I was recently on an airplane with a hotel entrepreneur. His family had immigrated to the US about 20 years ago and they decided to enter the hotel industry. Being new entrants to hospitality, they started with lower quality airport motels (e.g., Econolodge) and gradually moved up to more premium hotels (e.g., Marriott).
I had always assumed that a hotel with a better brand made more money for the owner. I was surprised to learn that this wasn’t necessarily true. Premium hotels are priced higher but these higher prices are eaten up by higher costs in service, staffing and quality of amenities (e.g., beds).
However, it’s generally easier to run a premium hotel. For example, the guests are better behaved, despite their bad rap for being overbearing and demanding perfect levels of service. Guests at economy hotels bring bad behavior to a whole new level. My new friend told me about having to break up fights between guests or calming down a customer who was threatening one of his front office staff with racist remarks. People are much more likely to treat the hotel property poorly and even break things in an economy hotel. This leads to additional costs.
One of the worst problems in economy hotels was bedbugs — and not the way you’d think. Customers who already have bedbug problems at home would check into his hotel. Then they would smuggle in some of their bedbug-infested linens into the hotel room. Then they’d check out and wait a few days for the bedbugs to entrench themselves in the hotel room. Then they’d sue the hotel and say that their house became infested with bedbugs because of the hotel. So now the hotel has a room with bedbugs and a lawsuit to deal with.
But stuff like that doesn’t happen at a Mariott (at least I hope it doesn’t). Hotels with premium brands set expectations on the customer experience —price, quality and customer behavior. Put another way, the brand provides a level of trust to the traveler that they will have a good experience.
So what does this have to do with Airbnb? For years, staying at a hotel was the only way that a traveler could trust that they would get a good experience. So when Airbnb came along, most people rejected the idea. In fact, Airbnb was rejected for seed funding by the first seven investors that they approached. I remember hearing that Airbnb was a combination of the two worst ideas in Silicon Valley:
- Staying in the home of a stranger
- Renting out your spare room to a stranger
In his excellent site Stratechery, Ben Thompson talks about how Airbnb (and others) changed the game. It starts off with something called the Law of Conservation of Attractive Profits that Clayton Christianson wrote about in his book The Innovator’s Solution.
In short, there are commodity suppliers and integrated suppliers in the value chain. The integrated suppliers are the ones that make the big profits. In the original PC business, IBM was the integrated supplier, with its brand and its proprietary components, and everyone else was a commodity supplier. But it’s possible to change the game and commoditize others in the value chain take the profits for yourself. This is what Microsoft did to IBM. Who thought that the OS provider could commoditize the hardware provider — but they did.
Now let’s look at Airbnb. Travelers have the same needs that they’ve always had. They want a place to stay that’s comfortable and safe that’s somewhere close to the activities that they want to do. So how can a supplier deliver a great experience to the traveler? Before Airbnb, hotels needed to own the whole building (or have a franchisee own it). They would deliver a consistent experience by having a set of corporate standards that represented the brand. So a traveler knew exactly what to expect when they went to a Mariott Courtyard.
However, with Airbnb, the company can set expectations for the traveler during the booking and reservation process. Instead of focusing on broad standards like bed type, free breakfasts, and free Wi-Fi, Airbnb can focus on individual customer experiences for each room that’s rented out. This lets Airbnb commoditize (sometimes called modularizing) the experience of each individual room and still maintain a consistent Airbnb experience. It also let’s Airbnb source from much smaller and diverse suppliers who have extra rooms. So Airbnb becomes the most important player in the experience and therefore the most valuable component in the value chain.
To learn more about how this all works check out Ben Thompson’s writing on Aggregator Theory at Stratechery.com.