Posted on February 6, 2020
I previously discussed how The Cap-Ex : Op-Ex Conundrum is the foundational issue that keeps the building industry from innovating. The planet is still on fire, and the real estate industry (broadly) is the biggest single contributor to the carbon footprint. Innovation can solve this problem, but it hasn’t happened yet.
But what type of innovation are we talking about, here? According to the Harvard Business Review, there are four types of innovation: basic research, breakthrough, sustaining, and disruptive innovation (RIP Clay Christensen). I am not going to dig deep into each type of innovation, but rather focus on sustaining innovation.
Sustaining innovation. Most innovation happens here, because most of the time we are seeking to get better at what we’re already doing. We want to improve existing capabilities in existing markets, and we have a pretty clear idea of what problems need to be solved and what skill domains are required to solve them.
For these types of problems, conventional strategies like strategic roadmapping, traditional R&D labs, and using acquisitions to bring new resources and skill sets into the organization are usually effective. (Greg Satell, 2017)
Problems and domain tend to be well defined in the real estate industry, so we can see that sustaining innovation applies here.
But a real estate owner/developer goes through what I call a Rich-Poor cycle on the cap-ex side. This cycle makes it difficult for sustaining innovation to occur. There’s clearly a middle state as well, but for the purpose of breaking the problem statement down a binary approach creates clarity.
The Rich Phase is when a real estate owner/developer has a defined project. Budget, schedule, and scope are set. They have a project to get done, and they have a lot of money to get it done. Back when I worked at Gehry Technologies (yes, Frank Gehry — the only topic I never write about), we were consulting on a large corporate campus in Cupertino. It was a multi-billion dollar budget being managed by a fairly young team. (How many 20–30 somethings do you know that manage $250M+ budgets on any given day? It’s actually super common in construction/real estate management.)
This is when I came up with the idea of the “micro-economy of projects.” A single real estate project creates a discrete economy. During the duration of that project, people have jobs, restaurants in the area are packed, and parking garages are full. Hence the Rich Phase. During the Rich Phase, the real estate owner/developer has the most money available to them. They also are at their highest point of risk aversion. Why? Well, they have a schedule. Inserting anything unproven can put the schedule at risk.
So the Rich Phase can afford plenty of research and development, but has no room for any type of risk. Any potential research and development must be funded within the contingency budget of the project and must be implemented during the schedule of the project. This really limits the amount of innovation to commercially available technologies provided by larger vendors. The maximum risk is that we “have never used them before,” but it looks like everyone else is using them. Oh, the possibilities…
The Poor Phase is when the real estate owner/developer has the least money but the most time. In most cases, the real estate owner/developer is trying to identify and prioritize their next projects. They have the time and space to contemplate innovation and how they could do something better on their next project. However, since they have no project, they have little to nothing in the way of research and development budgets. If they come up with a game-changing idea, they lack the ability to test it or execute it.
In this setting, risk tolerance and money are inversely proportional. I am most risk-tolerant when I have no budget to take risks, and I am least risk-tolerant when I have the most budget to take risks. If you walked around the head of a real estate owner/developer, you would see them cycling through these phases. This is the cap-ex side of the real estate owner/developer.
When the project is complete, the project is handed off to the op-ex side of the house. Hopefully, the op-ex side is managing a project that is profitable. While they have a great operating budget, they do not have a research and development budget. They can only apply new technologies that have an immediate impact. The investment must be absorbed by the cash flow of the project, so the ROI cycles must be short.
So essentially there is no money or time for any level of sustaining innovation in either cap-ex or op-ex. I was told yesterday that the company that solves this problem will be worth a lot of money. Guess what? The good news is that I have a solution! The bad news: I am not sharing it with the masses currently. Let’s just say it is our secret sauce for now.
If you want to learn more about this, I would love to chat about it. However, I probably won’t share my solution with you just yet.