Thursday, August 21, 2003 :::
 
TiVo, Part the Second: TiVo Shakes Up The Advertising Industry (But More Importantly, How?)

Here’s how in love I am with my Tivo: not only is it impossible for me to stop telling (boring) my friends with tales of its coolness, but I feel compelled to write a second blog about it, a scant two days after I’d written my first TiVo-related story!

After finishing my last blog regarding how TiVo will do in the face of new competition, we started wondering what effect TiVo would really have on advertising. Does TiVo spell the end of television advertising as we know it? Will TiVo and PVRs be subjected to a dozens of legal challenges from advertising agencies and television networks, eager to protect their advertising revenue streams, in a situation which resembles the Recording Industry Association of America’s current war on file-sharing? Or is the issue more complicated—and potentially more interesting or lucrative—for advertising agencies? After thinking the issue through, we’re convinced that TiVo may ultimately prove to be a financial boon for advertising agencies, particularly great ones. (We’ll get to exactly what constitutes a great advertising agency in a few paragraphs.)

The conventional wisdom suggests that advertising agencies are in pretty tough against a machine that enables the viewer to skip the product (tv advertising) they sell to their clients (marketers). Usually, when TiVo’s effects are discussed in the annals of business, it’s positioned as a doomsday device that will (almost certainly) pose the end of the advertising agency as we know it. This perspective is best-summed up by a recent article in BusinessWeek, which declared in the overly-dramatic and over-hyped fashion that’s a hallmark of that magazine: “Coming Soon: A Horror Show For TV Ads.” . The article goes on to describe that thanks to TiVo’s ability to collect highly precise information on the television watching habits of its viewers, it’s becoming apparent that (surprise!) most viewers skip through ads, particularly on the most popular shows:

TiVo's initial data reveal some trends that ad agencies and networks might prefer to bury…On April 11, 2002, ABC's popular TV drama The Practice drew a TiVo rating of 8.9, meaning 8.9% of TiVo owners watched the show live or recorded it and watched it later. But those viewers watched just 30% of the ads shown.

In other words, the early data from TiVo suggests that advertisers face a big dilemma: it’s exceptionally hard to get large amounts of viewers to turn into an ad, as viewers of popular shows (like the Practice) will tend to skip ads altogether.

An additional finding of note from TiVo’s data is that “event” programming (e.g. sports, reality TV, awards ceremonies) has a much higher percentage of viewers who watch ads than “episodic” television content (e.g. narrative tv shows like Friends, The O.C., or our personal favorite, Diff’rent Strokes.) Here’s BusinessWeek on the subject:

Certain genres are "stickier" than others, TiVo's research shows. Big-budget situation comedies and dramas tend to have the lowest retention and commercial-viewing rate because couch potatoes tend to record them and skip through the commercials rather than watch them live. Reality TV, news, and "event" programming such as the Oscars do significantly better at getting viewers to see the commercials. Just 39% of viewers watched ads during the highest-rated network TV show, Friends, vs. 75% for the 45th Annual Grammy Awards and 58% for Fox reality show Fear Factor.

This finding suggests that its much better to spend advertising dollars on “event” programming than it is on Friends, as marketers can be more assured that the eyeballs they’re paying for are more likely to actually watch the ads. Of course, this discovery—assuming its corroborated over time with more data—will also significantly increase the price that networks charge for advertising slots on these programs, making them inherently riskier (due to the need to justify the larger initial investment) for marketers buying spots on these channels. In turn, this places a greater burden on the advertising agency to show that the expensive spot delivered at this time actually delivered what it was supposed to (awareness, recall, and ultimately, sales and loyalty). The bad news here is that as of yet, nobody’s been able to develop an industry standard of actually measuring what constitutes ROI for an advertising campaign.

