The contrasting Canberra Times articles bring in to stark sobering light the very different life paths that our choices can lead us down.

On one hand, Debra Jopson (Canberra Times, April 10, 2012) interviews a Yarralumla couple who invested considerable effort and sacrifice in to their retirement planning.  They are today reaping the rewards and enjoy an early retirement with little concern for their future.  This was not easy as they went without a great deal that many of us take for granted – new cars being a notable example – and having to invest “three weeks of full time work a year into it, even
with assistance from a financial planner and accountant”.  However, they are now enjoying the rewards.

On the other hand, Debra Jopson highlights the sobering reality that many, in particular Australian women, face as they enter what should be the most wonderful age in their lives.  When they should enjoy freedom, they are forced to enter economic slavery due to a combination of poor planning and poor legislation (although as a liberal economist, I advocate personal choice over state coercion).  Debra Jopson, citing research by Sydney Micro-economist Carolyn Evans, writes

“Women in their late 50s and early 60s have surged back into the workforce and held on to their jobs much more than men of similar age, because they cannot afford to retire”

The research commissioned Australian Business Foundation found that surveyed women “almost without exception … they had to come back to work, or they were going to retire and when they did the numbers, they didn’t have enough to live on” or face “.. genteel poverty for another 40 years – mot starving, but no holidays, no treats and no fun”.

Unless one lives in a rainforest and is entirely self sufficient, this does not sound very appealing at all.

It is yet another reminder of the importance of proactive retirement planning, and of the peril of poor planning.

Retirement should be a place of dreams and freedom, not economic slavery.

The choice is ours.

Image Credit – Poets United

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Essentially, the authors (below) are reminding us of the importance to focus less on ourselves, and more on the competition.  Or more specifically, why our customers focus on the competition.  They go further and present a number of simple formulas to estimate your businesses “wallet share” of your customers, or the proportion of their spending that is going to you or away from you to your competitors.  They suggest that where you are not number one in your niche, to ask why, and not get distracted with satisfaction measures that may only lead you to preach to the converted.

They make the example of a supermarket providing a nice ambiance that scores well on satisfaction surveys.  Focusing on this strength may further enhance customer satisfaction along this dimension, but may not address your competitive weaknesses if in fact, it is price of staples that is driving your customers toward your competition.

The authors also remind us of the importance focusing on our competitive environment, and addressing that, rather than focusing on our own strengths and weaknesses.

My personal experience supports this argument as I have seen all to many businesses fail over the years that took a personal passion or flair and turned that in to a business only to realise too late that it was not what the market was looking for.

I argue that before investing a single hard earned dollar toward any venture, it is of critical importance to understand the current market and competitive environment.  Belief in one’s self and one’s vision is inspiring, but will it draw customers away from your competition?

I wish to thank the Harvard Business Review and Timothy L. Keiningham, Lerzan Aksoy, Alexander Buoye, and Bruce Cooil for providing the inspiration for this article.

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This is an all too common scenario and no matter how often this is repeated by government campaigns and financial planners, this advice sadly often goes unheard.

What are your thoughts?

Before you answer it is worth considering a few even more sobering facts about inflation:

People often forget inflation.  I.e. if you believe $50k / year would be a comfortable retirement figure today, that will rise to $100,000 years in around 20 years at 3.5% inflation.  20 years after that, which is a reasonably conservative life expectancy estimate post retirement, that figure will rise to $200,000 / year.  All to sustain what $50,000 / year today would provide.

Some rough back of the envelope estimates for what amounts of superannuation would be required to provide this yield are in the millions, quite easily approaching $3 million.  Just to support a comfortable, but by no means exorbitant lifestyle in retirement.

Thought provoking?

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The World Trade Organisation and an increasingly loud chorus of commentators are now supporting my position that I have pushed for over a year now.  I have grown increasingly concerned with Australia’s reliance on commodity exports, and I am convinced that the single main reason Australia avoided the worst of the GFC was due to China’s insatiable appetite for our red and black dirt (iron ore and coal) which account for around half our entire national exports, perhaps more.

