Challenges ahead for the business model of the CBD landlord

Graham Lauren
Jun 16, 2017 · 12 min read

Collaboration is the inevitable end state for the modern working environment for two good reasons. First, it gets more done: collaboration represents the history of success in our species. Second, we have technologies increasingly capable of enabling it in and beyond the physical workplace. Advances in tenant-driven workplace strategy suggest that gaining greater expertise in landlord-tenant collaboration represents a hurdle commercial property owners may be wise to jump.

To realise the full benefits of our native ingenuity, possibilities for improved collaboration must be nurtured at every turn, across our entire society.

The will, the ability and the need to collaborate more effectively in smaller, more agile teams implies that coworking, or something much closer to it, is an inevitable state for the immediate future of work.

Although it may take some time for them to feel it, this nevertheless has significant implications for many current owners of CBD workplaces, around whom the world of work is changing fast.

Some, such as GPT, through its investment in the Australian operations of US coworking operator WeWork, have already seen this future. But the revolution still has a long way to travel, and WeWork is most likely not it.

There is still a piece to be written looking at the impacts of change on the current business models of the major commercial property owners (CPOs).

This isn’t that piece (I am working on it), but a precursor to it.

Currently, the occupation of Sydney and Melbourne CBD properties is reportedly at an all-time high, with there being little stock available and historically low vacancy rates, driving high rental prices as growth in the pipeline of supply also momentarily slows.

But history proves that what goes up must come down.

As we move into the age of mobile computing and agile or activity based working (ABW), workspaces are no longer the physical manifestation of the organisation chart.

They are instead knowledge laboratories in which old work and its outputs are constantly being challenged in ways it is hard to predict, except for the fact that this is happening increasingly fast.

In this environment, which may itself be distributed geographically, digitised collaboration is the way in which things get done.

Certainly, the modern workplace requires that to remain relevant landlords themselves are going to have to learn some of the skills of workplace strategy if they are to service, negotiate and collaborate more effectively with their tenants.

Their challenges may be created in part by the complacency borne of sitting on a timeless and reliable business model. For owners and agents, there is evidence elsewhere that their greater risk may be of this model evaporating more quickly than they would like in getting the lid back on the bottle.

With the power of the cloud behind them, modern businesses are combinations of a business model, embracing executional ability, knowledge creation and rapid adaptation and learning.

In a digital age, the challenge to leasing property at scale is that technology enables much more work to be performed by far fewer people, much more of it off-site and remotely, even overseas.

At the beginning at least, this doesn’t take much space, and as an example, when Instagram sold to Facebook for $US1 billion in 2012, it had a headcount of just 13 people.

It was a pointer to things to come.

In a world of machine learning, even those businesses still employing people will find new things to do in less costly ways, with ever fewer heads.

We are moving into an age in which the physical manifestations of businesses will be shaped around the knowledge they contain, and that which they need to bring together.

These are their knowledge architectures, and they still need people, but fewer of them, and they have a much reduced physical footprint.

Witness the rise of Uber and Airbnb, the latter of which famously doesn’t even own the property assets it promotes.

Originally published in 1960 in the Harvard Business Review, Theodore Levitt’s Marketing Myopia presents a powerful analogy between the United States’ railroad owners and the behaviours of Australia’s present-day commercial property giants.

Levitt wrote:

The railroads did not stop growing because the need for passenger and freight transportation declined. That grew. The railroads are in trouble today not because the need was filled by others (cars, trucks, airplanes, even telephones), but because it was not filled by the railroads themselves. They let others take customers away from them because they assumed themselves to be in the railroad business rather than in the transportation business. The reason they defined their industry wrong was because they were railroad-oriented instead of transportation-oriented; they were product-oriented instead of customer-oriented.

If we relate this to the owners of commercial property, the analogy is that they need to see themselves as not space providers but facilitators of work. This is a much more fine-grained and subtle business.

When the present boom recedes, we can already see a parallel squeeze coming.

The top CPOs are unlikely to become operators of new CBD coworking spaces essentially because they run counter to an already challenged business model.

  1. As tenant companies are becoming more knowledgeable about activity based working and workplace strategy, they tend to take less space. This is clearly not in the interests of the CBD property-owning establishment.
  2. CPOs generally have limited knowledge of the ways in which those businesses leasing their spaces are actually using them. Not being either invited or able to see through their walls limits their abilities to refine their product to address genuine needs. If meeting such needs encourages those taking space to take less of it, the owners are unlikely to indulge them, or even to begin the conversation.
  3. The age of machine learning presents the prospect that with digitised combatants becoming smarter in the way they do things, many office jobs will simply be automated out of the workforce. This is another looming problem for the landlords.
  4. Where incumbent landlords want to lock customers into the longest lease term possible for the greatest amount of space, the space-takers now occupying coworking spaces want precisely the opposite. Coworking residents want to buy the smallest amount of space, a single desk for a month — or space-as-a-service — without commitments any longer than that month.
  5. The inherent uncertainties of coworking’s unit of sale of a single desk per month and the complications of providing supporting services geared to the interests of a specific niche of customers does not fit the model of a typical incumbent property owner. If they can’t understand how to manage it or how to make money from it, they are even less likely to encourage it.

