[ZG – Zillow] “Transformational Innovation”
I’ve followed Zillow on and off since its merger with Trulia and find myself more confused by it with every passing quarter. There is always so much going on at once and management has failed to concretely explain how its disparate assets all fit together. What Zillow has effectively demonstrated is that lead gen is a tough gig, even for someone with its commanding market presence. Incremental returns on capital have been terrible, with EBITDA up by ~$100mn over the last 7 years ($134mn if you back out losses from the Homes segment) on a ~$3bn bump in gross capital (how does a company with over 90% gross margins manage to deliver only 8% EBITDA margins?).
Nobody disputes Zillow’s popularity among consumers: according to SimilarWeb, Zillow has ~2.5x the monthly visitors of Realtor.com, the second largest real estate listings portal, and over 4x the visitors of Redfin, the most heavily trafficked brokerage site. But the real test of Zillow’s worth is whether its Premier Agents, who actually pay Zillow, convert leads into home buyers more cost effectively than they can on other marketing platforms.
The vast majority of real estate searches start online and yet, as CEO of Realogy Holdings, the largest franchisor of residential real estate brokerages, reminded an audience last year, nearly 2/3 of its clients are sourced from the personal networks of agents and, with respect to web-based leads generally:
“It is always about the quality of the lead. Always. Web-based leads closed at a very low rate. I won’t name many of the media channels…because I don’t want to pick on anybody, some of them were public companies. They literally have a closure rate of half of 1%, think about the money that’s invested and generating that traffic. And your closure rate is half of 1%”
(Richard A. Smith, CEO, Realogy Holdings; Investor Day, 8/10/2017)
The strength of any cross-side network effect depends not only on the number of aggregated constituents but on the quality of interaction between them, and over the last several years it seems Zillow was wrestling with engagement issues, which translated into lower conversion rates. Consumers who reached out to Premier Agents were apparently only hearing back half the time and expressing their frustration by assigning 2.5 star (out of 5) ratings.
So in 2q15 (the quarter that Trulia closed), Zillow changed its sales incentives to reward “net revenue” rather than “number of agents”, reflecting, as management put it at the time, a “strategic focus on high ARPA [Average Revenue Per Agent] agents who provide a superior consumer experience”. Basically, the company started funneling more leads away from “hobbyists” and towards its most productive agents, the ones who would actually return prospects’ emails. The number of agents predictably declined over the next two quarters (3q15 and 4q15), while growth in Average Revenue per Agent accelerated1.