Australia is becoming an asset based economy – an economy based increasingly not on productive capacity but the value of assets such as residential property and other investments, but mostly residential property and general consumer debt which I strongly suspect accounts for most of Australia’s private (non government) debt.  In other words, our wealth is increasingly based on how wealthy we feel and how much value we place on assets, rather than on what we actually do.  The only significant non commodity export, education, is being wiped out by the rallying dollar that is driving us to a drunken splurge on overseas goods.

In response to my blog posts, I have received suggestions that I am falling victim to mercantalist economic theory, and that our long term trade deficit and reliance on exporting dirt, is nothing to be concerned about.

In fact, I argue the opposite.  I am passionately opposed to all forms of trade protection support minimisation of economic distortion and manipulation by governments.  What I am concerned about, is that we are growing drunk on false wealth, and if any market distortion is justified, it is toward business investment and away from non productive assets such as property.  I am not suggesting slowing property construction, I am suggesting trusting natural market forces to govern the property market and remove distortionary taxes such as stamp duties and negative gearing.

I support national competitiveness, not mercantalism which is an outdated nationalistic mode of thought.

The following is a brief collection of some of my writing over the last year on these topics, and I will continue my campaign to raise awareness of our need for economic competitiveness.

Australia’s Unsustainable Export Composition (May 2010)

Questioning Our Obsession with Property (May 2010)

Australia’s Reliance on Coal Exports (June 2010)

Conflicting Opinions on Real Estate (June 2010)

Government spending masking real economic risks (June 2010)

Property investment masking threats to business investment (June 2010)

The following excerpt from Wikipedia makes for chilling reading, as this sounds remarkably like the USA before their crash:

In an asset-based economy, manufacturing, as well as perhaps services, no longer provide the engine for growth. Rather the appreciation of assets leads to an increased net worth among individuals which, in the direct sense, can serve as collateral for borrowing, which in turn creates greater demand for goods and services. Proponents of the model often advocate reduction of tax rates in order to stimulate greater demand for assets, which in turn raises asset prices yielding even greater equity.

Critics of the asset-based economy contend that it is highly flawed because it depends on the continuation of low interest rates to stimulate the borrowing that will finance the purchase of assets at a rate sufficient to sustain the upward trend in asset prices. Thus, they reason, the model is highly vulnerable to the perhaps inevitable decreases in the real estate and financial markets.

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Competition is heating up, your suppliers exerting upward pressure, your customers are exerting downward pressure, your products and strategies are being imitated.

Sooner or later no matter how successful your product based business is, you will hit a wall unless you are very lucky.

So how did Apple beat this game?  Lets look at the smartphone market.

Smartphones were hardly new before the iPhone, as were portable music players before the iPod.  It is arguable that Apple has not really released anything ‘new’ in the last decade or so, but they have taken technology that would have been a prime candidate for commoditisation, and revolutionised it.  Their success is nothing short of stunning, now accounting for more raw profitability in the smarthphone market, than any other manufacturer.  Nokia are practically dead in the water, and while Android is rising fast, these devices do not enjoy Apple’s profit margins and likely never will.

I bet you would like to run a business like that!

One trick is to consider where your business operates.  Let me show you.

Spheres of Operation

The five circles ‘Extended Enterprise’ concept is a useful model that can be used to illustrate how successful companies such as Apple preserve profit margins, while established and once leading companies such as Nokia succumb to falling margins and the never ending arms race to rebuild profitability – the dreaded profit trap below.

What’s the difference?

Boomer (2007) suggests that great companies that are successful in commoditised markets operate in all of the five circles described below.

The Inner Circles

Products, Services and Unique Processes

The inner circles focus on products and basic services sold on top of those products.   This is the traditional bread and butter of most companies, and where many sucumb to the seduction of their initial success, become trapped, and ultimately die.  Who remembers Novell?  Today I walked past a once prominent Novell building in my city (Canberra), and the building is up for lease.   Novell has been carved up and sold off.  It once commanded an unassailable lead in it’s market niche, until it’s suppliers marched right up the value chain and took over – in other words – they had their lunch cut for them.  Last week I heard another story about a company called Wang, that once had this city ‘stitched up’ – who knows them now?  Mainframes were once a golden cash cow – a veritable river of cash.  Sadly, it seems that inadequate investment was laid in to future strategies, and they are no longer with us.

