From assets to access: the servitisation of the supply chain

For example, large asset manufacturing companies have been used to making and selling big, complex pieces of equipment, often giving away the service contracts to secure the sale. And then they celebrated this sale, despite the fact that the lifetime value of the service contract they had given away was worth as least as much, if not more, than the tool itself. However, radically changing markets, an increase in competition and the resulting erosion in profits are forcing organisations to offer more to their customers than just the sale of a product, such as extra services. They are now considering how they can solve their customer’s long-term problems, rather than focusing solely on a one-time transaction. They are spending time evaluating and engaging with their customers’ operations to establish how they can add long-term value. They are embracing the concept of servitisation.

The word servitisation first appeared in a 1988 article entitled ‘Servitization of Business: Adding Value by Adding Services’.[i] However, it never really took off. This changed with the arrival of the digital revolution. A combination of the internet, 4G and cloud computing enabled digital goods such as software to be sold on subscription; as a service that can be distributed and updated remotely. Businesses no longer needed their internal IT department to take huge risks on infrastructure and spend inordinate amounts of time and money maintaining and updating a multitude of different pieces of software and related licenses. Instead they could now pay a monthly or annual subscription to gain instant access to the latest version of this software.

Media soon became the second industry to embrace the servitisation revolution that this digital revolution enabled, allowing subscription- based access to music via Spotify or movies and TV shows via Netflix. Companies that continued to stick to old model where the customer had to come to them in order to buy or rent movies, music and games – such as Blockbuster or HMV – saw sales disappear and bankruptcy beckon. They seemed surprised to find out that the customer was not a fan of last-minute panic trips to return their rented games and videos before incurring late fees, or of having shelves that were full of unattractive CDs, DVDs and video games. The planet was also eternally grateful for this shift, seeing a dramatic drop in the amount of excess or unwanted electronic media being buried in landfill sites.

Now, 32 years since the servitisation concept was conceived, the concept of selling access to solutions rather than selling assets and products has become established across numerous industries, creating what has become dubbed as ‘the sharing economy’. As well as software and media, now you can get most aspects required to run the most modern of businesses as a service, as follows:

• Logistics as a service (LaaS)
• Space as a service (SPaaS)
• Transportation as a service (TaaS)
• Manufacturing as a service (MaaS)
• Supply Chain as a Service (SCaaS)
• And many more

This new business model reduces the high overheads that previously prevented new entrants or start-ups from being able to make any headway into an existing market. In many cases, it flips the situation on its head, allowing agile new start-ups to avoid the costs associated with these overheads, such as expensive rentals, long-term IT contracts and costly manufacturing assets – plus the extensive upgrade and labour costs involved in undertaking updates and regular maintenance. Now, new agile start-ups simply hire what they need for as long as they need, sizing to fit their requirement and budget and simply scaling up when required. Also, this ability to rent capabilities prevents each company from having to spend significant time effectively replicating their development, leaving them free to focus on developing their unique selling proposition. In a recent example, Amazon spent ridiculous amounts of R&D cash in developing its ‘just walk out’ technology that underpins its new, cashierless, Amazon Go stores. It knows that its large competitors will struggle to match that investment, and smaller stores have no hope of being able to develop it. But it also knows that customers will use these ‘just walk out’ stores given the choice. So, it now offers this technology as a service, allowing even independent retailers to take advantage of this tech, changing the entire shopping paradigm whilst also providing Amazon with an enormously lucrative new business model.

Space as a Service

One of the markets that is set to change dramatically due to the servitisation movement is property, both personal and commercial, through the provision of Space as a Service (SpaaS). SpaaS refers to space that is procured on-demand, whether by the hour, day, week, month or year. While people are familiar with the sharing economy’s entry into the personal property rental via companies such as Airbnb, and personal storage via companies such as Clutter, its impact into the B2B world and the Commercial Real Estate (CRE) market has been less pronounced – until now.

The CRE market covers everything from the rental of office spaces to logistics parks and retail outlets, and the rise of SpaaS offerings is consider part of the PropTech digital revolution. Fig 1: below shows the PropTech sector breakdown in Europe as of August 2019.

SpaaS represents a paradigm shift in the way in which the commercial real estate industry has provided products and services to tenants, transforming the role of commercial landlords from rent collectors to service providers.  It also requires CRE companies to not just understand the space they are selling, but to really understand their customers and what their ‘job to be done’ is. For SpaaS represents a customer-centric revolution in real estate, requiring lenders to provide the spaces and services appropriate for the ‘job to be done’ of not just every company, but also the employees that work within them. That entails everything from providing digital connectivity to furniture, fixtures and even the staffing required to operate their businesses.

