the financials of Patch’s sale to Hale Global. It has been widely reported that AOL invested $120 million/year in Patch at its peak, and the terms of the sale were not disclosed. Your guess is as good as mine.
When the investment and the valuation of a business are in conflict with the size of its market, people lose money.
WeWork Has to Enter a Large Market With a Solution That Satisfies Unmet Needs
To think about how WeWork can find a large enough market, it’s worth taking a moment to consider: what is a market?
The most common way to hear analysts define markets is by the product people are buying. This leads to terms like “the office space market,” “the cloud services market,” “the phone market,” “the mp3 player market,” “the encyclopedia market,” or “the film market.”
“Wait a minute,” you may be thinking to yourself, “nobody buys MP3 players, encyclopedias, or film anymore. Why did you use those examples? Those markets don’t exist!”
And that is precisely the problem with thinking about markets in terms of products. Some day a new technology will lead to a new product that causes no one to buy the old products. Products and technologies change every day, which causes product markets to disappear.
History is littered with examples of once great companies that focused on improving positions in markets defined by products and then failed. Kodak failed in the film market. Britannica failed in the encyclopedia market. With the Zune, Microsoft failed in the MP3 player market. While those companies were investing in improving their products, other companies created entirely new products based on new technologies that caused nobody to need film, encyclopedias, or MP3 players.
It’s hard to blame Kodak, Britannica, and Microsoft for these mistakes. If you plug products that don’t exist and don’t have buyers yet into a traditional market sizing formula, product price * number of buyers, you get a zero dollar market. So then you try to guess how many people will buy the product and the whole enterprise starts to feel very risky. It seems much safer to invest in the existing products whose market size you know for sure, right?
Wrong. All product-based markets will eventually go to zero as the old products are replaced by the new. As Jobs Theory states, “Nobody is buying your product, they are hiring it to get a job done. When a new product can get the job done better, they will fire the old product.”
We can use this insight to create a more stable definition of a market and a more accurate market sizing formula. Instead of defining the market as a product, we can define it as a job-to-be-done. If we stipulate that the job is a goal customers want to achieve independent of any solution, we now have markets that stand the test of time. Furthermore, if you want to position yourself better in a job-based market, you need to be the one who will find the new product to get the job done better rather than clinging to your old product.
Using the Jobs definition of a market, instead of the “mp3 player market,” we have the “create a mood with music market.” Instead of the “film market,” we have the “share memories” market. Instead of the encyclopedia market, we have the “find information market.”
To size the market, we can use customers’ willingness to pay to get the job done rather than the price of the product. This enables us to size markets regardless of the new product and helps us see opportunities to create value. Imagine how scary it would be to invest in a new product (the iPhone) that would kill your cash cow (the iPod) using the traditional market sizing formula. But, if you looked at how much people were willing to pay to “create a mood with music on the go,” “talk to their friends and family on the go,” and “use the internet on the go” much better than they could do before, investing in the iPhone wouldn’t have been scary at all. Those markets together represented an enormous opportunity. And considering the willingness to pay to get the job one helps you understand why Apple was able to charge $500 for the iPhone when Steve Ballmer preferred Microsoft’s $99 mobile phone strategy in comparison.
So if a market is a job-to-be-done and the size of the market is the customer’s willingness to pay to get the job done, what job should WeWork look at?
Here is the criteria:
- The willingness to pay (the market size) has to support a valuation greater than $47 billion for SoftBank to make a return on its investment
- WeWork has to have a believable path to satisfying needs in the job better than the competition.
Let’s take a quick look at the two “markets” WeWork already tried to expand into: housing and education. The core jobs here would be “secure a place to live” and “learn something new.” The willingness to pay likely varies significantly across segment, but it’s pretty safe to say these are very large markets. However, the projects underwent heavy criticism. Most likely few people believed WeWork’s solutions for these jobs satisfied unmet needs and would enable WeWork to grow in these markets.
While thinking about this problem, I came across a lengthy NYTimes aritcle from Feb 2018 called The Rise of the WeWorking Class. In part, it tells the story of Mabel Luna, a WeWork customer:
“She hung up her shingle as a private C.P.A. Though she never advertised, she quickly outgrew herself; she told me that 90 percent of her customers have come through WeWork, either via hallway run-ins or through the social-networking features of its mobile app. She had several clients in the building — including a brewer of natural alcoholic kombucha, a sole-proprietor attorney and the German sunglasses manufacturer by the printer.”
Mabel used WeWork to acquire customers and grow her business. The acquire customers market is enormous. It’s the advertising industry and the CRM industry. Google and Facebook have grown to multi-hundred billion dollar market caps in this market.
Here’s how WeWork can figure out if it can realistically take share in this market and generate sufficient equity value:
- Identify the key customer to target: Is it a solopreneur like Mabel, small businesses, large businesses, all of the above?
- Identify the market: What is the job they will target? Is it acquire customers? Grow sales? The trick here is to avoid splitting hairs and articulate the goal in the language of the customer.
- Identify the market size: What is the willingness to pay to get this job done?
- Identify the unmet needs: In what ways are customers struggling to acquire customers? In other words, what are the key problems WeWork can solve?
- Identify the customer value: How will WeWork productize what it has done for Mabel to help customers satisfy their acquire customers needs better than any other solution they could use?
Answering these questions will lead WeWork to define a de-risked product strategy. Jobs-to-be-Done customer research can answer all of these questions *before* building the product. It is much cheaper to execute the customer research to de-risk the opportunity than it is to build a failure.