Never become complacent – when times are good – do not rest!

For if you do rest, you get trapped, in what I refer to as the Vortex of Doom.

Boomer (2007) argues that companies that remain caught in the inner circles (what I refer to as the Vortex of Doom) fall into a never-ending trap of margin pressure, cost reductions and subsequent lack of ability to innovate as retained earnings suffer. These companies will either fail, or strive to become extremely efficient at producing and delivering standardised cheap products in a never ending fight with competitors.

Lets look at Woolworths, a company that trades with about as much excitement as government bonds, yet is a an organisation I watch very closely

Disclaimer – the author does not hold any shares in Woolworths.

Woolworths is a moderately diversified company (nothing like the strange case of Wesfarmers that seems to be in to, well, everything)

So how does it’s various divisions stack up?

In 2009, Woolworths reported the following profit margins:

The fuel division reported a drop in petrol sales directly due to lower petrol prices, and a ‘good result’ of 1.6% profit “reflecting the solid volume growth and increased non fuel sales through new and existing canopies” (Woolworths Limited 2009). In contrast, the hotels segment reported almost 20% profit, in a bad year. Supermarkets reported over 5% profit in the volume driven sector.

This example contrasts service oriented hotels, from volume driven fuel, where most profit is extracted from non fuel purchases.

In the fuel sector, as fuel prices drop, players must immediately drop their advertised price in response due to intense competitive pressure and a lack of difference in the fuel product from one operator to another. A player in the fuel business would not survive selling only fuel.

However, in the hotels operation, despite a financial crisis and very significant price pressures on hotels, a 20% profit margin was still attainable. This is due to the ability to differentiate on service and the problem solved, rather than just volume.

This illustrates how product centric versus services oriented business models can yield very different profit margins depending on their market environment, market maturity and the state of commoditisation of the product or service being sold.

In the absence of differentiation and value adding services it is not unreasonable to foresee a future where all product based businesses are subjected to similar pricing pressures. This will drive down margins to a point where investment capital is drained trapping the business in a cycle of an inability to innovate due to deteriorating profit, and an inability to drive up profit through lack of innovation capital.  Once caught in this cycle a business can not escape without significant external capital injections.

In the New Financial World Order where equity will take precedence over debt (remember the Global Financial Crisis), this means to raise money, you erode or even lose control of your business to new shareholders.

Don’t end up like the milk farmers under Woolworths – differentiate!!

Image copyright David Reilly – Australian Broadcasting Corporation

I raise these examples to illustrate how some of Woolworths business lines appear to be caught in the inner 3 circles of my aforementioned Vortex of Doom, where I can only assume that that Woolworths survives and thrives here by erecting barriers to entry based on price competition and supply chain control.  Interestingly though, I have noticed an aggressive push by Woolworths to get in to the marketing game – ever wonder what those barcodes on your fuel ‘saver’ shop dockets are for?  They link your every purchase to your ‘loyalty’ card and build a nice little earner for Woolworths based on monitoring your habits.  Remember how QANTAS once made more money from their marketing database (Frequent Flyer) than actually flying?  Well, it makes you wonder why Woolworths are so aggressive about their loyalty card scheme too.

Image from another supermarket chain – but the concept is the same – note the barcode that links your purchases to your fuel purchase – Communist Russia would have drooled over this level of sophisticated intelligence gathering!

In the other corner however, the Woolworths hotels operation could be argued to not be subjected to these forces to such a degree, although websites such as Wotif will undoubtedly have an impact.  Hotels traditionally have been based on brand and service distinction, not volume.

Boomer explains the risks of remaining in the inner circle (Products) in particular as “with time, almost any product can be re-engineered or cloned, and globalisation has increased the rate at which this is happening” and intellectual property “can normally protect a product for a limited time”.

Boomer proposes the second circle, services, as typically product adds on to differentiate from competitors, such as maintenance services or updates.  However, this is also subject to cost pressure and competition and ultimate commoditisation.   In the case of Woolworths, they have sought to develop online delivery models to provide services on top of grocery products.  This however is still subject to cost pressures.

