Disruptive innovation vs. sustainable innovation in US residential real estate industry
Disruptive innovation is defined as a new development that dramatically changes the way certain industry functions. Disruptive innovation typically either creates a new market or creates an unprecedented value by improving the way a product or service is traditionally sold. For example, Amazon.com drastically improves the way books are sold over the Internet, and Airbnb has created an entirely new market of short-term rental options to compete with hotel accommodations. Both companies are examples of disruptive innovation.
The Internet itself, without a doubt, is the core of all disruptive innovation in the last several decades, but not all innovation the Internet is responsible for is considered disruptive. Many companies in many different industries mainly able to adopt Internet technology as a sustainable form of innovation – disruptive innovation is a very rare phenomenon.
Let’s begin with sustainable innovation first. The United States residential real estate is the largest B2C market in the world, making adoption of the Internet a very lucrative proposition in a form of sustainable innovation to incrementally improve real estate operations in exchange for predictable revenue.
Many real estate brokers have adopted Internet technology in the form of sustainable innovation to improve customer acquisition costs, agent acquisition costs, agent retention, brand awareness, listings exposure, and similar metrics.
Companies such as Compass, eXp Realty, Redfin, Reali, Door Real Estate, Opendoor, TRELORA and many others have systematically worked to adopt the Internet technology to remain competitive. Of course, every one of these companies will actively argue that their approach is highly disruptive, but it is not.
A real estate agent in the United States is a defined licensed occupation, and by this definition, a real estate agent is capable to only achieve a sustainable innovation without breaking the antitrust law. Here is why:
Disruptive innovation requires a massive bid of Internet technology as a way to build and expand using network effects alone. A real estate agent, on the other hand, is only able to effectively use the Internet to develop and advertise better service offerings and competitive fees in local markets - this is the definition of sustainable innovation. Regardless of how much better the service offerings may be, or how much lower the advertised fees are, a real estate agent is always in competition to provide a service to consumers locally. The same is true for real estate investors willing to buy off-market properties directly at a discount for the future purpose to re-sell them in an open market.
There are many interesting proposals in housing PropTech (Property Technology) industry in 2019, including stand-in cash offers, partial homeownership, down-payment assistance, etc. all of which claim a significant disruption to the industry, but these too, are sustainable innovations. The reason for that is lack of scale. In the United States, $1.6 Trillion worth of real estate assets are exchanged every year out of aggregate assets valued at $31 Trillion. Unless the innovation in present addresses the entire market in some meaningful way, it must be classified as a sustainable form of innovation.
For example, Ribbon is a great example of a company that offers a stand-in program for buyers, but with limited funds available to the company, it is only able to cover a very small segment of the real estate market, therefore, Ribbon model must be classified as sustainable innovation. There are many other examples of similar companies that use debt as a mechanism to help facilitate a transaction of purchase or sale of a home, yet, none of these are able to reach the bulk of the industry that operates with an aggregate of $31 Trillion in real estate assets. All of the iBuyer models combined are responsible for only about 0.02% of all transactions in the United States during 2018, despite all the VC mega-rounds funding the industry.
Since the wide adoption of the Internet, only three companies were able to propose and accomplish disruptive innovation in the residential real estate industry: Zillow, Trulia, and Relator-dot-com. The reason for this is that all three companies have built property information portals, theoretically, none of them have done so as real estate brokers. These models have focused their attention on democratizing and publicizing the aggregate MLS information that was only available for brokers up until that point. MLS aggregation has become a disruptive innovation technology because it has resulted in massive network effects via the release of new and valuable data to consumers (Yes, I am excluding Redfin Corporation from this short list, a reason for which will become apparent by the end of this article.)
In 2018 however, all three portals have become an extension of a brokerage industry with the mass adoption of referral fees broker approach, which inevitably leads to degradation of trust with consumers. Zillow Group has adopted Zillow Premier Broker Program to collect referral fees, and Realtor-dot-com has acquired Opcity brokerage that works to connect consumers to agents for a cut of their commission. In the last year, these referral fee programs are now fully dedicated to selling consumers “as leads” on a mass scale, something that neither Zillow nor Trulia have envisioned in their original ads-based approach for revenue generation.
Having made this distinction between disruptive and sustainable innovation, no real estate broker can develop a genuine marketplace experience for consumers without breaking basic antitrust laws. All real estate brokers must compete with each other, not promote one another. Each broker must independently acquire new business, independently advertise their services, independently set service levels, listing rates, and/or rebates for their representation services. Any licensed brokerage that acts as a dedicated referral fee network is unable to trade consumers “as leads” without engaging in market allocation practices at the same time.