By Levitt’s classification, the CPOs remain product- and not sufficiently market-oriented.

The “gig economy” is changing the wider economy materially around the CPOs’ businesses.

Pundits expect the workforce to move increasingly to part-time work, with individuals pursuing two or three jobs at any particular time rather than just one, perpetuating the growth of coworking.

If they can’t see it coming, the incumbents may be disrupted, not least because alternatives are being forged, and smaller, more effective workplaces are on the rise. Coworking spaces offer a genuine and preferred solution to the real estate needs of many smaller businesses.

Addressing the mainstream workplace itself, we continue to see failures in large-scale corporate property relocations, in which workers by the hundreds, thousands even, are still being shoehorned into properties which fit principally the whims and fashions of their bosses.

In practice, the change management processes through which such transitions are managed are reportedly typically found wanting, even when the premises actually fit the organisations concerned. (This is by no means guaranteed.)

Unlike large-scale corporate environments, coworking spaces are places in which people choose to work. More pervasive coworking is therefore an inevitable work state, at whose extreme, we even see Hoffice, a variant emerging emerging in Sweden, which aims to help freelancers get things done by transforming apartments and homes into temporary coworking spaces.

As Austrian-born American economist and political scientist Joseph Schumpeter described in the 1930s, in the move towards coworking we may be witnessing another present-day manifestation of the eternal process of “creative destruction,” in which the new persistently overwrites the old.

It is now the fate of a commercial property sector that the waves of creative destruction should come washing at its doors, carried by changes outside its business and largely beyond its prevention.

Management consultant, author, speaker, and co-chairman for Deloitte LLP’s Center for the Edge, John Hagel distills business models into three basic types. (The others are product innovation and commercialisation businesses, and customer relationship businesses.)

According to Hagel’s framework, property owners work in an infrastructure management business whose focus is on managing high-volume, routine processing kinds of activities, including aggregating participants and transactions.

Such businesses are driven by a cost-focused efficiency culture in which the key is to drive down cost per transaction without compromising quality or reliability.

Predictability is one of the highest values in these businesses, and standardisation is also key, as variability tends to push up costs.

Property ownership is asset-intensive, with assets being managed to drive increasing utilisation and efficiency over time.

Property businesses are driven by powerful economies of scale, attempting to lower unit transaction costs as they become bigger.

In their industrial-era incarnation, these businesses are characterised by the scale and fixed nature of their assets.

Although as a reaction to change, they may try to adapt their products, evidence suggests the CPOs and their managers’ mindsets are not necessarily optimally equipped to deal with rapid, discontinuous change.

It is those blinded by their own good fortune who are most vulnerable to change when it comes. The patterns of change that precipitate disruptions within apparently stable markets are now well documented.

Harvard Business School professor Clayton Christensen is the pre-eminent authority on industrial disruption and writes that it is an irrepressible if unseen force. Disruption is as inevitable and ultimately unavoidable as gravity.

Christensen describes how when a new entrant with a new idea enters an established business’s market at its bottom end by offering lower costs, a disruptive innovation can incentivise a whole new population to become customers.

Christensen offered as one classic example Toyota’s introduction to the US market of a small, affordable car that the local auto industry didn’t see as a threat because they could only conceive of producing large and increasingly luxurious versions of existing models.

As in the Toyota example, at first, those running the old system don’t notice the change as a few “edge” customers move over to the rival’s new solution. When they do, they assume it’s not significant.

Industries never welcome newcomers, but then there comes a point at which the entrant becomes more than a minor irritant by continuing to steal more of the incumbent’s sales. The established business remains in denial that this incursion will last. It declares it a passing fashion, or fad.

Even when it is clearly failing, the established business’s managers grab on to the strategy that has served them well, but now execute it with even greater vigour.

Finally, the entrant’s new model succeeds so well that it becomes the main game and the managers of the old organisation suddenly wonder where their business went when they’ve squandered most of the time they had to adapt. Once you see this pattern, it is ubiquitous.

By the time the US manufacturers recognised that the Japanese car maker was beginning to eat into their dominance in the US markets, it was too late.