A changing market

The marketplace for both office work and retail has changed dramatically over the last decade, and events such as the COVID-19 pandemic has rapidly accelerated this transition. The world of office work has been transforming from one where desks are lined up in rows and everyone is in their cubicle doing structured, repeatable, predictable work, to one designed around the aforementioned ‘job to be done’ concept. This means providing spaces designed for quiet work, collaborative work, reflection, reading, resting, and remote events and workshops that require teleconference capabilities, podcasting rooms or video and / or music studios. There is also a transformation in the size of the companies that require these spaces. While larger employers have been struggling, smaller, more entrepreneurial start-ups are flourishing. In the UK for example, 40% of employees work for companies that employ over 250 people, 48% work for those employing less than 50 people and just 12% for companies between them. In the US this transition is more defined, as only 23% work for companies that have over 500 employees. Since 2010, three-quarters of all new jobs in the US have been created by companies with under 500 employees, and currently 77% of all employees work in those companies, with 41% working for organisations with under 50 employees. Smaller companies have different requirements to larger ones, requiring more spaces for brainstorming and creativity and less desks to house administrative staff. Flexible working has increasingly been becoming a defining characteristic of the 21^st century workplace; a movement that received a massive shot in the arm due to COVID-19 as companies realised that new telecommunications technology enabled their workforce to operate effectively without being in the same physical space. Suddenly their prime location office lease looks more like an expensive luxury than an essential requirement.

These shifts have all had a profound effect on both the size of space required and the tenure. In London, for example, there are only 205 companies that employ more than 250 people. As a result, 70% of all occupied units are less than 10,000 square feet and fully 50% are less than 5,000 square feet. Lease length has been shortening for the last 20 years, reaching an average of just seven years in the UK, and 75% of UK occupiers vacate their premises on a lease break. Given the predominance of smaller firms and start-ups, and the fact that sub-5,000 feet units make up 50% of the London office leases, then one could assume that given the right product/service offering, most of those smaller operations would be delighted to off-load the responsibility of running their workspace so they can focus on growing their business. Which probably explains why London has become the European mecca for the PropTech industry, with 805 of the 3,219 European PropTech companies located there. 

From malls to marketplaces

In the retail world, the decline of the high street and the closure of the malls that people have thronged to since the 1980s has been caused by the rise of eCommerce, and at the time of writing we are not sure what how bad the devastation will be on this industry by the pandemic. Yet before the market struck, transitional changes were underway to transform retail spaces from a place for big name stores with long leases, to a more flexible space with more flexible terms. For example, a SpaaS concept known as ‘Brandboxing’ has emerged that is transforming the traditional retail model by applying the changes happening in the office space into the retail market. The provision of new services such as all-inclusive setups, flexible terms and contracts make this concept appealing for new, smaller, more digitally native retailers, who wish to test and scale their products in a physical environment but don’t wish to be tied into prohibitive, multi-year leases or high rents. The retail spaces are often modular in design and come complete with prefabricated plug-and-play technology and utilities including Wi-Fi, retail analytics, POS systems, security tags and cameras, storage for inventory, and even break rooms. Thus, they are both all-inclusive and fully flexible, able to be rapidly re-positioned to suit a brand’s image and messaging. Brandboxing lowers the barriers to entry and makes it easy for online merchants to scale and test the success of the brick and mortar stores without having to procure a permanent location. This has the potential to turn high streets and malls into a thriving marketplace of small independents, allowing towns and cities to develop different and constantly changing retail offerings, rather than just being boring replicas of each other.

Warehouse spaces

The SpaaS movement is also making its way into the logistics real estate business. The continued growth of eCommerce means that there is an increased need for fulfilment centres, and the need for rapid delivery means that this needs to be near the customer base it that services. However, customers are also reluctant to pay more for faster deliveries, with 54% opting out if additional shipping costs are added. To help profitably service this new requirement, companies such as LogistCompare and StockSpots have emerged to offer what has been called ‘the AirBnB of warehousing’, an ‘on-demand’ service designed to allow retailers to search, compare and book logistics space instantly. LogistCompare has a network of over 2,000 warehouses scattered across UK, while StockSpots currently covers most of Western Europe, and has plans to expand into Eastern Europe, starting with Romania, Poland and The Czech Republic.[iv] The idea behind these platforms is relatively simple – allow logistics operators to rent out their unused capacity to customers looking for temporary or long-term storage space, enabling them to make money from existing assets. StockSpots believe that currently more than 30% of all storage space remains unused – space which they want to people to book through their online platform, with full visibility of any additional logistics services supplied by the provider. This allows users to create their own ‘on-demand’ warehouse networks that can scale up and down as necessary.

The demand for flexible space provision comes from various scenarios, the first of which is the ability to cost-effectively meet excess seasonal demands and inventory peaks, especially at Christmas when most eCommerce retailers experience upwards of 30% increase in demand. Currently, retailers absorb the costs of this needed capacity all year round, but now the SpaaS model enables them to offer the unneeded capacity for rental during the first two quarters, or reduce their permanent space overheads, safe in the knowledge that they can rent this additional volume when they need it, for as long as they need it. There is also the increasing need for retailers to have physical inventory closer to their customers to improve lead times, provide multiple returns or after-market storage locations, or simply to have access to overflow capacity as and when required. Other reasons include the desire for retailers to manage growth and enter into new markets without making extensive capital outlay when future demand is uncertain.

