Before I can reveal my new business model which is going to revolutionise the way books are published and sold I need to explain some of the economic theory behind this brilliant new innovation.
Often described as the dismal science Economics it is anything but. Indeed, for those prepared to study the research carefully it can be the path to riches beyond the dreams of avarice.
To illustrate what I mean let's take a look at the airline industry, which is a particularly good example of the way innovative thinking can completely transform the way business is transacted.
Warren Buffett, the billionaire US investor, famously observed that between 1947 and 2003 the airline industry has managed to loose a cumulative 5 billion dollars. That's right. 5 billion dollars. And that's despite the fact that it has been run by the brightest and best business brains that money can buy. Or, to put it another way, your granny who in the same period put her money in a biscuit tin under the bed, managed significantly to outperform all those Harvard-educated whizz-kids who've been running the world's airlines.
The reason these guys managed to loose so much money is that they had the wrong business model in the first place. And the reason they had the wrong model is because accountants don't talk to economists. Economists know all about marginal costing and pricing and profit maximisation and accountants don't. What accountants think they know all about is breakeven analysis. But actually that in itself is a pretty contentious and poorly understood discipline.
Anyway, as a result of the accountants' ignorance here's what's been happening in the airline industry for years.
First off the airline goes out and buys a new fleet of planes and the CEO asks the accountants to work out what the breakeven figure (the load factor) is per plane. Let's say the plane seats two hundred people and the accountants work out that to break even the company needs to sell 100 tickets at £300 a pop. Unfortunately, that's the wrong answer to the wrong question but nevertheless our airline CEO gets his marketing guys (who are also very highly paid of course) together and asks them if they can sell that many tickets on average per flight. It's a stretch but the marketeers say they can if they increase the marketing budget and indeed, with a bit of luck they might sell 120 seats at that price on certain popular flights.
Indeed, that's exactly what happens and the following year at the company's AGM the CEO announces record profits, the first the company's made for years. Unfortunately, the champagne goes a little flat when he also warns of tougher times ahead due to competition from the new breed of low-cost airlines that have sprung up all over the place. Reassurringly, he explains that though these new compeitors will prove troublesome for a while there is no way they can make a profit at the prices they are charging and he's sure that they will soon go out of business. One shareholder stands up and asks if the company is really maximising its profits with the current fare structure. Of course, is the answer, the company is sweating its assets hard and squeezing every last penny of profit out of its planes.
Except of course it isn't.
With a load factor of 60% the plane is flying 40% empty - that's 80 seats adding absolutely nothing to the bottom line. The marginal (ie extra) cost of filling those seats is next to zero. So if the airline sold them at, say £10 each that's another £800 profit per flight. A profit it would not otherwise have made. A not inconsiderable sum, especially when multiplied by the number of flights the airline runs every year. In other words, the airline is failing to maximise its potential profit. But the airline didn't sell those seats because it had a rigid pricing structure and a lot of people stayed on the ground because they couldn't afford to travel at that price.
The first airline in the USA to realise how crazy all this was was Pacific Southwest Airlines . Later on, in Europe, Michael O'Leary saw what Southwest was doing and decided to apply the same principles to Ryanair. From here on I'll concentrate on Ryanair as that's the airline I'm most familiar with.
Ryanair is the world's most profitable airline and it's growing exponentially. Its genius was the way it took marginal costing and inverted it. In other words, it sold the cheaper, marginally profitable and previously unsold seats first. This simple inversion of logic revolutionised the way the industry worked. In particular, it gave Ryanair an unbeatable marketing edge. It could sell you a seat for a pound if you bought one far enough in advance. Even its competitors in the industry couldn't understand how Ryanair could do it. Everyone predicted Ryanair and the other low cost operators that followed would soon go bust. They were wrong because they simply didn't understand the economics the way you and I do now.
In fact, if you think what Ryanair did was clever, you ain't heard nothing yet. Ryanair has even worked out a way to make money from the seats they give away for virtually nothing. Sounds incredible, but it's true.
The point I'm trying to make here is that looking at the way a business operates in a totally different way can have a profound effect on the business model.
Of course, the traditional airlines are all now desperately trying to fight back by adopting the Ryanair pricing model in a more or less half-hearted way. But for them it's too little too late. Soon they will be as extinct as the dodo, which also couldn't fly.
In my next post I'll explain how the traditional publishing industry is about to go the same way as the airlines when I introduce my new Read On Demand business model.