Coopetition – Making Friends with your Enemies
Welcome to this week’s blog.
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Competition is the driving force behind most businesses. As Herbert Hoover noted, it is both the basis of protection to the consumer and the incentive to progress as a society. It also shapes many of our day to day activities: winning the pitch, getting an award, being the one selected for promotion, being the most financially successful organisation. There is clear evidence that the best firms in all industries are pulling away from the pack. So, to what extent is success driven by competition and are there circumstances where single-minded competition is counterproductive?
In today’s blog, we explore how competition impacts on profits, why competitors don’t always need to compete, and what lessons we can draw for the real estate industry.
The typical determinant of sustainable advantage is through differentiation (both on value and costs) – this is both a choice and a capability. If you can innovate and change your offer in a way that allows a customer to express a preference for your product over that of your competitors, then you are less at risk of price comparison, and more likely to drive market share gain. Equally if through efficiencies you can reduce your costs of production below that of your competition, then you can price your competitors out of the market.
However, not all financial success is due to competitive choices; at least part of the performance of a firm is about riding the industry wave. Consider an example from the last year. You might be the most skilful and expert nightclub manager going; however, there is little that you could have done to buck the challenges of the industry over this period. This is of course an abnormal example; however, in most cases industry choice is less impactful on firm profits than the choices that a firm makes within the industry (some studies suggest <20% of total financial performance).
There are however factors of the competitive structure of the industry that can lead to sustained differential performance. Imagine an industry without competition; a monopoly. In such industry, the sole supplier can charge whatever it feels a customer will realistically pay, in the safe knowledge that the product cannot be acquired elsewhere. Once you add in a couple of competitors, then the supplier needs to have mind not only to what customers will pay, but also the potential for their competitors to charge less. Add in full market competition, and profits will be significantly at risk from price cutting. So, if your industry has one or a handful of dominant players, there will be lower competition and greater potential to extract profit. This explains for instance why the typical ROE of tobacco companies is in the high 30s, whereas the typical ROE of food production businesses is ~5%.
Therefore beyond different choices around product and operations, additional competitive strategies for leading players include: creating barriers for others to enter an industry (through for instance the creation of intellectual property or economies of scale) and deliberate industry consolidation through M&A to reduce the number of effective competitors. These can be equally if not more important than winning the race within the industry.
In some cases, therefore the best interests of the firm come not through rivalry with long standing competitors, but rather through joining forces with them to improve the overall performance of the industry. A classic example would be where two rival shopkeepers in an Old West frontier town join forces to fund a new railway station, which triples the amount of local trade. A more recent example would be the creation of the USB standard. In 1994 a consortium of rival PC manufacturers teamed up to create a single universal specification for a port to connect peripheral devices. By working together, the competitors were able to reduce costs and inefficiencies in their design, to improve the customer experience of all types of PC by making them ‘plug-and-play’, and to give confidence to the manufacturers of peripherals that their devices would be supported. Collectively, this helped to enable the subsequent massive growth of the home computing market to the benefit of the whole consortium. The term ‘coopetition’, a subset of game theory, is used to describe this kind of win-win cooperation between competitors.
Isn’t this meant to be a blog about real estate? Ah, yes, I was coming to that. There are three ways in which I believe this discussion is applicable to real estate in the modern era
Product differentiation – Historically, real estate hasn’t seen itself as a consumer facing industry. It has been led by investors who have wanted to park capital and ride macro trends. By far the biggest factor in determining real estate value has been location (70%+) and (at risk of offending developers and architects) most buildings are commodities, between which tenants barely discern in the form of their rental offer; the market rent is the market rent. With large numbers of buyers and sellers, no barriers to entry other than capital, and relatively undifferentiated products, competition is therefore high, and pricing hinges on uncontrollable factors of market over or undersupply relative to demand. In recent times this paradigm has been challenged. Real estate is increasing being seen as a ‘product’ and investors are being seen in cases as a ‘platform’, with additional items such as service provision, flexibility, events, brand, customer experience, membership and affiliatory rights being bundled with the traditional demise. By introducing these concepts, investors are now in a better position to shape the industry environment, and make product-oriented, differentiated competitive strategies. Over time this will increase the number of reference points for consumer comparison, hence leading to a broader range of price points (no longer a single market rent) and in doing so will result in a softening of the structural competitiveness of the real estate market.
Placemaking / agglomeration – I have set out a view in previous blogs that in the search for the best experiences (both retail and workplace), there will be fewer but clearer winners. If ‘experience’ becomes dominant over convenience, then the consumer will travel further for the best centres and the poorer ones will disappear. We have seen in recent years evidence for the value of placemaking. Particularly, large sites in single ownership that are better able to create a sense of place and arrange uses in a way that is more conducive to the customer experience do better. What happens if you don’t control a large site? An answer can be found in coopetition. As the market starts to polarise between best and worst, the prize for cooperation becomes greater. Take the example of a parade of shops all in separate ownership. Individually they will look after their own interests, compete for tenants, cut rents to avoid vacancy and will soon look inferior to the regeneration scheme down the road that has invested in placemaking. The alternative is collective action through co-investment. By looking at the parade as a collective asset, new investment opportunities are unlocked. This might for instance include destroying individual value (e.g. changing the use of some buildings) to release collective synergies, in the knowledge that the value is pooled and all will win. Or it might take the form of investment in placemaking or lobbying local government for a change in planning policy (or use of CPO powers). The winning locations of the future are ones where competing investors work together.
Data standards – As an industry, we are borderline data illiterate. Recently the focus has been on catching up with the finance sector; however, there is a long (long) way to go. With no central exchange, regulation or common reporting requirements, data transparency in real estate is weak. The data itself might be seen as a competitive business asset by some firms; however, the lack of common standards about the form of our data means that there are huge inefficiencies to sharing information that limit the success of all firms. Even very basic rules around the data definitions and hierarchy of ‘a property’ are currently absent, which means that it is currently very difficult to reach common benchmarks and transfer knowledge between competing (misaligned) systems. This in turn makes trading, valuing, managing and onboarding properties a much slower process than it needs to be. As our industry matures on its digital journey, common data standards need to be at the heart of progress. In the same way as the creation of the USB standard, this will require cooperation between competitors to deliver.
Finally, on a personal level, in a business environment increasingly determined by network effects, you don’t win by being a lone gun. Vanity drives desire to dominate a market. However, by belonging to a group of people prosecuting a common agenda, your voice is louder, interest in your subject matter rises and your opportunity increases by taking a smaller share of a much bigger pie. If you’re one of my competitors and found this interesting, drop me a line.