Pricing a home is hard. Why? A house rarely trades, has imperfect comparables, is subject to supply and demand forces that are often unpredictable, and relies on agents who have asymmetrical information and act as gatekeepers to aid in home discovery, pricing, and closing.
Zillow launched in 2006 to disrupt this system by providing consumers with price transparency and home discovery through their “Z-estimate” technology, and charging agents for customer leads. While the website proved to be incredibly powerful in providing discovery for consumers and lead generation for agents, the product did not change the fundamental nature of the transaction process between the home buyer and seller, as agents remained the gatekeepers.
In 2018, Zillow Group launched Zillow Offers, a service that allowed for users to buy and sell homes directly through Zillow without agents involved in the transaction process. Zillow Offers eventually grew to become the company’s largest revenue channel with a reported $1.7 Billion in 2020. In Q3’21, Zillow halted Zillow Offers.
In the following sections, we examine Zillow Group’s decision to enter the iBuying space. We assess the company’s position before and after the addition of Zillow Offers. We do so utilizing the frameworks of: (1) “Jobs to be done” as we look at who Zillow’s “Best Customer” is; (2) “Low End Disruption” as we analyze Zillow’s core services for their best customer; (3) “New Market Disruption” as we break down Zillow’s entry into iBuying; (4) “Profit Formula” in assessing Zillow’s core business model in comparison to their emergent iBuying business; (5) “Resources, Priorities, and Processes” as we analyze Zillow Group’s organizational readiness to execute both an agent-centric lead generation business and a consumer-centric iBuying model simultaneously; then we will use both (5) “Schools of Experience” and (6) “Role of the CEO” as we assess the leadership team and their decisions in establishing the priorities for the organization in executing the emergent strategy. Lastly, we conclude with recommendations for Zillow Group as they move forward in 2021 and beyond.
“Job’s to be done” and Zillow’s Best Customer: The Agents
Zillow performs a functional job for consumers by providing a convenient way to discover throughout the buying, selling, renting, and financing process. The convenient price transparency that Zillow.com provides also performs an emotional and social job, acting for some as entertainment and for others as reassurance. With that said, Zillow’s monetization strategy addresses the jobs-to-be-done of real estate agents. As suggested in the Jobs Module note, we’ll focus on understanding first on how agents make money.
Agent’s profit formula begins by acquiring customers. Prior to Zillow.com, local agents largely relied on word-of-mouth and expensive means of marketing, such as local print advertisements, radio or TV commercials, signage, and SEO optimization support for their websites as noted before. Online, agents typically created their own websites or used a website provided by their brokerage. However, agents were limited in their ability to optimize SEO and digital marketing themselves, and instead, racked up expensive and unsustainable costs.
Agent’s then provide value by creating value for buyers and sellers, a service they are paid for when the transaction closes. This begins by scheduling walkthrough, researching local demand, comparing properties along certain qualitative and quantitative, and forming a valuation. Agents typically then meet with the buyer to understand their tastes and preferences and find potential properties from local listings that fit their needs.
Before closing, the job of agents is preparing the paperwork. These jobs include drafting contracts, helping with escrow documents, and any disclosures for lawyer review. Agents may also help facilitate inspections or repairs and facilitate the mortgage process. In short, the agents have many functional jobs and coordination responsibilities. The operational efficiency in completing these jobs to get to closing is an important input into their profitability formula.
Finally, agents perform an emotional job for consumers. They provide buyers and sellers reassurance that they made a good decision. In many ways, agents are in the customer relationship and affirmation business: They provide a trusted voice when assessing the pros and cons of deals and provide consumers satisfaction with their final choices. They rely on the currency of trust to create word-of-mouth referrals, creating a flywheel effect in their business model.
Zillow’s business model is centered around providing a suite of products to create operational leverage for their best customer, the agents, and by providing solutions that simplify the most functional ‘jobs to be done’. Zillow’s “Premier Agent” product provides agents with lead generation, digital marketing, and a CRM to further assist them in their job-to-be-done of customer acquisition (See the section titled “Low End Disruption: Zillow disrupting the way agents do business” below for further details).