So are advertising agencies up the creek without a paddle? A particularly ominous prediction from the usually-reliable Wall Street Journal about a PVR study from Forrester Research says that they are. (Unfortunately, the complete Wall Street Journal article is only available in the WSJ archive, for the princely sum of $2.95. The complete citation of the article is at the end of this blog.) Last year, Forrester polled 112 marketing execs (including the heads of marketing at P&G, General Motors, and Coca-Cola), and learned that 76% of them planned on reducing TV outlays “significantly” when PVRs reached 30 million US homes. Although there are only about 3m PVRs currently in US homes, that number is increasing quickly, thanks to cable companies eager to bundle them into set-top boxes, and Forrester projects that we will reach the 30 million number before 2007. We’d also be willing to bet that as more data about how the relatively scant attention viewers pay to (most) TV advertising begins to filter out from the good folks at TiVo, the more likely it is that marketers start paying much closer attention to their TV advertising budgets.

It’s our perspective that although TiVo poses a significant challenge to the advertising industry, the increased prevalence of TiVo and PVR’s will likely result in a culling of the herd of advertising agencies, rather than resulting in the extinction of all television advertising as we know it. Moreover, we strongly believe that for some advertising agencies—even some agencies that concentrate exclusively on producing tv advertising—will actually see their profitability increase over the long run because of TiVo.

Why do we feel so strongly that the threat of TiVo is a little bit overstated? First, let’s examine the facts: although many TiVo users (ourselves included) utilize TiVo to fast-forward through ads, it’s important to note that we don’t fast-forward through all ads. The data BusinessWeek cites bears this out, too: even if only 39% of viewers watching Friends on their TiVo aren’t skipping through ads, that’s 39% of viewers who are actually choosing to watch ads (or choosing to watch the ads that they like). Secondly, people were skipping through ads long before TiVo, either by channel surfing through commercial breaks or by simply leaving the room to pursue alternative activities (making a snack, using the phone, going to the bathroom, etc). The difference was that in the pre-TiVo days, the existing ratings systems (Nielsen) had no way of capturing or measuring this viewer behavior. Consequently, when marketers purchased television advertising, they were essentially making a leap of faith and hoping that television audiences stayed tuned in during the advertising slots that they had bought. The only difference in TV advertising in a pre-TiVo and a post-TiVo world is that now marketers can better determine whether or not the ads that they’re buying are being tuned out, or listened to.

TiVo’s ability to measure and report (with a greater degree of accuracy) whether or not audiences actually watch commercials is what makes it as much of an opportunity for ad agencies as it is a threat to them. With TiVo, it suddenly becomes possible to accurately measure how good an agency really is: can an agency or specific creative team consistently deliver advertising that viewers want to watch, or does an agency consistently create advertising that viewers choose to ignore (fast-forwarding through it, skipping it, etc)? In such a world, advertising agencies will be priced by the marketplace in a different fashion: good agencies will receive top dollar, and average ones will receive less, and bad ones…well, bad agencies probably won’t be long for the world. It should also be noted that since TiVo and PVRs makes it harder to create audiences for commercials (by allowing people to opt-out of advertising more effectively than ever before), the price of good advertising that can deliver an audience should also increase (as a function of scarcity and the law of supply/demand). In other words, agencies that excel at create advertising that “works” (e.g. advertising that people tune in to) will not only be able to charge more than their competitors, they should see their ability to generate revenues soar. Much as television stars that could “guarantee” a big national audience saw their value skyrocket through the 1990s as it became harder to assemble such an audience due to the proliferation of cable channels and other media—consider the ever-increasing salaries of the cast of Friends, top-flight agencies will be able to extract significantly greater value from their buyers than in previous eras.

