WeWork: Blitzscaling or Blitzflailing?

Prominent news organizations, ranging from The Economist to Wired (multiple times), have been describing WeWork as an example of blitzscaling. New York Magazine offers a vivid example, writing in a WeWork profile:

“The [Softbank] Vision Fund began making enormous bets on Uber, Slack, DoorDash, and dozens of other companies, employing a strategy that has come to be known, with some derision, as “blitzscaling”: pumping up a company to a market-dominating size as fast as possible, without worrying about profit.“

We certainly appreciate their awareness of blitzscaling, the term we coined for the strategies and tactics for value-creating hypergrowth. We argued extensively in our book, Blitzscaling, that these strategies and tactics describe why Silicon Valley Bay Area – which has a population of less than 4 million – generates such a massively disproportionate number of global technology companies. If you add together Apple, Alphabet, eBay, Facebook*, Lyft, Palo Alto Networks*, PayPal, Salesforce, ServiceNow*, Twitter, Uber, and Workday*, these twelve companies alone have a market capitalization of $3 Trillion, a little bit more than the annual GDP of the United Kingdom in 2018. (Disclosure: * denotes a current or former Greylock portfolio company.)

But to answer the question, “Is WeWork an example of blitzscaling, and perhaps even more importantly, is blitzscaling appropriate for its business model?” requires a deeper understanding of how we define blitzscaling, which is substantially more than just “get big fast.”

This analysis will show that despite the company’s remarkable revenue hypergrowth, the WeWork business model as implemented always lacked some of the key growth factors required for successful blitzscaling.

What is Blitzscaling? Why do it?

The precise definition of blitzscaling, which you can find in our book’s first chapter, is:

“Blitzscaling isn’t simply a matter of rapid growth. Every company is obsessed with growth. In any industry, you live and die by the numbers— user acquisition, margins, growth rate, and so on. Yet growth alone is not blitzscaling. Rather, blitzscaling is prioritizing speed over efficiency in the face of uncertainty.”

Blitzscaling does call for prioritizing speed over profits, but the more important question to consider is: when and why blitzscale?

The purpose of blitzscaling is to achieve enduring market leadership in what we call Glengarry Glen Ross markets. A Glengarry Glen Ross market is a winner-take-most market that occurs when being the first player to reach critical scale brings lasting competitive advantage. The term comes from the classic movie about a sales contest where “First prize is a Cadillac, second prize is a set of steak knives, and third prize is, ‘You’re fired.’”

Often, this is due to network effects, as in the case of communications tools like Facebook or two-sided marketplaces like Airbnb, but can also occur due to other forms of lock-in and outside of the technology industry, like 99-year mineral rights leases during the shale oil boom of the 2000s.

Once achieved, leadership in a Glengarry Glen Ross market can provide decades of substantially profitable operations, repaying and justifying the costs incurred in blitzscaling. And many of the Silicon Valley technology companies achieve their global prominence due to blitzscaling — which provides jobs, tax revenues, and new products and services to society.

What makes a company Blitzscale-able?

So how do you know whether a company should blitzscale? In Blitzscaling, we lay out the four key growth factors that enable a company to successfully blitzscale, as well as the two key growth limiters that can make the strategy a poor choice. These growth factors are:

Market

Blitzscaling requires a big market to provide a big potential reward to compensate for the risks and costs involved. It doesn’t make sense to expend massive resources to win a small market.

Distribution

You can’t achieve market leadership unless users and customers adopt and buy your product. A good product with great distribution is more likely to win a Glengarry Glen Ross market than a great product with poor distribution.

High Gross Margins

The purpose of blitzscaling is to win the market so that the company can generate massive profits for years or even decades. While a company might not have high gross margins – or indeed even profitability – on day one, it needs to have a reasonable hypothesis on how to achieve them in the future. (Consider Amazon’s evolution from a low-margin retailer to a high-margin marketplace and cloud computing leader.)

Network Effects (or other competitive moats)

This is the key growth factor that defines a Glengarry Glen Ross market. Without this growth factor, it’s hard to financially justify the high cost of blitzscaling.

But growth factors alone aren’t enough. A would-be blitzscaler also needs to navigate two key growth limiters:

• Lack of Product/Market Fit. Product/Market fit doesn’t guarantee long-term success, but a lack of Product/Market fit does guarantee long-term failure. Achieving market leadership isn’t profitable unless that leadership lasts, which is hard to do if people don’t keep using the product.
• Operational Scalability. Designing a scalable economic model isn’t enough if the company can’t scale up operations to meet demand. This applies to both the infrastructure and the organization.

The more a company can design a business model that leverages the growth factors while managing the growth limiters, the more likely it is that blitzscaling will be a successful and profitable growth strategy. That then allows entrepreneurs and investors to evaluate the investment equation: How much capital is worth risking to build an enduring business of how much value?

Should WeWork have blitzscaled?

WeWork has undoubtedly prioritized speed over efficiency. The company has raised nearly $13 billion, has already spent over $10 billion of that investment, and lost an estimated $900 million during the first six months of 2019.

The question is, given its intended business model, should WeWork have pursued a blitzscaling strategy? Let’s evaluate it based on the growth factors and growth limiters.

Market

Yes. The market for commercial real estate is huge, and the world is shifting towards more flexible office space, not less.

Distribution

Yes. WeWork has built a well-known brand, and because it is a real estate company, its own locations serve as its best marketing tool. Millions of potential customers walk by a WeWork location every single day.

High Gross Margins

This is where the WeWork business model becomes problematic. The WeWork S-1 filing reports that in the first half of 2019, the company had revenues of $1.5 billion and expenses of $2.9 billion. Even if we restrict our cost of goods sold analysis to what WeWork calls “location operating expenses” plus depreciation and amortization, this generous interpretation still leaves WeWork with gross margins of just 3%. For reference, Apple’s gross margin is 38%, and Alphabet’s 56%.