The third circle, Unique Processes, is often developed and under-valued by companies and leaves with employees.  The challenge is to retain unique processes.  In the case of Woolworths, the supermarket and fuel operations successfully leverage unique processes to maintain business wide efficiency and market responsiveness.   Any new entrant to today’s supermarket and fuel markets would require immediate strengths in all of these three circles to succeed, or failure would soon result.   Aldi is a good example, as they entered the Australian market with mature processes.  This is why small ‘corner shops’ and local fruit grocers often cannot compete with supermarkets and instead exist in niche environments based on consumer experience or niche markets such as higher margin organic markets.

Outer Circles

The outer circles are where successful high margin companies operate, with Apple being a notable example.  These constitute the extended enterprise that is crucial to maintaining margins where products have become commoditised.

Community, the fourth circle is the domain of companies that operate within a community of networks and as a trusted advisor.

The fifth circle Global Environment refers to communities external to the normal spheres of operation or influence for the company in question.  These communities do not currently operate within the company’s spheres of operation and influence, however they may be attracted to the this sphere through various communication channels.  This seems like marketing, however it is a little more complex than that, and this touches an important point in this series.  It is marketingbut not selling, it is about building your empire of influence, because that builds your market, and that builds your sales.  People are smart, and they can easily identify the intent behind a communication, whether it is to sell, or to influence.  Many people are more receptive to well intended influence, than naked selling.

How this relates to Value

Any service will itself be subjected to commoditisation without sufficient execution of a strategy focussing on these circles, with a particular emphasis on client relationshipsand value to clients, with value being the primary source of resistance against commoditisation. The outer circles are important to build perceived value of services.  Remember, Value is not the product of hours worked, commodities transformed or value by virtue of scarcity, it is the subjective perception of benefits that each client perceives that a product or service can yield to them. It is client centric, not producer centric.

So Where Does Apple Fit In To All This?

Apple is a company that suffered from the effects of competition and commoditisation and came very close to bankruptcy in the early 1990s.

Today Apple is one of the few successful examples of companies in the extremely competitive and commoditised personal technology sector.

How did they do this?  The figures are where it gets really interesting.

Company Profit

In terms of margin on company operations, Apple enjoys EBIT profit margins of 40%, compared to Microsoft at 38% (who don’t even make products), Nokia at 4.9% and Dell at 4.1%(Forbes Magazine 2010).

Product (Gross) Profit

In terms of gross margin on products, on the iPad alone, Apple enjoys gross margins of up to 55%, with concerns raised when the gross profit margin falls to ‘only’ 40%(Forbes Magazine 2010), with up to 60% gross profit for the iPhone (Elmer-DeWitt 2010)

Conversely, Nokia and HTC fall to almost half of this figure at just over 30% gross product profit margin, if they’re lucky.

Apple successfully achieved the above margins by creating a thriving commoditisation resistant ecosystem based on “multiple revenue streams by leveraging common technology and intellectual property” (Halpern and Vasiliadis 2009).   Apple is one of only very few companies to have ever increased profitability in a rapidly commoditising market, without market dominance.  Apple did this by focussing on the ecosystem (community) and valuerather than the product. The productmerely become a platform to execute the sales and retention strategies that Apple is now famous for.  It could be argued that Apple is an example of a company that has successfully engaged all five circles outlined in the diagram above (Company Operations).

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Well..  It’s been a busy week in Nokia-Land.  It seems the new Nokia CEO charged with turning Nokia around from slowly sinking Titanic back to market leader has made some bold moves.

First the significant Microsoft shareholder and Nokia CEO Stephen Elop (deliberately?) leaked a memo brutally exposing his views on Nokia’s mistakes.

Then, Nokia and Microsoft announce an alliance – from Microsoft to boost their struggling mobile market share, and from Nokia to stem the increasingly rapid decline in their once leading market share.  Microsoft even offered offered a considerable amount of support to the slowly sinking Nokia who’s market share continues to slide.