There are two catches with the scenario outlined above. First, there will be a lot of bloodshed in the advertising industry over the next five to ten years, particularly for agencies that specialize in television advertising. This is largely because of the fact that the market for quality in the advertising world is uneven—while all agencies are created equally, not all agencies are equal in terms of their ability to create advertising viewers want to watch. At a certain level, the buyers of television advertising services seem to have realized this, and the rumblings of a shakeout can already be heard. Consider Coca-Cola’s decision to shift its TV advertising from McCann-Erickson to the reputedly more creative, and much smaller, boutique agency Berlin Cameron/Red Cell agency last November. Obviously, we’re hypothesizing that a “more creative” agency might be better at creating “more interesting” ads that are consequently less likely to be fast-forwarded through by viewers. Regardless, however, Coca-Cola’s decision to go with a smaller, “edgier” agency has recently been mirrored by several large firms—such as Sun and Coca-Cola’s own Sprite division—who’ve sought to relocate their creative work to other such stylish boutiques. At the very least, the growing trend to go with shops that look more “creative” signifies growing client dissatisfaction with the current status quo of agencies and a desire for more effective television advertising.

The second catch is that while advertising that can deliver an audience to marketers will dramatically grow in value, it is less clear as to who will ultimately capture that increased wealth within an agency. Although agencies would ideally like it ensure that they increased ad spending, the real question at hand is, who is ultimately responsible for creating consistently great advertising: the entire agency, a creative team, an individual within the creative team (a great copywriter like Bill Bernbach, for example), a savvy account planner, or another party altogether? If great advertising is the product of an entire agency, than the agency will get to receive the spoils of client spending. If, however, it becomes apparent that such advertising is more the result of one part of an agency than another—a great copywriter, or a planner who can consistently intuit what a customer segment needs, and how to best reach that segment—than the pay scales of advertising agencies will change significantly. In this scenario, since such talented individuals will be able to move quickly between agencies, or simply sell their services directly to clients, they will capture virtually all of the value of increased client spending on advertising.

In closing, TiVo doesn’t portend the end of advertising as we know it. What it does portend, however, is a fascinating shift in the economics of advertising itself. Most importantly, TiVo will ensure a Darwinian shake-out amongst advertising firms that choose to specialize in selling television advertising itself, with the best firms surviving, and the worst dying out. In short, it’s clear that the advertising world is going to get much more competitive in coming years.


(The citation for the Wall Street Journal article mentioned in this article is as follows:
Vranica, Suzanne. “Technology Confronts TV Marketers—Economics May Change As Consumers Use Devices To Shift Time and Skip Ads,” The Wall Street Journal, November 26, 2002. You can find the archives for the Wall Street Journal here.




::: posted by Matthew at 3:24 PM



Tuesday, August 19, 2003 :::
 
Overpowered By TiVo

Over the weekend, I (finally) hooked up my brand-new TiVo. Ordinarily, the installation of consumer electronics products is a pretty mundane activity, and not a very blog-worthy activity at that. However, in case you hadn’t heard from the growing course of TiVo fanatics (a roster that includes publications like the Wall Street Journal, cult leaders like Oprah Winfrey, and fictional characters like Miranda from HBO’s Sex in the City, TiVo is a revelatory, life-changing, and even epiphanic experience.

Although most American consumers currently consider TiVo’s and personal video recorder (PVR) technology to be little more than a souped-up VCR that uses a hard-drive rather than tapes, there’s actually much more to it than that. (You can find a reasonably decent demo of what a TiVo actually does by clicking here http://www.tivo.com/1.0.flash_demo.asp, if you prefer visual descriptions to written ones.)

First, TiVo has a variety of interesting bells-and-whistles—the ability to “pause,” (to answer a call, go to the bathroom, or gorge yourself on food), “fast-forward,” through commercials and “rewind” through live TV, a feature that works via a buffer in the TiVo hard-drive that records the channel you’re watching as you watch it. Secondly, TiVo has an interesting feature that recommends shows and TV events to viewers based on their viewing habits—imagine Amazon’s “Users Who Purchased this Item” feature applied to TV programming—enabling non-Entertainment Weekly reading viewers to quickly get up to speed on pop-culture.

