iAsk research / If co-working space is a mistake in America, then why a success in China?
Sixteen years ago, the global giant eBay broke into the market in full swing, competing against the local company Taobao founded by Jack Ma. At that time Taobao didn't have a big market share but it joined the battle fearlessly.
Ebay began to block Taobao's marketing channels by buying out all the possible advertising space at twice the price.
In a situation that so intense, Taobao turned to the home of small webmasters which not only helped reduce the budget, but also gained sound advertising effect.
In the limelight of the exhibition site, eBay purchased all the advertising spaces. Nevertheless, Taobao put up their advertisement on the windows of the opposite building. "A silent war" has begun.
Since their entrance into the Chinese market, eBay adhered to the "subscription mode" whereas Taobao adopted the "free of charge mode".
After that, eBay was defeated because it didn't adapt well to the local market. With the vast expansion of Taobao, it overtook eBay by becoming the largest retail network in the world.
Over the years, more and more international pioneering companies lost their battles to our domestic emerging economic power, i.e. with the vigorous development of sharing economy, the global giant Uber exited the China market still; with business booming all around the world, Amazon's retail business had no choice but to leave China.
This time, the same story will be played out again in the co-working industry.
As an international pioneer, the image of WeWork collapsed in just six weeks.
Endless arguments now flooded towards the prospect of the co-working industry.
However, the battle between eBay and Taobao, as well as Uber and DiDi seems to remind us that China market has always been a distinctive one.
On this land, in the co-working industry, only those enterprises with strong vitality and combat effectiveness are likely to represent the future.
Due to different national conditions, the market increments of China and America are different.
The urbanization process and population flow trend determine the growth potential of the market size of the co-working office in both China and America.
Process of urbanization
From 1949 to 2019, 70 years were gone in a flash. But for Chinese people, great changes have taken place in the past 70 years.
In 1949, China's urbanization rate was only 11%, and the total resident population of all cities and towns was only 57.63 million.On the other side of the Pacific Ocean, American urban population has increased by 50 million in just 20 years after the industrial revolution in 1890.
According to public data, the urbanization rate of the United States was 83% in 2018. And the urbanization rates of some metropolitan areas were close to 100%. Now the United States is considered to be the country with the highest degree of urbanization in the world.
Whereas, the global average urbanization rate is only 54%.
In 2018, the urbanization rate of China's permanent resident population reached 60%, the number of which was only an equivalent to that of Britain in 1868, Germany in 1910 and the United States in 1945.
The urbanization process in China was decades behind that in the United States. But the growth rate in China is mind blowing.According to official data, the target proportion of China's urbanization level will reach 70% by 2025. With this speed, there will be more than 200 new cities with a population of over 1 million people in 2030, which means that 400 million people will move from rural areas to urban areas and that number there is equivalent to the entire population of the United States.In the long run, the trend of global population is to concentrate on large cities and megacities.
The population of China is 1.4 billion. However, we only have four megacities with over 20 million inhabitants and they are Beijing, Shanghai, Guangzhou and Shenzhen. The capacity of each city is limited.
None of them can accommodate 100 million people alone.
New urban residents will inevitably move to the second tier cities like Hangzhou, Chongqing, Wuhan, Chengdu, Xi'an where the next "super metropolis" will be born.
The "battle for population" has already kicked off in the major cities. In addition to Beijing and Shanghai, many other cities are actively encouraging population inflow.
In contrast, the urbanization of those developed countries has been completed. Thus, the population flow is slower and the stratum tends to solidify.
In the future, China will have the largest number of cities with a population of more than 10 million in the world.
Urbanization in the United States is almost at completion while that in China is still growing but at a high speed.
The large number of population represents the scale of consumer and service target that will generate a huge market for infrastructure construction and service capacity. And here comes the requirement of a large number of small and medium-sized businesses to meet the demand.