Then an ex-Nokia employee who left in 2002 yet kept ties and interest with Nokia declared this as the beginning of the end of Nokia because of the huge losses and strategic mistakes in investing so heavily in Symbian, and then Meego, to finally concede defeat and abandon these struggling platforms.

This is a far cry from the days of old (2004) when Symbian was the prize coveted by Nokia when Symbian appeared to be the future of the mobile world.  Nokia eventually siezed control of Symbian at a huge cost, to release it as ‘open source’ only to see it’s market share and revenue continue to slide.

So what happened?  Some insiders have claimed it was a total disconnection with the market place (and here) that led Nokia to release a string of buggy failing products.  I have heard from some sources that it was a case of corporate arrogance where the management team believed themselves as beyond reproach (however I can not validate these claims).

Personally, I believe this is New Coke all over again, and the string of disasters at Nokia will be taught in marketing classes for many years to come.  I believe this is a classic case of too many MBA’s, too many presentations on ‘vertical’ and ‘horizontal’ integrations, and not enough raw hard market and competitive research.

I believe the long drawn out Nokia fiasco is a classic case of group think and serves as a lesson to us all to surround ourselves with diverse people and opinions.

Those who seek to build empires based on self reinforcement, will always be doomed to fail.

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In this article, I will further the case for considering services in your business by distinguishing products from services.

Part Three, will look at the success of the Apple Strategy and some real examples of real profit margins including from the sector spread Woolworths enterprise.

So Why Services?

Why would you want to move a business from products to services?  In your business, things are ticking along nicely.  The factories are running at full capacity, customers are happy, everything seems fine.  So why change?

Because to remain competitive you will eventually be faced with one of the following choices:

1) Stay in the same game, and sharpen your cost margins to a point where other competitors find it difficult to get in (note this can lead to a price war trap);

2) Look at your profit margins, and boost them.  Profit margins can mean escape.

3) Broaden in to other products, innovate, stay ahead, constantly strive to find the next big thing;

History is littered with examples of companies who didn’t change, who remained the same, and faltered.

IBM, in the early 1990s, almost went bankrupt for this very reason when their products based business started to fail and they were forced to see a future in services.  However, such a massive company, with a long history entrenched in manufacturing (their name stands for ‘machines’ after all) has struggled to reinvent itself as a services company, even so will probably divest away from products base entirely.  This has already happened to a large extent with the loss of their laptop business to Lenovo.  There will no longer be anything known as a ‘IBM PC’.  There will come a time when there will be no ‘machine’ in IBM, just services, and even this strategy is unlikely to succeed if IBM can not shake it’s product history that brings a focus on cost management rather than profit boosting.  IBM long ago stopped being IBM, and is now more of a ‘International Business Services‘ company.

IBM had encountered the Product Life cycle.

So Why Do Product Profit Margins Decline?

or

What is Commoditisation?

When products first hit the market, they can do very well.  Remember the very high price of computers in the early 1980s at over $10,000 (in today’s terms) for something of very limited capability, compared to today when Dell may only scrape a 3-5% profit margin on devices that can now be found in some supermarkets on special in Aisle 10 along with vegetables or garden implements.  This is known as an industry lifecycle.  What was once valuable and innovative is now a commodity.

Most industries tend to go through these standard cycles that were identified many decades ago.  These are

1) Introduction

2) Growth

3) Maturity

4) Decline

(Berkshire Select Inc. 2010)

This process is accelerating.

In the early 20^th century the Product Life Cycle may have spanned a generation (e.g. railways, cars and electrification). Today, this cycle may extend through a mere decade or less due to intense technological advancement and competition.  PC’s from their introduction moved through to commoditisation within two decades as open standards allowed new players to enter the market and drive down profits.  This led to IBM, a founding member, to exit this industry for this very reason and move into services. As IBM shows, it is often not possible to transform a product based business into a services business, so IBM actually chose to progressively divest from the products arm (i.e. Lenovo) while building up the services arm.

Competition

So where does all this competition come from?

In the 1970s, Michael Porter developed the ‘Competitive Forces Model’ to illustrate exactly this.  All businesses are subject to these competitive forces from the humble fruit grocer to the multinational corporation.  Those who understand them can succeed, those who ignore them will almost certainly fail unless they are very fortunate.

