We’ve discussed a number of success stories in this book so far, and if we go down the list, most built their loyal consumer base by going direct to customer. Whether we’re talking about product companies like Dollar Shave Club or novel services like Spotify, they were able to generate hundreds of millions, and sometimes billions, in revenue without ever opening a physical space. And though that might be the new normal as we enter the next chapter of digital commerce, there’s been an interesting pivot by online-first consumer brands into traditional omni-channel, adding an offline presence to their core e-commerce model in order to reach new heights.
Warby Parker, widely considered a first-mover category disruptor in eyewear, was initially all about avoiding high-priced glasses by eliminating the overhead incurred by physical stores. Warby’s lean start-up model, where consumers could buy cool frames for less by shopping online, made perfect sense. Then, in 2013, in the wake of Warby Parker’s rise to darling of online retail, the company switched gears, announcing its first flagship store location, in New York City. Their store count has since grown to roughly 100 locations across North America, with thirty more planned for the latter half of 2019.
As e-commerce continues to grow rapidly, sales at most brick-and-mortar retailers, especially mall stores, remain stagnant.
Source: Wolf Richter, “E-Commerce Does it Again: The Stores that Got Pummeled,” Wolf Street, August 17, 2018, https://wolfstreet.com/2018/08/17/despite-strong-retail-sales-brick-mortar-meltdown-pummels-these-stores-the-most-e-commerce/.
Warby’s successful move from online to omni-channel has prompted others to mimic the strategy. Most online-to-offline copycats typically believe that selling online has a proverbial revenue ceiling, and, in turn, that brick-and-mortar expansion offers a way to break through the glass, letting the next wave of new customers discover, engage, and purchase in-store (and/or online).
Some are using physical stores as inventory-free showrooms. Warby Parker shoppers, for example, try on products in-store before ordering their final selection, which is later shipped direct, off the website. Indochino, another online-first brand and a leader in made-to-measure menswear, created its store showroom concept around an appointment-based experience. Customers go online to book a timeslot with one of the company’s “style guides,” who then takes measurements and selects customization options, all in person, before the order is processed online. As with Warby Parker’s glasses, the suit is then shipped direct—in this case, approximately four weeks later.
Other online-first businesses have partnered with established legacy retailers to build a real-life presence in order to soften overhead costs. Casper, a New-York-based mattress brand that began testing its physical presence with pop-up trailers in select cities, has since partnered with Target, Nordstrom, and the Hudson’s Bay Company (in Canada) to make their products available for in-store purchase. Their Canadian-based counterpart Endy did the same, announcing similar partnerships with other showroom retailers across Canada. In 2018, Birchbox announced a partnership with Walgreens that saw Birchbox showcase products in several Walgreens locations. Walgreens now owns a minority stake in the cosmetics company.
Opinion is divided on whether brands with an online-first growth story should be taking their businesses to storefronts. The bulls argue that, notwithstanding retail brick-and-mortar’s decline and the high cost of things like build-out and monthly rent, companies like Warby Parker and Indochino do have a business case—namely, that $3 trillion out of $3.4 trillion, or almost 90 percent, of retail sales in the U.S. are still courtesy of brick-and-mortar. Moreover, e-commerce predictions suggest that global online sales will still only account for 17.5 percent of total global retail by 2021 (up from nearly 14 percent in 2018).1
And while that sounds good on the surface, the bull case misses a key point: stores suck a ton of cash from a growing upstart, and unless you’ve got a nice war chest to risk—or a firmly entrenched partner to piggyback on—a move into stores is inherently dangerous.
Bonobos, another online-to-offline player in apparel, which owned its own factories, was saddled with challenges once it began to use venture funding to launch its personalized-fit Guideshops—and in the end, the company sold to Walmart in 2017, in what looked like a desperate move to cover cash lost from its physical expansion and to return capital to its venture investors. As mentioned, Birchbox, too, had to shut its doors in New York and scale back additional store plans as a result of financial challenges, opting instead to partner with Walgreens.
This isn’t to say that digital-native brands should steer clear of physical stores. The strategy can work well for specific categories, like eyeglasses, or swimwear, where people have a hard time determining fit via a website. Since glasses are personal and pricey, there is a cohort of people who simply prefer to try ’em on in person. Rather than alienating that potential customer base, it’s prudent to consider a physical store. Cleverly, Warby didn’t sign an expensive lease when it first started to test things out. In fact, in 2012, the company used a classic yellow school bus as a mobile storefront, for a cross-country retail tour it called the Warby Parker Class Trip—kind of like the Peterman Reality Tour (if you didn’t catch the Seinfeld reference, move on). The bus rolled through different American cities, showcasing Warby’s $95 frames to thousands of curious shoppers. When the tour was well received, Warby knew the next iteration might resemble something more permanent.