Measure what matters

For commercial real estate landlords, regardless of whether they are in retail, office, logistics or multi-unit markets, the transformation to SpaaS will, over the next few years, change the fundamentals of their business; moving from providing real estate to providing service, experiences, flexibility, data and branding. The value and success of CRE landlords will become increasingly dependent on their ability to build effective ‘user experiences’ (UX) centred around their physical assets. Creative use of tools such as data analytics, the IoT, and digital twins will enable a better understanding of their occupants and how they engage with the facility they are using. Rental values will become associated not just with the location, but also the tenant experience and level of comfort, hence the sudden rise in development of smart building apps designed to enhance the occupant experience, build communities, and create unique experiences.

One of the things that will therefore change over time will be the measures used to determine an assets value. Elements such as flexibility, productivity, wellness and sustainability will increasingly become important to tenants, factors considered when determining the value of a location. Is the asset capable of being constantly adapted? Does it enable the tenants to successfully complete their ‘job to be done’? Is it space that helps people be productive? Does it provide a healthy environment? Is it sustainable long-term? Given what’s measured is managed, successful CRE companies will increasingly become those that adapt their internal measures of success to match those the this new, service-focused, customer values. Changing these metrics is perhaps the quickest way to change mindsets – which is often the barrier to change in most organisations.

Space race

Money is pouring into the PropTech industry, and a whole host of start-ups have formed across the continent desperate to grab pole position in this race to exploit the new opportunities.  The below graphic shows the best funded PropTech startups in Europe in February 2020.

According to German PropTech investment fund Proptech1 Ventures, €77 million was invested in PropTech in 2014, but that rose by 550% in just five years to around €500 million.[v]  This investment is likely to accelerated, not diminished, by the COVID-19 pandemic. Before the pandemic most of the European money poured into the UK, with US$821 million raised so far, with Germany the second biggest receiver of funds, followed by France. New financing vehicles have even been developed to take advantage of this flourishing new sector, such as  A/O PropTech , which is a new European VC that launched in February 2020, which raised €250 million of ‘permanent capital’ to invest in technology companies that have a mission to disrupt real estate. Their investors are some of the largest institutional real estate companies in Europe, who together hold a pool of residential, commercial and hospitality assets. PropTech companies that receive A/O PropTech backing can leverage these assets as a sandbox to test, pilot and “fast-track the commercial and operational scale” of their offerings.[vi]

Analysis by Unissu shows how the largest area of focus for these PropTech developers is in the management of spaces, with more companies focusing on developing digital tools to optimise the space management than there are on the acquisition and renting of it. This ends to support the previous observation that the tenant experience is the key area of focus to this sector.

Fig 4: PropTech Lifecycle breakdown in Europe as of August 2019. Source: Unissu.

While it may have devastating effects on the economy and real estate in the short term, the COVID-19 pandemic may prove to be the catalyst for more investment and tech adoption. For COVID taught companies that they don’t need massive, expensive real estate, and their teams can remain effective remotely. Instead they need space as and when they need it, and thus need these spaces to be flexible and scalable – both up and down. As a result, countries where commercial real estate companies have so far shown little interest in SpaaS, may find that post-COVID, customers request to know what offerings they have in this space. There is therefore the opportunity for countries that do not appear on the above chart, specifically the CEE and southern European market, to start to consider how they will adapt their offerings in preparation for this eventual shift.

Post-COVID, attention will also go back to issues that have been side-lined so far in 2020, specifically climate change. One thing we learnt from COVID-19 is that laws, regulations, and measures can be enacted ‘overnight’ if the cause seems urgent enough, which will encourage activists to renew their pressure on governments to take climate change as seriously as they took COVID. This may prove a bonus for areas such as Scandinavia in which the PropTech market is currently small but primed to grow. Countries such as Sweden, Denmark and Norway may become much more attractive as sustainability and climate control issues become more prevalent, as these nations have real estate industries that take climate control seriously. When the rest of the world finally tries to play catch up, they may be looking towards Scandinavia for much-needed help. 

Conclusion

The next decade will bear witness to a paradigm shift in the way commercial real estate is designed, built, occupied, managed and valued. The industry will, over time, transform to become much more service-focused and centred around the total user experience and not just the location, providing tenants with greater community- and productivity-based amenities and services. As this transition occurs, and the nature of the industry’s customers and competitors changes, more attention will be given to technology and its ability to help monitor, manage and enhance the tenant experience. CRE companies will therefore also look to take advantage of the servistisation movement, renting on-demand, ‘as a service’ offerings to provide new and exciting services to their clients, ranging from warehouse automation systems and manufacturing robots, to analytical tools and smart lighting solutions. These tools will go through a technological acceleration post-COVID, providing new and exciting ways to enhance the real estate industry for landlords and tenants alike.