Applied to the Personal Computer industry example above, Porters Five Forces model explains why the PC industry underwent a rapid cycle from innovation through to growth and plateau as open PC standards allowed new entrants and substitute products to enter the market.   As margins decreased over time to the point where laptops can now be purchased in supermarkets, IBM left the PC market entirely. Competitive rivalry increased to such a point that economic viability in the PC industry was no longer feasible except for companies based on extremely large volumes and extremely rapid hardware innovation in the never ending ‘arms race’ to outpace competitors.

Conversely, Apple bucked the trend and actually increased margins, against text book wisdom, by creating a closed self reinforcing ecosystem.  Think about this next time you wonder why you can’t just plug in your iPhone and ‘copy’ music files to the device as with others, and why iTunes is required to ‘manage’ the device.  While this undoubtedly adds some value to the consumer experience through quality control and enforcing consistency, this is also a deliberate strategy by Apple to maintain control over the competitive forces above by exerting control over the Apple ‘ecosystem’.  End result, Apple enjoy up to 50% gross profit margins, against text book wisdom, while most other technology companies struggle along with less than 10%, sometimes as low as 3%.  Apple understand and manipulate supply chains very well and you will see many companies (starting with Nokia) seek to emulate this strategy from 2011 after focussing on product supply chains and vendor sales channels and largely ignoring the end consumer.

So Where Does Services Come In To This?

To pursue higher margins, services can leverage already commoditised products to provide high margin services based on expertise and relationships to solve specific client problems.

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In this multipart series, I will take you through what services are, and how you can build a services based business or transform your existing product based business, in to a services based business.

So what are services?

Services sell a solution to a problem or fill a gap.  Services can not be consumed like products in finite supply can.  Theoretically, the value of services lie not in their scarcity or limited supply as with products, but in their value to the client.

This is important.  Remember – it is all about value.

What is Value?

If you want to sell services, you need to understand value.  If you don’t, you will fail.  Period.

Value is not price or cost based.  Value is determined by the  significance of the problem or gap solved for the client.  Subsequently,value focuses entirely on the client and what this means to them.  This is why product based business often fail in their attempts to become service based businesses, as they often do not understand this or do not entrench and understanding of value in their organisation.  They continue to think in terms of costs plus profit which suits products based businesses.  Product pricing revolves all around you, and not around the client.  It is about how much margin you can make on the costs to make that product.

In services, you need to revolve around the client and that’s where value comes in.

In services, you don’t sell, you solve.  And this needs a strong, healthy ongoing relationship with your clients so you can know what you can do for them.  This is why pricing is important and costs are irrelevant.  You need to focus on the client and ask ‘how important is this to them’?  And there lies your pricing strategy.  You need to be able to distinguish clients and charge based on the value of the problem or gap you are about to solve or fill.  If you are mass selling a service, you need to nail your market segmentation and price points.  If you are a relationship based organisation, you need to leverage that relationship to know how to set your price.

Of course competitive forces still come in to play here, as they do with products, but only so far as you sell a commoditised service (i.e. if everyone else can do it).  The trick to beat margin eroding commoditisation of your services is to strive for uniqueness.   Fill a niche,  embed your relationships.  Brand loyalty in services is much stronger than for products.  Use that.  Build it.  Do not box and drop, keep that relationship going.

So what are some examples of services?  One unorthodox example I find very interesting are data services – i.e. selling data as a service as opposed to a product.  Sure, services can be anything from housecleaning to consulting, but I find data services really interesting as there is a lot of action in this field all over the world, right now.

What Are Data Services?

Example – The Entertainment Industry

Lets talk about the entertainment industry to kick off this series and provide a background to future discussions.

When a consumer visits a video store to rent or buy a film, they license a boxed data product.  They are consuming Data as a Product.

Data Services

If they subscribe to PayTV, watch Free-To-Air digital TV or stream video online, they are consuming Data as a Service.  If the data is retained it is regarded as cached for ‘delayed’ consumption and is often not transferable unlike a boxed data product (DVD or Blu-Ray).  Or at least it shouldn’t be transferable for the business model to work.