To complement their Premier Agent services, Zillow introduced Zillow Closing Services to address the next series of jobs to be done by agents. In addition, Zillow purchased Hotpads (acquired in 2012, $16M) to expand the size of Zillow’s rental audience, Streeteasy (acquired in 2013, $50M) to further penetrate the New York City market, and Trulia, Zillow’s largest competitor (acquired in 2015, $2.5B) to improve Zillow’s data and product portfolio. These acquisitions effectively purchased consumer attention, which they monetized by providing agents a larger pull of potential customers. In addition, Zillow aimed to create more services for agents, a strategy they executed through a series of leverage your business (LBM) acquisitions. These acquisitions included Mortech (acquired in 2012 for $17M), DotLoop (acquired in 2015 for $108M), Bridge Interactive (acquired in 2016), and Showing Time (acquired in 2021, $500M), which together enabled Zillow to offer agents transaction management, document tracking, showing management, and compliance solutions (See Exhibit 1).
Overall, up until the launch of Zillow Offers in 2018, Zillow Group executed a product strategy focused on adding customers to the top of the funnel and executing the jobs-to-be done for agents, clearly demonstrating their commitment to agents as their best customer.
Low End Disruption: Zillow disrupting the way agents do business.
Zillow created a low cost, customer acquisition solution by “owning” the top of the customer funnel and qualifying leads. In fact, roughly 200 million consumers a month visit Zillow’s websites. To filter these visits to leads, Zillow pushes agents’ leads based on Zillow’s impressions data. Ultimately, agents who use Zillow are reported to experience 2 times more closings than agents who don’t, and experience a 260% ROI. Together these advertising solutions reduce the overall advertising cost for agents. Effectively, Zillow competes in the real-estate advertising market along the performance dimension of cost-to-acquire a customer.
Together the low cost of advertising and lead generation offered by Zillow provide an agent experience that may still not be good enough for top tier up-market brokers, who have the means to fund sophisticated advertising, CRM, and SEO optimization, but is “good enough” for lower market or mass market real-estate professionals. By providing these low cost tools to agents who were being overserved at a higher price point for these services, Zillow executed a low-end disruption strategy in the agent services industry.
New Market Disruption: seeking non-consumption customers in sellers and buyers.
In 2018, Zillow launched “Zillow Offers,” a business who’s position relied on the consumer as their “best customer.” Management felt Zillow Offers was a chance to “unstick” sellers by offering a trustworthy and convenient “sell-now” option. In doing so, they aimed to target non-consumption from potential sellers along jobs or functional and emotional performance dimensions of convenience, trust, and speed.
Management entered this market largely due to its seductively large size. The TAM for U.S. real estate related advertising is $19 billion while the TAM for annual home sales is $2.2 trillion, “which we [Zillow] participate directly through buying and selling homes through Zillow Offers as well as through Zillow referred transactions, facilitated by our Premier Agent partners,” according to Zillow’s 2020 annual report. Zillow Offers expanded Zillow’s TAM by over 115 times, which helps explain why Zillow, in the words of CEO Rich Barton, may have chased “down the funnel towards the transaction” to “win the race for online real estate 2.0.”
In the process, Zillow Offers risked displacing agents, Zillow’s current “best” and most profitable customer. Management suggested on CNBC this was not the case. In 2018 CEO Spencer Rascoff explained, “We think this [Zillow Offers] is additive to the core, the Premier Agent advertising business..most people are not going to accept the offer we make for their home. Most people are going to want to sell their home conventionally and when they do we will hand them off to a Premier Agent. So it actually enhances our core business while opening up new opportunities.” However, if consumer preferences have changed and consumers truly do want “magic to happen with the press of the button” as Rascoff also explained, it may follow that at scale Zillow’s value proposition to the Premier Agent would be inversely related to the success of Zillow Offers.
Profit Formula: From asset light high margin, to asset heavy low margin.