However, the most compelling feature TiVo offers is that it not only records TV, but it does so via a remarkably easy-to-use interface that allows you to easily record what you want to watch, and then access that content at a time that’s convenient for you. In short, the TiVo achieves what VCRs were supposed to accomplish way back in the day: the simple recording of television programming. For most Americans, VCRs have been “recorders,” in name only: although it’s theoretically possible to record tons of TV programs with a VCR, most people don’t do so due to the complexity of programming the VCR, and the cumbersome nature of videocassettes themselves. And when people do record TV, they usually record the channels that they’re watching at that time. Consequently, for most people, VCRs have existed primarily as VCPs—video cassette players, used mainly to play movie rentals, or home movies created on a different device altogether.

The recording feature of TiVo is great simply because it’s so liberating. I stopped watching large bursts of TV about a decade ago, not because I hated the quality of programming, or because I’m an anti-pop culture Luddite, but simply because I’ve almost always been preoccupied or busy with work, school, or a social life during the prime-time hours during which the lion’s share of worthwhile TV happens to be aired. Since that time—e.g. prior to TiVo—most of the episodic TV (the Sopranos, Six Feet Under, etc) I’ve watched has been on DVD. In any event, it’s hard to describe how amazing it is to finally be able to watch television programming that was previously unavailable due to a hectic schedule—after just four days of having convenient access to Sponge Bob Square Pants, The O.C., The Office, Queer Eye for the Straight Guy, etc, it’s simply thrilling to be plugged back into the mainline of pop culture. Not too mention the fact that it’s a pleasure to finally be able to watch the cream of the television show crop, and not have to settle for the chaff that’s regularly on.

Obviously, PVRs is vastly superior to any substitute product used to currently record television programming, such as a VCR. Furthermore, from the perspective of consumers, it’s pretty clear that TiVo is, to use Dave Eggers-style random capitalization, A Truly Great Thing! Whether it’s a great thing for investors, however, and moreover, whether it’s TiVo that ultimately wins the coming battle for dominance in the PVR marketplace between cable and satellite companies and giant consumer electronics firms, remains to be seen.

Recent analyst reports—not too mention the current consumer buzz in the marketplace—suggest that PVR’s like TiVo are on the cusp of mass acceptance. The technology consultancy Forrester Research projects that 14m PVRs will be in use by the end of 2004; TiVo’s own projections, according to its SEC filings (http://www.tivo.com/5.6.5.asp), call for its subscriber base to rise to more than a million (from 703,000 users today) by January 2004. Meanwhile, the prevailing conventional wisdom in the consumer electronics world suggests that PVRs look like they will be the DVD player of this Christmas season. The growing size of the marketplace, coupled with the fact that technological barriers to entry are especially low—a PVR is effectively just a combination of a hard-drive and software of average complexity—has ensured that TiVo is facing increased competition from a collection of electronics firms and cable companies eager to capture TiVo’s revenues for themselves.

With increased competition, the threat to TiVo will increase substantially, especially since its most recent quarterly report (released in April) reveals still mounting losses at the firm--$7.8m on $26.5m in revenue. (TiVo’s latest financial reports should be coming out later this week.) It’s hard to see how these losses can’t do anything but grow given TiVo’s current model, which sees revenue being generated by sales of hardware (which the firm is considered by analysts to break-even on) and “subscription” revenues (users pay a monthly fee of $12.95 or lifetime fee of $300 to receive TV listings that allow the easy recording of TV programming.) Increased competition will almost certainly lower prices of PVRs, perhaps pushing TiVo’s hardware sales from a break-even revenue stream into a loss-generating one. Competition will also likely cut the fat out of the hefty subscription fee (the one element of TiVo that we found hard to swallow, incidentally), which should also pose a challenge to TiVo's efforts to turn a profit.