Companies like Amazon and Shopify, which maintain plenty of cash on the balance sheet, have a much easier time experimenting with in-store experiences. Amazon has done so since 2015, the year it opened a half-dozen bookstores, a score of campus locations, and a grocery store without cashiers (Amazon Go). Shopify recently opened its first physical space in Los Angeles, called ROW DTLA, described on the website as “a destination for current and aspiring business owners to learn, experiment, and build with Shopify.” These initiatives are digestible if store failure is nothing but a rounding error. As you might recall from the Amazon chapter, Prime’s 100,000 individual customers spend about $1,400 a year across the Bezos ecosystem. Amazon can afford to meet customers on Mars if that’s where they’re shopping.
It’s hard to talk about budding subscription players and online/offline hybrids without mentioning a nine-year-old company that, at one point in 2019, was on the verge of a $50 billion valuation. WeWork, the SoftBank-backed community workspace company started by two visionary founders in 2010, now occupies more Manhattan office space than any other company, renting 5.3 million square feet in Manhattan, and knocking the previous title holder, J P Morgan Chase, off its throne.
WeWork, the hottest brand in coworking, has spread like a virus. In 2017 alone, the company opened ninety buildings across the globe. As of Spring 2019, WeWork locations numbered over 600. The company has attracted over 260,000 monthly paying members since inception—and the demand is increasing. Occupancy rates rose to 84 percent across all establishments in 2018, up from 78 percent occupancy one year prior. In certain cities, WeWork is close to 100 percent occupancy, with prospective members waiting for vacancies.
WeWork, rooted in a subscription membership model birthed by founders Adam Neumann and Miguel McKelvey, has nearly perfected what a community co-working space should be: festive, trendy, aspirational, and community-oriented. Both men seem to have come by the vision honestly—McKelvey grew up in a hippie commune in Eugene, Oregon, and Neumann spent his early years in Israel living on a kibbutz.
The two met in the mid-2000s in New York City, when Mc-Kelvey was working as a junior draftsman at an architectural firm. His coworker was roommates with Neumann, who had moved to New York (after serving in the Israeli Defence Forces) to tinker with a couple of start-ups selling baby clothes. Neumann and McKelvey soon found themselves working across the hall from one another in Brooklyn. Often the guys would chat about how the building they both worked out of could make more efficient use of its space. What started as casual conversation soon amounted to a mini-pitch to their Brooklyn landlord.
In a bid to lease out one of the unused floors, Neumann floated the idea of letting he and McKelvey do a full office makeover, and lease out the newly finished area as shared offices. Although the initial conversation didn’t bear fruit, subsequent follow-ups resulted in the landlord agreeing to try the concept out on another property he owned across the street. The pair drafted floor plans and a brand vision for what they called Green Desk, an environmentally conscious shared workplace, and came back with a formal proposal. The landlord accepted, and a new business partnership was in motion. The initial Green Desk pilot was profitable, quickly growing to 350-plus members in the one location, but when it became clear the landlord was working his own agenda, Neumann and McKelvey crafted a deal to sell Green Desk to him, and each walked away with a few million.2
The cash from the deal provided an opportunity to recreate the Green Desk vision using a different brand name and location, this time calling it WeWork. The first location bearing the moniker opened at 154 Grand Street, in New York’s Soho neighbourhood, in April 2011. The location was at full occupancy within a couple of months.
After several years of continuous growth, Neumann found himself in a position to meet with Masayoshi Son, Japan’s wealthiest man and CEO of the SoftBank Group. Although SoftBank has invested over $10 billion in WeWork, the company, which announced plans to go public in early 2019 as The We Company, has since delayed its IPO (as of September 2019) as a result of tepid investor interest, plunging valuations, and questions about its leadership.3
When the company’s S-1 (the form that companies must file to the U.S. Securities and Exchange Commission before an IPO) became public in August 2019, it prompted intense scrutiny of its finances—and of the odd behavior of Neumann, whose prolific pot smoking and aspirations to the prime ministership of Israel were detailed in the Wall Street Journal.4 Neumann stepped down as CEO in September 2019, reportedly at the insistence of SoftBank.5
WeWork’s fundamental business model isn’t unique. In fact, the idea to create shared space for profit was brought to the mainstream in 1989, when Mark Dixon launched Regus, a company that offered tenants community office space complete with maintenance, staff, and a flexible lease term. When Regus went public in October of 2000, it was valued at £1.5 billion and was considered the first large-scale shared office space pioneer. But, like many first movers, Regus fell into unforeseen business ditches. Namely, the first big dot-com bubble burst, which saw many tenants vacate Regus offices around the world in favor of more affordable options like home-based set-ups and coffee shops. Having inked long-term leases with landlords, the firm was left holding the bag with too few tenants to cover the gap. After a near collapse, Regus re-emerged from bankruptcy and remains a formidable player today. However, new entrants, like WeWork, have surfaced with competing offerings.