Similarly for cinemas which offer a pay-as-you-go data service.  Cinemas tend to focus on the overall customer service experience and may offer ancillary services such as premium seating and food and beverages.  You take nothing home but the ‘experience’.  And maybe some popcorn stubbornly wedged in your teeth and clothes.

The advantage of entertainment data as a service is that it is fresh and often delivered instantly.  You can keep ‘em coming back and up front costs can be lower to the client.  The advantage of data as a product is that is portable and always re-usable, although not updatable with new content.  Once it’s boxed, it’s boxed.  But it’s theirs, the consumer can give it to their friends or grandmother, whatever they want.  Presuming your copy protection is adequate and your product does not wind up being a free service to the world.

An astute observer will notice the marketing and business strategies for these two business models are completely different.  You will notice FoxTel (an Australian Pay TV company) sending out ‘consultants’ to public places such as shopping malls, and to people’s homes, often during dinner, to market the solution that Foxtel can provide in the consumers life.   A consumer can’t buy Foxtel in a box.  They subscribe to a service and lose access to that service when the subscription expires.  Nothing is or should be retained.  The subscription model also allows Foxtel to differentiate consumers based on tastes (solutions) and budgets and vary this according to changing markets or often a very low price entry point as a ‘teaser’.  You will notice a good FoxTel salesperson will strive to develop a rapport and an understanding of your interests in order to sell a solution to you.  The most common opener being “what sports do you like, yes we cover that, just for you!”.  I once conducted an experiment on a FoxTel salesmen (when I was in the middle of dinner and not feeling very accommodating) by seeing if I stated that I enjoy weekend stunt Mig aircraft flying and monster truck driving if he too would develop a sudden passion for these sports and tell me that we can bond our shared passions together, on FoxTel Sports.  He did.  It was an interesting experience to see someone claim to take Mig aircraft out for stunt flights on weekends.

Cinemas also often focus on the consumer experience, and differentiate standard from premium seating and sometimes offer various forms of subscription models.  Cinemas also sell a service.  The Premium Seating being a recent evolution to segment their market and obtain maximum margin from the most willing segments.

Data Products

In contrast, video stores sell a boxed product, either for permanent retention (owning) or Pay-As-You-Go ‘consumption’ (renting).  The boxed entertainment strategy often requires stores to be placed near strategically aligned fast food outlets and other places of high consumer traffic.  Video stores do not send out consultants to sell a solution, they sell a product at a one size fits all price, even the rentals, and have done so since about 1983.

The blur of video rentals and their product based thinking, with emerging availability of home based data services such as online ‘rental’ is where it gets really interesting, and this is the point of this example.  It shows the clash of product and service based models and thinking in motion.

So many video stores have wound up struggling against Pay TV and more recently online data delivery that have more flexible pricing models and deeper customer segmentation with subscription based models.

In response, some video stores have attempted to leverage their product centric operations and strategies into services by launching subscription models.  However these have met limited success.  Consumers do not associate video stores with video services, and the company may not be structured appropriately for this model.  Subsequently many video stores are still struggling as entertainment products trend toward home based entertainment services with instantaneous online and broadcast delivery.

Pay television and cinemas offer data consumption (services) while video stores offer licensed data products.

The above example hints at how business models and strategies that work for one are unlikely to work for the other.

It also shows how you need to constantly, always, understand market trends.  If you don’t see them well ahead of time, you could end up like this:

Next Up – What Is Commoditisation and How Does This Affect YOUR PRODUCT BUSINESS??

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More background on my scepticism of the ‘Australian Miracle’ can be found here:

Australian Coal Exports Continue to Expand

House price growth to slow – or grow?

Business Investment Falls

Australia’s Export Composition

Government Spending Props Up Economy?

Two reports emerged this week, that I am aware of in my current superficial following of the mostly subjective media outlets:

ABC Australia’s 7:30 Report, Tuesday 05 October – will Australia’s resource boom hollow out Australia’s economy? This report should have been aired 10 years ago, not today.  However,  am relieved that at last the assertions of outcasts such as myself are being acknowledged.