Moreover, the new competitors TiVo is starting to face have advantages that TiVo will have a difficult time matching. Large consumer electronics firms have more complete distribution systems, and greater clout with retailers like Best Buy and Circuit City. Cable companies have the advantage of being able to bundle PVR functionality into their set-top boxes, which thereby reduces the complexity of installing the system, and ensures that it will work seamlessly. (This is happening much more quickly than anticipated—AOL Time Warner is currently rolling out PVR cable boxes to subscribers in areas that it covers. And given the positive feedback it’s receiving from users—check out this review from the popular blog-site Atmaspheric –things look good for such offerings.) Due to the fact that TiVo isn’t particularly asset rich—it has just $57 million in total assets, of which just $39 million is cash, according to its April filing—things look pretty challenging for the company.

The good news for TiVo is that its business model and strategy has anticipated the commoditization of the PVR marketplace for some time. The company has always stated its desire to outsource the manufacturing of TiVo’s to consumer electronics partners such as Sony and Toshiba. In its reports and presentations, TiVo reveals its primary focus to be the “service” side of the business. The service side of the business is composed of two elements. The first of these is providing TiVo software to manufacturers, software that allows the easy recording of TV programs, enables users to record entire seasons of TV shows, and (most importantly, as we’ll discuss in a moment), TiVo’s semi-famous “recommendations” system, which allows viewers to easily find content based on their viewing habits. The second component of TiVo’s business model calls for providing information about viewers to advertisers, enabling advertisers to better understand who they’re reaching, and how their advertising is being consumed (if at all).

Can TiVo’s changing business model withstand what’s sure to be intense competition? The first component of TiVo’s business model—emphasizing the software component—will shield it somewhat if it turns out that creating the TV guide software, and the content programming, is much harder and more expensive than consumer electronics firms and cable companies seem to think it is. In our perspective, although TiVo’s software and interface is very easy-to-use, it doesn’t look like it will be too difficult for any new entrant to copy. Its recommendation system might be harder for any potential competitor to mimic, since the system relies on understanding viewing habits of existing customers, and then applying slightly more sophisticated data mining or cross-filtering software to that data, and finally making recommendations to users. However, anecdotal evidence and our experience suggests that TiVo’s recommendations—while fun—aren’t really as useful as you’d expect. Most viewers are already aware of what they’re missing, thanks to the cornucopia of media programming about television programs (e.g. Entertainment Weekly, Entertainment Tonight, and various online websites), and can easily find this content without a recommendation service. It is therefore unlikely that TiVo’s recommendation system will protect it from competitors.

The second component of TiVo’s model—selling data to advertising agencies and firms that want to reach their customers—is potentially much more powerful, and possibly much more lucrative. As TiVo already has the largest database of subscribers in the PVR marketplace—about 40% of what is still a fragmented marketplace—and because it has emphasized data-mining from day one, it has a much richer database and understanding of its viewers than any other one of its competitors. Building up such a detailed database, being able to use it effectively, is very hard to do, as most retailers who tried to compete with Amazon (Target, Toys R’Us, CD Now, Virgin, etc) have found out. (We’ve talked about this issue before, here.) It’s also clear that TiVo’s data is potentially much more valuable to advertisers than its competitor in this area—Nielsen—since unlike Nielsen, TiVo has a much deeper sample size, a better way of recording viewing habits (electronically versus forcing viewers to complete notoriously inaccurate viewing diaries) and moreover, an exact understanding of what advertisements viewers actually watch. (Nielsen doesn’t account for channel surfing during commercials, whereas TiVo can provide precise detail about such activities.)