Within the Internet, Media and Technology segment (“IMT”), paid advertising impressions and leads generation from its premier agents and other real estate professionals comprise the majority of Zillow’s operating profit. Advertising revenue is in part a function of website traffic, which reached 245M unique users and 9.6B visits to Zillow’s websites and mobile applications in 2020. Zillow’s IMT segment reports above 90% gross margin with an 18% CAGR from 2015 to 2020. In total, Zillow’s Internet, Media, and Technology (“IMT”) segment comprised 43% of 2020 revenues and 85% of Zillow’s total gross margin. In Q1 2021, Zillow’s operating margin entered positive territory (See Exhibit 2).
Overall, the reinvestment of the IMT cash flows into the iBuyer business beginning in 2018 has prevented group level profitability. Gross margins for the iBuying business varied between 4–9% through Q2’21. Margins decreased to (20)% in Q3’21, which represented a loss of $236M before considering overhead in one quarter. Zillow supported home purchases through a revolving credit facility, which altered their balance sheet profile significantly. As of Q2’21, Zillow held $1.1B of inventory on their balance sheet up from 491K 6 months earlier, supported by a $987K drawn balance on their revolving credit facility and an additional $554K of class C capital stock. In short, the low-margin iBuying business was initially profitable and competed in a large addressable market. The advertising business competed in a much smaller market, but was highly profitable and growing. Management attempted to straddle the two positions, but ultimately failed because of a misalignment between their resources, processes and priorities which prevented their ability to serve agents and sellers simultaneously as their best customer.
Resources, Processes, and Priorities / Role of CEO / Schools of Experience
Resources:
Data has arguably been Zillow’s most valued resource. To create Zillow’s first version of the Z-estimate, Zillow partnered with various media outlets across the country to develop insights on housing prices and combined these sources with other real estate data. With over 15 years of data, Zillow entered the iBuying space. In doing so, management assumed they could adequately price homes today, purchase these homes, and sell them 6 months in the future to collect a spread of about 4–5%. Due to the slim per unit margins, scale was required for bottom line impact, but accurate prediction was also essential to prevent significant losses. However, according to Zillow Group’s 2020 annual report, the Zestimate has a “median absolute percent error of 1.8% for homes listed for sale and 7.4% for off-market homes.” Therefore, when assessing the margin profile of 4–5% in conjunction with the error rates of 1.8–7.4%, it at least appears that Zillow’s data resource is barely good enough to execute the iBuying model if they proceed cautiously.
In addition to data and adequate pricing Zillow would have needed to acquire the following key personnel to execute an iBuying strategy. First, Zillow needed a CEO committed to executing a new market disruption business model inside an organization executing sustainable innovation. This requires a CEO who understands both business models, including the inherent conflicts, differences, and synergies between them and a full commitment to executing both. Zillow’s Co-Founder and CEO, Spencer Rascoff, seemed originally committed to doing so.
When faced with the “make-or-buy” decision to obtain the new capabilities to support the iBuying operation, Rascoff elected to bring into the company real estate operations experts to develop the capabilities required to do so. He recruited the leadership team from Colony America Homes, which was a rental property firm that successfully acquired 35,000 homes during the recession to flip them and eventually became one of the nation’s largest institutional buyers and renters of single family residences. In doing so, Rascoff appointed three key executive positions for the newly recruited talent. Arik Prawer, who previously led Colony’s growth and integration in a prior merger, was appointed President of Zillow Homes to oversee all of the Zillow Offer operation. Supporting Prawer in the field development and operations was Josh Swift, who was tasked with building out the house flipping processes at Zillow. Lastly, as Zillow continued to grow and experiment, they also formed banking relationships to obtain revolving lines of credit to fund the business. With their data and technology, Rascoff’s support and new team, and balance sheet ready, Zillow felt capable to start experimenting with iBuying. Of these resources, we view their data and current technology as their weakest resource, which they would need to improve as part of their process.