Canberra Times, Thursday October 7 2010 “Overvalued housing market threatens to derail economy” (David McLennan). Surprise surprise.  In the mad obsession to divert all available capital to the unproductive sector (residential housing), we have starved the productive sectors of capital, at a time when they need it most as the strengthening Australian Dollar squeezes Australia out of the global market.  Not to mention various layers of market and labour distortion in to the mix that have not helped, but that touches on a contentious area I am not yet brave enough to venture in to.  It is brave enough to question the dominant economic religion in Australia as it is.

In other news, the Reserve Bank of Australia (RBA) held interest rates last week.  This suggests that the RBA does not seem to subscribe to the dominant religion either.

So Australia, drunk on consumption, is blinded to a few dangerous factors that threaten to de-rail our economy and bring back the dreaded 1980s “Banana Republic”.  All of these factors together, can add up to a devastating fire storm.  Anyone who has lived near an area afflicted by a bush fire storm knows how this works.  Any factor in isolation is damaging.  Together, they can add up to something spectacular indeed.

1) High currency, aka the “Dutch Disease” (more on this later) hollowing out Australia’s economy, leaving little left after the mining is gone.

2) Consumption driven economy, fuelled by the above

3) Diversion of capital to the unproductive residential housing sector.  Not in terms of jobs as the dominant economic religion encourages us to believe, but in what this capital ultimately produces, which is nothing.  Residential houses are a lifestyle choice and a psychological support, they are not productive in the sense that a factory or office building is.  There is no net job creation like a factory will produce.  The jobs only exist for the construction of the homes.  It’s a zero sum game if anyone is looking for a ‘economic stimulus’ in residential housing.  We would be better off building factories and critical infrastructure if we needed ‘stimulus’.  And that of course also excludes ‘school halls’.

4) Sectors outside of of housing and mining continue to be starved of capital, when Australia should be making hay while the mining sun shines.  Nothing lasts forever, and China is not exactly quiet in it’s ambitions to buy up resources in Africa and South America.  Australia can only hold China to ransom for so long.  And countries without democratic election cycles, for all their ills, can play the waiting game much better than any democratic country.  China is not a country to under-estimate, and is a client relationship we depend extremely heavily on.

5) If the housing bubble bursts, the Emperor will suddenly have no clothes.  Or as other commentators have suggested, when the tide rushes out, we will see who is standing naked.  Unfortunately, this will mean that assets on balance sheets across the country will be written down, leading to catastrophic devaluations in stock markets and retirement funds.  I do not believe the effects will be as bad as in the USA, however the effects will still be severe, when Australia is facing a demographic bulge that is famously under-funded for its retirement and as economic volatility will continue to threaten government revenue.

If Australia continues on its current course, we will indeed become a banana republic when the party’s over.

However, there are options, one of which is to conduct a thorough survey of the assets in the national economy.  One of which is corruption and transparency.  Australia has long since left the USA and most of Europe, including the UK, behind on this measure.  That is a asset to be exploited in the financial markets.  Managing overseas superannuation or pension funds for Islamic countries is a once in a generation opportunity we can not afford to miss.  Within a generation, Australia could transform from hole in the ground to tower in the sky.  And it would not be difficult, it just relies on some diversion of capital, the right legislative frameworks to be in place and some smart marketing by the government and by our financial institutions.  Any financial product targeting overseas Islamic (or any overseas) pension fund management market should be tax exempt at the very least.  Countries such as China and Korea do not hesitate to support their national economic strengths in much more overt ways.  There is no reason why Australia should not do the same.  This would benefit the global financial system, as well as our own well-being.  Australia has a ready resource of highly educated Islamic students and citizens ready to go.  We should encourage them to stay, not let them all go to Singapore where a government less encumbered by democratic voting cycles than our own, has seen this potential and is happily harvesting this resource with full page advertisements in every global magazine.

This is only one option, and there are many others.  I will expand on these over the coming months, while I continue to challenge the dominant economic religion in Australia that threatens to de-rail our economy and send us all in to poverty unless we start investing heavily in our economic strengths, now.

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