However, the big hurdle TiVo faces selling its customer data is migrating the advertising industry to what’s clearly a better product, but one that will likely face ongoing advertiser reluctance. If, for example, TiVo’s data reveals that television advertising is largely ineffective, how likely is it that advertising agencies will want to use it, given that the current industry practice calls for agencies to receive approximately 15% of client billings, and TV advertising happens to be the most expensive form--and therefore most profitable, from an agency's perspective--of advertising around? Secondly, despite the fact that TiVo counts virtually all the major TV networks amongst its investors, how thrilled would those networks be when forced to tell the advertisers buying ad-time that most viewers simply fast-forward through or skip ads altogether when using TiVo? Perhaps TiVo will succeed in developing new subscription models to overcome these potential pitfalls—viewers who don’t want to pay a subscription fee will be unable to fast-forward through commercials, for example, or perhaps TiVo will be able to utilize broadband technology and its data to push relevant ads to users who’d actually want to watch them—but in each case, it’s likely to take time. And for a company that doesn’t have much cash on hand, and isn’t currently profitable, this poses an ongoing and growing challenge.

The one thing that TiVo has going for it right now is phenomenal awareness and buzz. TiVo, like Kleenex and facial tissues, or Xerox and copiers in the 70s, is in the eyes of many consumers, is inseparable from the category it currently dominates, PVRs. Yet history is also littered with companies that initially had great awareness, but ultimately lost out (the just-cited example of Xerox!). The biggest obstacle TiVo faces right now is its ability to complement its brand with a viable business strategy. As TiVo lovers, we hope they accomplish this goal.


::: posted by Matthew at 11:56 AM



Friday, August 15, 2003 :::
 
Saw an interesting article on The Gothamist, about the uniforms that employees of Song, Delta’s new low-cost airline get this morning. Specifically, Mr. and Mrs. Jack and Kate Spade have designed uniforms for the cabin crews and flight attendants of Song, in an attempt to give the airline a boutique-y cachet to complement its low-price deals. You can read the whole post here, but according to the Gothamist, they’ve pulled it off fairly well:

"We think it’s incredibly clever, because even though Song is low-cost, it just means the tickets are, not the experience…Gothamist was on a Delta flight with a Song crew a week and a half ago, and even though the flight was three and a half hours longer, we kept it together because the crew was stellar."

Hmm, an airline that’s trying to position itself as low-cost and cool? Sounds suspiciously like JetBlue to me! And, on closer examination—thanks to another interesting Forbes article, about Song’s chances, which the Gothamist pointed me to—it looks like that’s exactly what’s going on.

Apparently, according to Forbes, Delta’s faced significant competition on its northeast to Florida routes from that impressively profitable hipster clone of Southwest, the low-cost and cool upstart carrier JetBlue, for the last year and a half or so. JetBlue’s success has largely been attributed to the fact that its low ticket prices, and its reputation for providing a great customer experience—things like leather seats for all, blue M&M’s, onboard digital TVs in every seat, a young and stylish flight crew. This combination of features has enabled JetBlue to gain significant market share on the routes it competes with the major hub-and-spoke airlines (Delta, American, United et al), and consistently generate profits at a time when those same major airlines are losing billions. Jet Blue’s success on the NYC area to Florida routes posed a particularly big challenge for Delta, since its New York-Florida routes were pretty profitable, and even though Delta hasn’t been bleeding as badly as some of the other major hub-and-spoke airlines has, it obviously can’t afford to lose them. So, seeing the threat from the new entrant, Delta responded the way that the majors have always responded, by copying its low-cost competitor.

So the big question is whether or not Delta can succeed in its quest to put the smackdown to JetBlue with Song. Forbes certainly seems to think that they can:

"The two most important factors for the target audience of leisure travelers are price and convenience--in that order. Song's flights will run from $79 to $299 each way, on par with JetBlue. It's possible that Delta might have an edge in the convenience department, since it will fly out of all three New York airports, whereas JetBlue only flies only out of JFK International. Furthermore, JetBlue has no presence in Boston and offers service to only one Florida city from Washington, D.C. Song plans to offer service to Florida from both Boston and Washington."

However, I’m betting loud and clear that despite having cool uniforms and more destination airports, there’s no way that Song will succeed against JetBlue, unless JetBlue loses its strategic focus, something that seems highly unlikely given the quality of the management team there.