According to industry data, the market of co-working space in China has experienced rapid growth in the past five years. The market scale has increased from 1.2 billion RMB in 2013 to 17.4 billion RMB in 2018, with an annual compound growth rate of 72%. It will continue to grow with this momentum in the future, with an expectation to reach 132.3 billion RMB in 2023.
For the co-working industry, China's market demand will continue to expand with the development of the economy.
According to the statistics from Frost & Sullivan (hereinafter referred to as "Sullivan"), excluding the number of employees working in stores and non-desk industries, the number of people working in urban offices in China in 2018 is about 95 million. Based on the existing urbanization process, the growth space is very considerable.
According to Sullivan‘s data, our domestic co-working space only covered any area of 640,000 square meters in 2013. This figure now has increased to 8.94 million square meters in 2018, with a compound annual growth rate of 69%. It is estimated that in 2023, the space of co-working space shall reach 25.78 million square meters.
America is a highly urbanized country and the growth rate of co-working industry has slowed down. As can be seen from the chart below, the growth rate of the co-working market in the U.S. is far lower than that of China.
In 2018, more than one third (35%) of Americans were freelancers who made the main consumption force in the co-working market. The scenario is quite different in China.
In China, the most active customers are the SMEs, as well as the new dark horse businesses who are rapidly developing into large-scale enterprises.
SMEs have always been the main entity bearing the micro foundation of China's economy. The number of private enterprises accounts for more than 95% of all business.
In 1978, there were only 150,000 individual businesses in China. At that time, there were no private enterprises. By 2017, the total number of legal entities was 18.1 million, with private holding enterprises accounting for 97%.
In the past 40 years, the number of SMEs in China has shown explosive growth.
According to the data from the National Bureau of Statistics, there were about 2.5 million newly registered enterprises in China in the year 2013. In the past five years, the number of new enterprises in China has been growing at a compound annual growth rate of 22%. By 2018, the number of newly registered enterprises has reached 6.72 million.
These SMEs with limited initial capital are faced with a series of problems regarding a fixed investment at the beginning, such as minimum leasing area, minimum lease term, design and decoration cost as well as furniture procurement cost.
The launch of co-working space has greatly improved the flexibility of office usage. Many co-working companies have even launched the "workspace GO" service, which charges by hour.
This allows SMEs with an average life span of less than three years to start their journeys at a lower cost.
Take a co-working site as an example:
If 10 people rent an office space, the average office area for each person is 11 square meters. Then the rental price per day will be 3.5 RMB/sqm; the decoration cost will be 800 RMB/sqm; the property cost per month will be 7.5 RMB/sqm; the water, electricity and network cost will be 100 RMB/person/month. As for a traditional office, one-year rental cost is up to 180,025 RMB (the decoration cost is apportioned by 5 years). But with this co-working method, the company only needs to pay 900 RMB per person per month, which makes the total amount be 108,000 RMB per year. The unit price of co-working space is lower than that of the traditional office leasing (assuming that the per capita office area is equal in both cases). Thus, the total cost for a co-working space is equivalent to 60% of the traditional office leasing.
Choosing co-working space means a lower initial investment, alleviation on the burden of human resources, and a higher utilization rate of resources.
According to the model proposed by Sullivan, the introduction of the co-working model has brought along more "flexible office space" and effectively reduced the housing vacancy rate in the market.
The co-working industry relies on the tens of millions of SMEs in China. And they will continue to grow along with China's economy.
Population mobility trend
The rapid development of co-working industry benefits from macro trend support, favorable policies and other factors. First of all, China's rapid urbanization process makes a large number of labor force flow into the city, which has created a huge demand for high-quality urban office space. China's urbanization rate has increased from 55% in 2013 to 60% in 2018, and is expected to reach 65% in 2023.