Likewise, although not challenged directly by the internet, Kodak already had digital photographic technology, but its film business was so profitable it couldn’t risk cannibalising it, until it wasn’t.

Similarly, although not exactly at the bottom of the market, Nokia’s board’s apparently scoffed on taking delivery of the iPhone on the day of its release, and we all know what happened then. As noted by an observer, “Disruption on day one to a large corporation always looks like a toy.”

Where it used to be very expensive to deliver products to market with comprehensive feature sets and supporting delivery mechanisms, unbundling describes the ways in which products and services can now be delivered by internet-fuelled operators to meet the idiosyncratic needs of discrete customer groups.

Banking used to be an expensive business demanding a branch and tellers. But, as a bank grows its customer base by acquiring rivals and introducing new products, to manage its costs, it begins to cross-sell new products to that customer base, introducing lock-in mechanisms to prevent customers defecting to the products of rivals.

In doing this, viewed in isolation, certain of its products may no longer be best of breed, but through inertia, customers put up with them.

The internet accelerates disruption by enabling smaller players to pick on a particular customer segment or product, strip it back to get at what its essential value is and introduce a competitor in ways that the incumbent locked into its expensive encumbered business model simply can’t.

If you bank with more than one institution, for privacy reasons, it is unlikely that any single provider can give you an aggregated picture of your wealth across all of those with which you do business. Mint.com, however, began by delivering a snapshot from each enabling you to see the whole picture.

By building a different view of your wealth, and creating a new channel of distribution around its unique information, this may also enable it, ultimately, to configure new products more closely suited to the needs of the individuals using its platform.

Individual services in lending and asset management are now being offered by non-banking providers, and even the currency may be refashioned by cryptocurrencies such as Bitcoin removing banks altogether from the exchange of value.

Newspapers, once a package of stories, have been taken apart by the internet, because it can deliver only the subjects and stories a reader is interested in. The classified advertising, once newspaper publishing’s lifeblood, has also long since gone, eaten by Google.

Witness Apple selling music by the song, not the album, to counter the threat of illegal mp3 downloads, and its subsequent deleterious effect on the profits of the music industry.

University degrees, once the result of bundling together a campus of buildings, a bunch of professors and libraries stuffed with learning materials, are now being delivered online by MOOCs.

And so on, and so on. Internet operators unbundle, commoditise, repackage and drive down the price of everything.

It is arguable that the workplace can similarly be unbundled and repackaged by increasing instances of coworking.

It will certainly release a number of smaller competing properties into the market, and against this, if the headcounts of established businesses really shrink and there is space to be occupied, what will fill it?

The inherent uncertainties of coworking’s unit of sale of a single desk per month and the complications of providing supporting services geared to the interests of a specific niche of customers doesn’t really resemble John Hagel’s prescription for an infrastructure business.

Neither its yield nor the detail its management requires is likely to appeal to the mindset of present-day commercial property operators. This becomes a very different business model.

In parallel, growing sophistication in workplace strategy is becoming the unifying unbundling-rebundling force we can’t ignore in the delivery of work.

Its job is to rewrite the past and to overwrite old attitudes toward the workplace.

It is focused on discovering where real value lies and can be enhanced in the workspace.

It can become a philosophy of knowledge work, guiding collaboration and reinventing the envelopes in which work is done.

It embraces the physical spaces, the choices of collaborative tools, how they are used and the means to which they are put.

It addresses adaptation to new ways of working, and adaptation to workplace mobility.

At its essence lies the design of work and how and where it is to be done, and policies boosting workplace productivity, employee satisfaction, attraction, engagement and retention.

It reduces cost of accommodation, focusing on better space utilisation, minimising blockages in the flow of knowledge and reducing the hurdles in finding the right space quickly at the right time.

Its aim is to foster innovation and help to initiate faster product to market times.

Workplace strategy is knowledge architecture, and it is going to refashion the business models of all it touches.

In the words of Bill Gates, as in anything, we may overestimate the impact of technologies in the short term, but we are definitely likely to underestimate them in the long term.

We may be sure the current owners of commercial CBD workspace are mindful of this emerging risk to their livelihood, but at this point of how they intend to fight back, we may be less certain — especially over that longer term.

Workplace strategy

Workplace strategy is where building design, modern technology and new ways of working come together to deliver the future of work. Shiro Architects’ research focuses on understanding how to create a better workplace-design briefing for the future occupants of commercial space.

Graham Lauren

Written by

Shiro Architects director and business writer, writing, reading and researching workplace strategy, learning organisations and knowledge architecture.

Workplace strategy

Workplace strategy is where building design, modern technology and new ways of working come together to deliver the future of work. Shiro Architects’ research focuses on understanding how to create a better workplace-design briefing for the future occupants of commercial space.