The first reason that JetBlue will win against Delta’s Song is due to what Michael Porter—the godfather of strategy—calls “strategic fit.” To summarize Porter’s idea, in order to consistently generate wealth, a company needs to pick a profitable niche—in JetBlue’s case, low-cost, high-service flights—and optimize its entire business around that niche, choosing only to do activities that fit within the context of the niche you’ve chosen to focus upon. For example, if you’re going to be a low-cost high service airline like JetBlue, that means you’ve got to figure out a way to keep your own costs down and get the most out of your fleet, while still providing high-quality service. JetBlue’s been able to accomplish this through several innovative tactics. For example, it recruits bright young flight attendants right out of top schools, and pays them well—an hourly rate actually higher than the competition, but avoids the problem of the $80K/y senior flight attendant that plagues major airlines cost structures by maintaining a policy of no pay increases for its attendants after five years. This has the benefits of keeping JetBlue’s flight attendants young (reinforcing its youthful and fun image), non-unionized (people pick up after a few years, on to other opportunities), and in the end, much cheaper (no highly-paid, flight attendants with 25 years experience) without trading off on service (since JetBlue understands that there’s very little difference between a bright young flight attendant with one year’s experience and a flight attendant with 25 years worth of experience). Similarly, JetBlue gets far more out of far fewer planes by utilizing them far more effectively, resulting in much lower plane costs, enabling it to make money while flying passengers at cheaper rates than its competitors. It’s able to accomplish this because its made the choice to fly out of one uncongested airport—although JFK is crowded for international flights, air traffic is minimal for domestic flights—thus enabling it to fly its planes much more frequently than its competitors, offer more on-time departures and arrivals, in addition to greater convenience for its customers (flights at the times you want them).

Contrast JetBlue with Delta’s Song. The biggest problem that Delta’s Song has is that unlike JetBlue, it hasn’t made all of the trade-offs necessary to serve the strategic niche (low-cost, high service air-travel). Certainly, Delta has got some of the pieces of the puzzle right—Song’s Kate Spade-garbed flight attendants sound like they provide great service, and the leather seats with TVs and MP3 players in them certainly sound cool. But Song’s aesthetic virtues can’t hide the real problem: because Delta serves a different niche (a well-established and unionized hub and spoke airline that requires plenty of frequent fliers willing to spend money on premium hub-to-hub tickets), it can’t properly serve the same low-cost, high-service niche as JetBlue.

For example, unlike JetBlue, which is able to provide high service on its flights relatively inexpensively, through using bright-eyed and bushy-tailed college grads who are less interested in costly pension and health programs than their older and unionized peers at hub-and-spoke airlines, Delta’s employee costs are much more expensive. Not too mention, much less flexible, thanks to the fact that Delta’s entire workforce—unlike JetBlue’s—is unionized. Further adding to the costs of Delta’s foray into this sector is that Delta has been forced to use flight attendants and pilots with significant experience so as not to alienate its unions. The catch is that these employees, thanks to union contracts that reward tenure, are vastly more expensive than their cheaper counterparts at JetBlue—Forbes comments that employee costs are 25% of JetBlue’s revenues, versus 40% of Delta’s revenues. Moreover, unlike JetBlue, which gets substantially more use out of its airplanes (and therefore, lower costs) out of its airplanes by flying them in-and-out of uncongested airports (translating into approximately one additional flight per route per plane), Delta is hamstrung by having to use congested airports at LaGuardia and Newark to serve its customers. This means that Delta can fly less frequently than JetBlue, which not only translates into less convenience for fliers (less choice with time selection), but more importantly, less revenue per plane. In short, the equation for Delta’s Song doesn’t look too good: high expenses combined with a lower potential for generating revenue, or bling-bling as it’s called in some quarters.