For any actively licensed broker to operate solely as a referral fees scheme is a direct violation of antitrust regulations, RESPA Section 8, and numerous other regulations designed to protect consumers from collusion, false advertisement, and anticompetitive practices. Consumer brokering is not a legal business model, regardless of any “clever” justifications behind it.
An online marketplace is merely a tool to effectively meet and negotiate between users. A marketplace doesn’t offer a service, instead, a marketplace offers an end-to-end independent and competitive experience for a particular vertical or a set of verticals within the industry. An Open Real Estate Marketplace™ is the next disruptive innovation since Trulia and Zillow have opened the MLS to consumers. This type of marketplace is a novel and unique independent information source driven by network effects - not commissions, or real estate speculation fees. Each sale that originates via an online marketplace is the direct doing of the users themselves, where the marketplace only acts as a vehicle to bring parties into a competitive environment.
A successful marketplace requires to operate in a fair playing field. For example, if a massively funded real estate referral fee networks, like Opendoor Brokerage, can price-fix services of real estate agents in the market due to mega influence, a competitive marketplace becomes unnecessary – services that are price-fixed for consumers do not need independent negotiations. In the United States, price-fixing is illegal because it is an uncompetitive behavior that helps grow companies into monopolies and prevents healthy free market economy forces. An Open Real Estate Marketplace™ helps consumers and agents to restore fair negotiations principles in the housing industry as a disruptive innovation.
An Open Real Estate Marketplace™ that serves 147,000,000 households in the United States is not a planned enterprise. It is incredibly difficult to plot for the development and operations of this entity because it does not function the same way everything else functions in real estate – mainly, it doesn’t collect fees from transactions. An Open Real Estate Marketplace™ is also a potentially devastating threat to mega-funded companies that operate on high commissions, high commission rakes, and high transaction equity losses via home-flipping. Once established as a widely used platform, an Open Real Estate Marketplace™ is built to entice real estate agents to directly compete for consumers, it is able to actionably break up pay-to-play in the industry, to lower the cost of housing and make buying and selling homes a transparent and open experience. This is what disruptive innovations are capable of – to push aside the status quo.
In my recent letter to the US Department of Justice and the Federal Trade Commission, I wrote about the why I believe Redfin harms competition, but this is what to company thinks of their referral fees practices, taken verbatim from their 2018 Annual Report:
“Referring customers to our partner agents or other third parties may harm our business. We refer customers to third-party partner agents when we do not have a lead agent available due to high demand or geographic limitations.”
“Our dependence on partner agents can be particularly heavy in certain new markets as we build our operations to scale in those markets. Our partner agents are independent licensed agents affiliated with other brokerages, and we do not have any control over their actions.”
“If our partner agents were to provide diminished quality of customer service, engage in malfeasance, or otherwise violate the laws and rules to which we are subject, we may be subject to legal claims and our reputation and business may be harmed.”
“From time to time, we may enter into similar arrangements to refer consumers to other third parties when we are unable or unwilling to serve those consumers directly.”
“Our arrangements with third parties may limit our growth and brand awareness. For example, referring customers to partner agents potentially redirects repeat and referral opportunities to the partner agents.”
“Any third-party arrangements may also dilute the effectiveness of our marketing efforts and may lead to consumer confusion or dissatisfaction when they are offered the opportunity to work with the third party rather than us.”
“Partner revenue consists of fees partner agents pay us when they close referred transactions, less the amount of any payments we make to customers. In December 2017, we stopped giving any portion of our referral fee to the customer.”
In a way, Redfin has already disrupted itself with consumer brokering and price-fixing practices, but the company has yet to admit that it has harmed the real estate market and consumers.
When real estate brokers begin to utilize consumer brokering and price-fixing practices as a way to form a “marketplace” experience, they ask for three things: undeniably poor user experience, plausible action for antitrust violations, and a full force of disruptive innovation set against them.
Technology companies alone must deliver competitive network effects and build a superior user experience into a residential real estate end-to-end marketplace. Licensed real estate agents absolutely can and should focus their efforts to utilize the Internet as a way to produce sustainable innovation and offer better consumer representation experience with improved service and lower fees. At the same time, no actively licensed real estate agent is able to legally develop a referral fee network, or a marketplace, without subjecting the entire process to market allocation, collusion, price-fixing, or consumer brokering.
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