Processes:
To execute, Zillow would need to create a new process to predict home prices. Prior to Zillow Offers, the Z-estimate team only focused on daily price accuracy, not price predictions. Similar to banks, Zillow would need to create a “scorecard” to predict the future price of each home. The “scorecard” process would look as follows: an algorithm based on proprietary and third-party data creates an initial pricing — this price may include a confidence interval. Next, the scorecard would be reviewed by a central pricing team. This team reviews the pricing score and executes a checklist that provides an additional level of quantitative and qualitative pricing assessments. A home inspector would also be required to assess the final details of the home against a checklist. Maintenance and repair teams would need to be hired for any required updates. Walkthroughs would need to be reperformed. Based on the sum of these processes, the pricing team would sign-off on a final price and extend an offer. Zillow may create an internal audit process to standardize and audit the process overtime to maintain a level of internal controls. A risk management team would be required to assess balance sheet risk relative to market risk, interest rate risk, credit risk and other factors. Zillow would need a regulatory and compliance team to understand, comply with, and file the required regulatory filings. Finally, Zillow would need to create a separate sales and marketing organization with different incentive structures to facilitate sales in line with the business’s risk and profit formula and to reflect the reality of the competing interests and perhaps cannibalization effects of the two businesses.
While this process may seem mechanical, establishing and executing these capabilities is incredibly difficult given the slim margin for error. Local market factors may affect the precision of the algorithms, but also would significantly stretch the capabilities and capacity of the centralized sales, pricing, and risk teams. In addition, home inspections and repairs may not be good enough to assess key issues that affect a home price.
Meanwhile, Zillow assumed they could decrease all of these risks through quick turnaround times between the buy and sell. They targeted a maximum turn time of 90 days. However, the overall process was highly labor intensive, exposing them to duration and market risks, not only in the housing market, but also the labor market. These independent risk factors together have the potential to compound error rates, especially when the future reality is “out-of-sample” from the past data, meaning it does not apply to the current situation. We believe Zillow’s process was not good enough to execute this process given the confounding risk factors and slim margins for error inherent to the business model.
Priorities/ Role of CEO/ Schools of Experience:
To establish priorities, the “Role of the CEO” is critical. The CEO needs to provide a level of oversight, patience, and coaching to enable the emergent strategy process to occur separate from deliberate strategy within the core business. At the start, Zillow Offers required an autonomous team to execute disruptive innovation, helping Zillow experiment and establish the iBuying business model and go-to-market strategy. However, as the framework for organizational design would suggest, as this model scaled, managing the relationships between functional units required a heavyweight team approach to resolve the “unpredictable interdependencies” between the now established functional units. Fortunately, Zillow was experimenting with iBuying while their core business model had “substantial, profitable sustaining potential.” This allowed Zillow Offers the opportunity multiple years to build their processes and experiment with real sales.
Within the new business model, Rascoff also made trade-offs, especially when creating the right “Schools of Experience.” For instance, they strategically made the decision to hire Arik Prawer and the team from Colony Starwood homes to create an organization that better “fit” the task of buying residential real-estate. In other words, he focused on finding players who had track records of executing specific functions as opposed to latterallying over internal talent and allowing these team members the time needed to develop to execute each task. This decision traded cultural risk for functional expertise. However, critical to the execution of the iBuying machine was the previously mentioned interdependencies between teams. Originally, these team members would need skills to take the business from zero to one, but overtime heavyweight teams would be critical for reducing the risk between teams and processes as the organization developed. Simultaneously, Rascoff would be challenged with flexing his level of oversight to allow his team to execute a labor intensive, scale-oriented business model. At the exact moment when the risk of the business inherently increased the most as Zillow’s acquisition process added inventory quickly to the balance sheet, Rascoff’s influence over the process was at its lowest.
What is Next for Zillow Group?
Zillow decided to wind down Zillow Offers in Q4 2021 with plans to cut the labor force by 25%. Despite what appeared to be a team with the right “schools of experience” and resources, the processes failed. Management explained their process failed to take into account the turn time to flip a home. Relying on various 3rd party contractors to help flip homes, proved unscalable, given the unique circumstances and renovations required for each home. Rich Barton noted a labor shortage in the market proved to slow down their turn process, which ultimately impacted their balance sheet.