WeWork’s MO, much like that of Regus, is to sign long-term leases, renovate, and then rent out desks and closed-door offices to members on a per-month basis—taking enough margin along the way. On the consumer side, the no-lease, subscription-based model provides WeWork members with a low-risk option to get access to state-of-the-art office space for as low as $500 a month.
Critics of WeWork’s business model suggest the company could face a similar fate to that of Regus. In many respects, the flag-raising is warranted. At the beginning of 2019, WeWork had about $34 billion of lease obligations, was nowhere near profitable, and was shown to be losing about $2 billion a year.6 Despite the sobering financials, bulls, on the other hand, argue that the company has also examined how Regus got burned, and has crafted a strategy to mitigate its risk.
In the event of a weakened economy sparking a member exodus, WeWork has hedged, somewhat. Rather than holding each property under WeWork’s main corporate entity, the company has spread things around, using corporate shelters, which it calls “special-purpose entities,” to isolate the parent company from a possible blow-up. More important, the firm is inking lease deals that split profits 50/ 50, where incumbent landlords pay for the build-out and share in the revenue. WeWork is also adding buildings to its asset list, setting up a new division called ARK that purchases buildings outright and leases them back to WeWork.7
Yet the most important source of stability may be the firm’s evolving, diverse profile of paying members. Initially, 95 percent of WeWork occupants were start-ups (the segment most likely to fail in business), but the pie is now sliced three ways—only a third can be called start-ups, while the balance is equally split between small-to-medium-sized businesses and corporate-enterprise-level clients like Shopify, Microsoft, HSBC, Samsung, Lyft, and Facebook, which WeWork claims save about $18,000 a head when they move into a WeWork office.8 The big-firm movement into “We Space” means a more stable set of tenants to help weather any volatility in start-up entrances and exits.
Meanwhile, Regus is doing its best to stay relevant through its core brand, as well as its other co-working outfits like Spaces. IWG, the parent home to both companies, touts its Regus banner as having both more locations (about 3,000) and members (over 2 million) than WeWork—yet the publicly traded company is valued at “only” $4 billion, prompting plenty of analysts to both question Regus’s future and WeWork’s valuation—which, using comparable metrics, should be closer to $3 billion.9 In other words, investors who’ve been willing to put money into WeWork at a $40 billion valuation have to believe that each of the company’s members is worth about $156,250 and that, by comparison, Regus’s members are worth roughly $11,000—leading some skeptics, including Scott Galloway of NYU’s Stern School of Business, to call WeWork “the most overvalued company in the world.”10
Unlike IWG, WeWork doesn’t believe it is a real estate company. So, if WeWork isn’t a real estate play, what is it? The company used the word “technology” 123 times in their S-1. While hundreds of pages of documentation laid out some of the company highlights, SEC requirements forced WeWork to disclose a more sobering tale: that of a real estate company mired in mounting financial losses that were hidden behind the veil of a sexy start-up story.
Beyond the unit economics, WeWork does have a profound understanding of its core customer, which has helped the brand to nail its value proposition. Progressive millennials, one of its targets, are socially conscious, environmentally responsible, and hate the idea of commitments, contracts, and lock-ins—which explains their contempt for leases peddled by commercial landlords, and their love of the less restrictive, more community-based WeWork offering. As for Gen X, another big WeWork consumer cohort, a recent study claimed that 67 percent of Gen X leaders are effective in “hyper-collaboration,” and value the freedom to innovate and the flexibility to manage their work/life balance.11 As such, WeWork’s coworking spaces, which appear to break down metaphysical and metaphorical walls, are a natural fit.
Nevertheless, parts of the ongoing WeWork narrative feel a lot like that of Amazon, where growth and vision trump conventional metrics like profits.
The halting of WeWork’s public offering is not just about mounting financial losses and an unconventional CEO. It indicates that broader investor sentiment towards such venture darlings is shifting; they’re starting to be seen as not just less attractive, but outright dangerous investments.
As of late October 2019, WeWork had given up control of the company to SoftBank, who said it would inject more than $5 billion in capital, at an $8 billion valuation—a fraction of the $47 billion price tag it had assigned WeWork in its last round of financing. SoftBank will also pay Neumann $1 billion for his shares in the company and extend him $500 million in credit to help him repay a loan from J.P. Morgan, on top of a $185 million consulting fee.12 In plain terms, the deal means SoftBank has invested more in WeWork than the company is worth (as of October 2019), and given Neumann an allowance to retire off the grid and escape the carnage he’s left behind.