The hope might be that WeWork will be able to achieve much higher gross margins later. But what is the realistic path to this outcome? WeWork already reports an occupancy rate of 80%, which leaves little room for improvement. Will WeWork’s customers tolerate significant price increases? Another option is to develop new products and services that will generate massive new industries, like Amazon did with AWS, but this is challenging when the core business consists of renting out space. Unlike software, where you can sell as many copies as the customers want, you can’t rent the same square foot of space to more than one tenant.

Network Effects (or other competitive moats)

This is another growth factor where WeWork’s business model is lacking. It’s not clear that there are any significant network effects that apply to commercial real estate in general or co-working in particular. There is a small positive effect associated with the perception that WeWork spaces are a more “creative” community than traditional players like IWG (formerly Regus), but this is largely a matter of branding rather than a true network effect. WeWork also benefits from being the largest global player in its industry, making it more appealing to both digital nomads and large global clients. But in the end, WeWork’s business model doesn’t provide any lock-in. WeWork tenants can easily move, and many of its co-working members don’t even need a cardboard box to clean out their dedicated desks.

And while WeWork has locked in its locations with long-term leases, it can hardly achieve a monopoly on office space. Many competitors have arisen as a result. Here’s a list of eleven major co-working competitors in the United States alone.

In other words, it’s not clear that there is a “Cadillac/steak knives/you’re fired” market dynamic at work. Indeed, IWG’s own business seems to be doing just fine, whereas in a true Glengarry Glen Ross market, WeWork’s growth ought to have challenged IWG’s business.

Then there is the question of how the two growth limiters apply to WeWork:

Lack of Product/Market Fit

Having visited multiple WeWork and IWG spaces, we can confidently say that WeWork does a good job of creating a more appealing work environment than its more established competitor, and every WeWork we have seen in person seems busy and energetic. The numbers bear this out: WeWork’s occupancy rate of 80% compares favorably to IWG’s 72%. This suggests that customers like the WeWork product.

Of course, one factor that helps achieve this high rate is the fact that WeWork offers extremely favorable prices to its customers. For example, WeWork offers American Express Platinum customers an entire year of WeWork access for free—a $2,700 value that comes bundled with a credit card with a $450 annual fee. Offers like this can boost occupancy but hurt gross margins. Subsidies only make sense in blitzscaling if they are a temporary measure that allows you to achieve market leadership and establish a profitable and sustainable business on the other side of those subsidies.

Operational Scalability

Unlike a software business, real estate presents major operational scalability challenges with limited economies of scale. In the world of bits, serving each additional customer costs essentially zero, and scalability is functionally unlimited. In the world of atoms, specifically real estate, serving each additional customer costs real money, and scaling up requires signing leases, overseeing construction, hiring on-site staff, paying for housekeeping, performing maintenance, etc.

WeWork should be able to overcome these challenges, which are principally a matter of execution rather than requiring innovative technology or techniques, but doing remains costly in terms of financial and human resources, and hampers the rapid growth of blitzscaling.

Overall Blitzscalability

WeWork’s use of blitzscaling raises some important questions.

The purpose of blitzscaling is to create a highly valuable business whose long-term value far exceeds the risk capital and operational risks required to pursue this approach. The advantage of technology companies (particularly software but sometimes hardware companies too) is that their low ratio of “risk capital required to potential economic value” allows a strategy that takes some extraordinary risks in an uncertain environment, and supports an iterative approach. For example, Alphabet invented AdWords several years after launching; Amazon invented AWS more than a decade after going public.

While WeWork’s business model checks the boxes on big market, effective distribution, and Product/Market fit, the poor gross margins (with no clear path to significant improvement), operational scalability challenges, and most importantly, lack of network effects and lock-in, indicate that this is not a Glengarry Glen Ross market where you can build enduring and profitable market leadership. Thus, the choice of blitzscaling is likely a dangerous rather than intelligent risk.

In some cases, the growth factors and limiters are actually in conflict. Would WeWork’s Product/Market fit be as good at double the price? Conversely, the ability for WeWork customers to easily join and leave the service improves Product/Market fit, but creates real possibility of churn.

To successfully blitzscale its way to long-term profits, WeWork will need to change its model to increase margins and network effects. In fact, we have begun to observe this elsewhere in the real estate industry. Hotel companies like Marriott and Hilton have pursued an “asset-light” strategy where they manage the hotels that carry their brand, rather than owning the actual bricks and mortar. Airbnb is completely asset-less, acting as a two-sided marketplace to bring together hosts and guests.

Finally, while Blitzscaling details strategies and tactics for taking intelligent risks to win a Glengarry Glen Ross market, there are risks that should not be taken. In our book’s chapter on responsible blitzscaling, we explain why blitzscalers should never take risks that endanger their customers or pose a significant risk to the fabric of society. Nor should they take ethical or integrity risks like the self-dealing behavior that reportedly took place under the watch of WeWork’s founder and former CEO, Adam Neumann.

WeWork has definitely created something of value. It pioneered co-working and demonstrated its mass-market appeal. That expertise and brand should be extremely valuable, both to WeWork and others. The problem is that the value WeWork created doesn’t appear to exceed the amount of capital expended to build it.

In our analysis, the company has built and scaled a great product, but would need to make significant changes to become a blitzscalable business. This is the fundamental challenge facing WeWork’s new co-CEOs, Artie Minson and Sebastian Gunningham.

Without major changes to its business model, WeWork’s efforts at blitzscaling seem likely to turn into blitzflailing.