Zillow’s exit from iBuying suggests Zillow is likely to retreat back towards their original “best customer”, whom they know well and have the experience and operational capabilities to serve in a unique way. In their Q3’21 earnings call, management explained this will include focusing on Showing Time, Zillow’s acquired show scheduling software, as well as continuing to focus on integration of Zillow Home Loans and Zillow Closing Services. In addition, management is exploring an asset-light marketplace model, other integrations and partnerships to help owners sell.
In short, Zillow is refocusing on their original business model: attracting consumers to their websites and creating offerings for agents in return for a fee. Due to the fact that the resources and processes are in place to execute this business model, we expect Zillow to continue to create and experiment within the bounds of this profit formula.
Unfortunately, Zillow took on too much risk at once with Zillow Offers because they didn’t have the right RPPs in place to support growth. The experiment proved highly unprofitable. However, even if Zillow could create the right organization structure to execute the strategy, we believe pursuing a new market disruptive strategy would have been difficult in the long-run for the following reasons: (1) The iBuying strategy competes away the job of Zillow’s “best customer,” the Premier Agent and (2) The strategy requires an entirely new profit formula and balance sheet structure, which public investors may struggle to support. In other words, Zillow failed quickly due to their processes and priorities, but we believe Zillow would likely have failed even in the long-run because of the inherent inconsistencies between the chosen business model to support the jobs of agents and sellers as “best customers” simultaneously. Similar to Charles Shwabb’s pivot to online brokerage, we believe Zillow only would have been able to execute the iBuying model at scale if they were also willing to eventually close their highly profitable agent supported business. Based on our research of management’s goals and because of additional competition in iBuying, we felt this pivot would have been highly unlikely.
Recommendations
As of November 2021, Zillow is in a crisis. Therefore, they need to have a short-term strategy to stabilize the company and long-term strategy to grow and sustain the enterprise. We’ll analyze this through the lens of the “Project Planning to Link Strategy, Innovation, and Resource Allocation Process” and an “Emergent vs Deliberate” strategy framework.
In the short-term the company needs to reinforce customer, employee, and investor confidence. This begins by refocusing on Zillow’s core consumer facing, Z-estimate product and investing in the Zillow brand. They then need to create better integrations among the agent products to enable the salesforce to cross-sell services to existing customers. The goal of these efforts are two fold: (1) Grow cash flow and (2) secure investor and employee confidence to create patience in the marketplace and company for new growth initiatives. A no growth scenario and constant margin profile (i.e. $500M revenue per quarter, 90% gross margins, $375M operating expenses per quarter), would result in about $75M in pre-tax profit per quarter. Armed with these operating cash flows in addition to the billions of dollars expected to be received from the offloading of their housing inventory, management will hopefully be able to re-establish the required trust with employees and investors to invest in new growth opportunities.
Next, Zillow needs to make strategic bets to create growth and sustain the enterprise. One opportunity is to use an emergent strategy process. From the iBuying experience, management realized it was difficult to not only predict future prices, but to operationalize preparing the home for a resale. Agents, Zillow’s best customers, also face this problem as delays to close affect their operational leverage and profit formula. Zillow could perhaps experiment with creating a labor marketplace that “unlocks” the talents of professional home stagers, home inspectors, attorneys, escrow officers, title insurance officers, and other professionals executing along the performance dimensions of trust and convenience. By allowing agents the opportunity to immediately connect with these trusted professionals on-demand, Zillow may be able to (1) improve the speed of closing for consumers, perhaps creating a flywheel that improves the brand of Zillow Premier Agents, (2) coordinate payments and collect fees across the transaction value chain, which prevents commoditization risk in executing a single component, (3) create a deeper and more tailored service through an emergent strategy process by understanding the vertical’s full process, and (4) support agents as the central point of consumer trust in the transaction process, their most critical emotional job-to-be-done, by creating a trusted network to support the coordination of the many functional jobs of the ecosystem.
Exhibits
Exhibit 1: Zillow Brands and Products
- Exhibit 2: Zillow Financials
Source: Company Documents