Secondly, the development of sharing economy and the emerging needs of generation Z further promote the expansion of co-working space. In 2018, the population of generation Z in China will exceed 300 million, accounting for 24% of the total population. This generation of young people is gradually becoming the main labor force of the society who generally pursues a higher quality of life, cooperation and integration into the community. Their demand will have a huge impact on the entire office market.
In 2023, the potential market of China's co-working industry shall surpass 1 trillion RMB, but the total achievable market size is only 132.3 billion RMB. If adequate resources are provided to enable co-working operators to build more venues, this mode can be received by an even wider audience which will further increase the penetration rate of co-working space. Then the market scale will be likely to reach the level of its potential market.
According to Sullivan's report, there will be over 100 million people working in an office by 2023 in China. Among these 110 million people, Sullivan predicts that 35% of the population in the first tier cities would be willing to switch to co-working space, and 30% in the new first tier cities and 10% in the remaining cities. Based on this penetration calculation, Sullivan estimates that, about 22.8 million people are willing to choose co-working space in 2023. If we classify those potential users according to the city grades, and multiply the average rental income and average service fee income of the corresponding city level respectively, we will obtain the total potential market size of the industry of more than 1 trillion RMB.
By 2018, co-working space has accounted for 6% of the total commercial office area in the first tier cities, and this proportion has also reached 5% in the new first tier cities. In the next five years, the penetration rate of co-working space is expected to continue to rise, bringing greater development opportunities for this industry.
Things change with their contexts.
In addition to different market increments, the pioneers in co-working industry are under different conditions in China and America. WeWork is facing a lot of difficulties under the background of American law and policy.
According to its prospectus, it will take about 12 months for WeWork to break even and another 18 months to make profits for each building it signs.
At present, more than 300 out of the total 528 co-working spaces under Wework were signed within 12 months, all of which are in a state of loss.What is worth mentioning is that the prospectus shows the average term of these long lease contracts is about 15 years. As of June 30th, 2019, the minimum lease fee under WeWork's payment obligation is up to 47.2 billion USD.
However, WeWork's valuation only peaked at 47 billion USD in history.
What's more, the 15-year long-term lease signed by WeWork also stipulates, "unless the lease expires, there is no early termination clause" and "no sublease to a third party without the permission of the landlord".
According to the "lease obligation" guarantee, if there is an economic downturn, or under the scenario that WeWork wants to withdraw from the lease in the next 15 years, WeWork shall to bear a contingent liability of 6 billion USD.
In other words, the cost of WeWork is solid like a stone. And it's rigid. They have to pay with money earned or without.
And their revenue is like water. It's flexible. All depends on the economy.
Under a good economy, income can cover the cost. All looks good on the surface.
But once the economy turns down, their income is not enough to cover the cost of expenditure. With a tight cash flow, everything will be fall apart.WeWork seems to shoulder all risks for both parties.
Many insiders said, "There is no such risk in the domestic co-working industry. If the operation result is not ideal, the company can just shut down the office. The cost at most will be the cost for decoration and three-month rental deposit. Most of the time they don't owe any money to the landlord."
Due to the different business environments, the co-working operators in China are under a more controllable situation than their counterparts at the other end of the Pacific Ocean in terms of the key risk of cost-benefit mismatch. At the same time, the win-win relationship between building owners and co-working operators is far more harmonious than that in the US market.
Moreover, the co-working operators have received more support from the government than ever. The reason is that in the process of China's economic transformation, the momentum is to shift from real estate to the new economy driven by consumption and technology. Under such background, the remained space in real estate carrying a large amount of investment can generate new cash flow through "co-working + business services + enterprise services". The old bricks shall become the driving force of the new economy. No wonder that co-working is undoubtedly the most highlighted industry.
Since 2014, the co-working industry has ushered in explosive development with the help of entrepreneurship and innovation policies as well as capital.
Government encourages innovation and entrepreneurship.
