Disruption, Zillow, and the Power of the Innovator’s Dilemma
A Look at How Zillow Can Fight Back at Opendoor after Sitting on Its Hands
In my post on disruption, I explained that disruption works because incumbents typically don’t want to divert a bunch of resources to go after the disruptive form factor, since the disruptive offering won’t initially appeal to most of their customers and is expensive and complicated to get up and running. This concept is called the Innovator’s Dilemma.
I also cited Zillow Offers as a disruptive offering. Zillow Offers is a particularly interesting example in the disruption category because it is essentially Zillow disrupting itself. For those who aren’t familiar, Zillow’s existing main business (Premier Agent) is selling leads to real estate agents, who help those leads buy or sell a house and then earn a commission. So Zillow as it historically has existed is all about leeching off the traditional home-transaction process.
Zillow’s a well run company with a solid track record of innovation, so why has it been sitting on its hands so long with respect to actually disrupting real estate and buying and selling homes itself? Well, because it could. It wasn’t until Opendoor got up and running that Zillow realized iBuying was, as co-founder and current CEO Rich Barton explained in a 2019 interview with Ben Thompson, an existential threat:
while Opendoor did show a very interesting idea for short-circuiting this transaction, of course that kind of cash offer thing existed before and we all knew about it. However, it had never been professionalized, but more interestingly, it was because they were going at it so hard and raising so much money from Vision Fund and what have you, they actually gave us the air cover to attack the transaction directly. It became an existential threat.
As incumbents tend to do, instead of trying to get to where it needed to eventually go, Zillow had instead been focused on making its existing business better, which Barton analogizes to slacklining:
Barton: The company had become, when you look, have you ever slacklined?
Thompson: I know what it is, I have not done it.
Barton: It’s like a tightrope but wider, so people like you and I could do it if you work at it. When you look down at your feet on the slackline, you never keep your balance, you always fall off. You wobble, and then you fall off. The way to get across the slackline is actually to look up. This is true for whatever, snowboarding, surfing, two things that I do, any sport, actually. It’s the same for an organization. The organization had become really focused on looking down at the existing business and trying to solve for all the micro-problems and opportunities they saw in the existing business.
Thompson: This is where the auction issues and the lead generation stuff, is that an example of that?
Barton: Yes, yes…we need to stop looking at our feet — the big picture is there is a giant hill that is empty across the way here, and we need to get the high ground, take that hill, get there first, and if we don’t get their first then we are really in trouble.
Luckily, Zillow has started the work to get to the “giant hill that is empty across the way there,” which requires disrupting itself. Nonetheless it’s interesting that they didn’t really awaken to the problem until they were forced to by Opendoor. To me, this really shows the power of the Innovator’s Dilemma. Even well run, innovative companies like Zillow fall prey to its perverse incentives.
However, when incumbents can wake up in time, it is possible for them to successfully fight back against the disruptors by creating a disruptive offering themselves. This is what Zillow is doing to Opendoor with Zillow Offers, which Zillow started in earnest in April 2018. Obviously Opendoor has a bit of a head start given it started in 2014. Barton, Zillow, and its shareholders (including myself) are betting that Zillow’s built-in audience, brand, and easier access to capital will be enough for Zillow to successfully fight back. As Barton explains in the Thompson interview:
Thompson: How do you see yourself then? A fundamental question, let’s take you and Opendoor. A classic example of a new company comes in with a different business model, they are able to develop and build their company and their processes around that model. Zillow is coming along with a different model, a successful business with that different model being advertising, and now is trying to pivot into this other one. How do you think about the balance between the incumbent advantages of already having the demand-side versus the challenges and the straitjacket can come from already being successful being a public company relative to being an upstart that yes, they have to generate demand from scratch, but they can be much more focused and tuned to the opportunity?
Barton: I like our chances. I talk about peanut butter and chocolate a lot internally here. The reason we win with Zillow Offers is because we have this existing business that throws off big profits and this giant audience that is effectively free to the new business development. And the challenge is only one of strategic clarity and leadership execution, and that is why I am sitting here now. There are some things that only founders have the authority to do to get people to realize that this isn’t just a small, minor tweak and change that’s happening at the company here. This is a massive redeployment of resources, a complete transformation of our PnL, and a dramatic expansion of the opportunity that we face.
While it’s possible both Zillow and Opendoor do well, Barton believes that the market leader in iBuying will be structurally advantaged due to economies of scale, which would lead to a winner-takes-most end state:
Thompson: Is Opendoor your competition? Or is there plenty of opportunity for both of you?
Barton: They are our competition.
Thompson: I like that!
Barton: I mean there’s a ton of TAM, but I wouldn’t want to be Eric Wu. We’re coming, and we’re coming fast. I believe the economies of scale here are pretty pronounced and that to the extent the larger player will have an increasing advantage, the bigger the delta over the Number Two.
Thompson: There are two vectors of advantage: One is the capital advantage I think you’re referring to and the other one is the demand advantage. If Opendoor is going to have to spend on advertising to counteract the demand advantage, that’s definitely going to be a challenge.
Barton: Yes. And the capital is one, but most of the leverage is going to come from scale/density in geography leading to leverage on the expense line out of inputs, and with those efficiencies being fed back to consumers in the form of lower fees which of course drives more scale.
It will be interesting to watch over the coming years to see whether Zillow, as the incumbent, can successfully disrupt itself and fight back against Opendoor. As @akidnamedjimmy mentioned on Twitter the other day, initial results for Zillow look promising:
Either way, it will be fun to watch and will surely be an interesting future case study in disruptive innovation.