Since this year, in the face of more difficulties and challenges both domestic and abroad, China's economic operation has remained stable, in line with expectations and in a better structure through the implementation of effective macro policies. At present, the world economy and global market demand are still sluggish, new uncertainties in the international environment are still increasing, and the subsequent impact is unpredictable.
According to Xinhua news, China will vigorously implement the strategy of innovation-driven development, focusing on mass entrepreneurship and innovation. We are determined to stimulate market vitality, promoting new mode, new technology and new industry to flourish with the help of "Internet +", promoting the development of new forms of employment, promoting transformation and upgrading of traditional industries, accelerating the shift in driving forces for development, cultivating new economic structure. And the goal is to optimize supply, support growth, attract employment and improve people's livelihood.
The state has also issued preferential policies, including the introduction of enterprises, talent policies, preferential tax returns and operating subsidies, providing impetus to the upgrading of innovation and entrepreneurship.
Take Shenzhen, the capital of innovation, as an example. Co-working operators like Ucommune, soho3Q, Tencent Public Space, TechTemple, Bee+, WEPLUS, Funwork and other entrepreneurial platforms emerged on the market one after another. And even large-scale real estate enterprises such as Vanke, Kaisa, Gemdale have entered for a market share.
By 2018, the number of domestic co-working operators has increased dramatically and become a new highland for innovation and entrepreneurship. According to market statistics, the financing amount of domestic co-working enterprises raised nearly 6.8 billion RMB in 2018. At present, the penetration rate of domestic co-working is less than 3% (total area of domestic shared office industry / total area of all domestic offices), which may reach 20% in the next 10 years.
Just like a new technology has a development cycle, an emerging industry also has the peak of inflated expectations and the plateau of productivity.
After the peak phase, the co-working industry ushered in a reshuffle.
According to the data from VCSaaS, from 2018 to March 2019, about 40 co-working brands disappeared and 28% of all the co-working brands were under slow development or close to bankruptcy.
So can we say that the industry is crumbling just because of 28% failure?
This is the normal law of development for a new industry to mature. We all know that gold is never found till the waves wash away the sand. As the boom fades, creating a "gold" product has become the top priority for all players in the industry.
At the same time, in terms of model innovation, there are also many innovations based on Chinese characteristics. According to the public data, Ucommune has formed a business model with multiple sections including space service, community e-commerce, precision marketing, design engineering output, etc. KrSpace has left its matrix of new media and transformed into a co-working space service provider. Nashwork puts forward a new mode of "independent + joint" model for co-working service.
In the recent two years, innovators represented by these companies are actively exploring the second growth curve based on space business.
Co-working enterprises now pay more and more attention to empowering companies and boosting the development of start-ups. In terms of To C services, precision marketing, finance and taxation, intellectual property, human resources and others have become important sources of profit for co-working operators. For example, a co-working enterprise launched a welfare society, providing exclusive preferences for the daily personal needs of the employees of the member enterprises, covering work efficiency, food and accommodation, health and sports, leisure and entertainment, medical examination and other fields.
At present, the platform service revenue of some co-working enterprises has accounted for more than 30% of the overall revenue scale.
At the same time, China's mobile payment environment provides benefits for co-working enterprises to expand value-added services.
According to data from Merchant Machine, 47% of Chinese consumers are using mobile wallets to pay their bills, which is the highest penetration rate in the world. The United States only ranks seventh, with only 17% of people using mobile payments.
With the popularity of mobile payment in China, the revenue of value-added services in the co-working market has grown significantly.
According to data from Sullivan, the income of China's co-working industry mainly came from rental income in 2018 (accounting for 88% of the total income), which is expected to decrease to 48% in 2023, and the floor efficiency of China's co-working will be further improved.
The co-working business is on the track in returning to the essence of business - to create solid products and improve profitability.
At present, the industry is indeed facing various disputes and challenges. Disregarding the mist, we can see the essence of business itself and we firmly believe that the industry entrepreneurs in China will give the best answer to the value created by the co-working space.