The second reason that JetBlue will ultimately defeat Song is economic: it has already sunk its costs into developing the reputation and route structure between the metro areas it will be competing with Song in. Whereas Song must retrofit a number of 757s to get them up to JetBlue-standards of amenities (an estimated cost of approximately $65m), JetBlue already has its planes. Furthermore, Song must undertake an expensive advertising campaign to build its brand and reputation, JetBlue already has a reputation, and a reputation that continues to grow thanks to great word-of-mouth from the superlative experience it provides its passengers. Since JetBlue has already accounted for these costs, while Song has not, all JetBlue needs to do is lower its prices on the routes it competes head-to-head with Delta on, and all things being equal in terms of customer experience of the two airlines, it will acquire passengers at Delta’s expense. This places Song in a very precarious position—as Forbes notes, Delta’s basic cost structure is already much higher than JetBlue’s, and the costs of building up Song to the point where it can compete with JetBlue will raise this cost structure even higher over the next year or so. By lowering fares, and forcing Song to compete on price, it’s likely that JetBlue will push Delta further into the red at a time at a time when it can least afford to be losing cash in the eyes of its shareholders. In essence, the question will eventually become for Delta, is it worth it to lose money on these routes to compete with an upstart, or do we cut our losses altogether and exit? I’m betting on the latter.

Anyways, in closing, I’m certainly intrigued and impressed by Delta’s attempt to compete with the challenge of a low-cost carrier on these routes. They’re certainly doing a better job than United’s disastrous foray into setting up a discount airline when that airline was confronted in California by Southwest in the 1990s. But the key thing that I think Delta’s challenge with Song illustrates is that it’s vital to understand that a great consumer brand, experience or identity is only one component of success in an industry: ultimately, this brand has to be complemented by an unrelenting focus on a particular niche, and nothing else. In short, if a firm is truly going to compete in a niche, and do so profitably, it must ensure that everything it does fits with the needs and requirements of that niche

That about does it for today, but I should also add that if you’re interested in a good background of JetBlue as a company, there’s a fairly decent Harvard Business School case study on the subject that you can download for the princely sum of $6.50.




::: posted by Matthew at 12:37 PM



Friday, April 11, 2003 :::
 
2003: The Year Wireless Broke

It seems kinda strange to begin a blog about the economic promise of technology when we’re still mired in a three-year on-again off-again (but mostly on-again) recession. Especially on a day when the Business Roundtable (a panel consisting of the CEOs from the 100 largest companies in the US) predicts that there’s no rebound on the horizon, and the general consensus on Wall St and middle America is that the economy pretty much sucks. In fact, getting ready to sing the praises of hip new telecommunications and wireless technology feels pretty retro, but we’re more than happy to lead the charge of the light brigade for 90s nostalgalia.
The appeal of wireless is extremely difficult to explain to somebody who’s still tethered to a CAT-5E cable somewhere. From the perspective of a regular consumer, wireless is a liberating experience—once you’ve installed a wireless router, and hooked up a couple of devices with wireless cards, computing becomes truly amazing. It’s an amazing experience to be typing out emails from a balcony, to idly read your laptop in the living room while watching tv, or to receive an instant message wherever you’d like. We’ve heard for years that eventually, PCs will find their way out of the office and into other rooms of the house, and wireless makes that vision a reality.
For a business, the appeal of wireless is initially unclear. Certainly, it would be nice to have an office where people could move their laptops anywhere and everywhere to work with each other, but aren’t offices already wired that way with traditional networking cables? Although a cursory examination of wireless might lead managers to decide that the only benefit of wireless would be the increased productivity workers would achieve by being able to work anywhere they need or want to, that sells the potential of wireless short. Improved productivity aside, wireless offers sizeable cost savings to businesses once it’s implemented—it’s faster and cheaper than running cable, the speeds are quick, and perhaps most importantly, it allows the Internet to permeate corners of the firm that were previously unreachable. In other words, wireless suddenly makes it easy to reach say, the factory floor of a production line in South America or Asia, and track individual components as they’re integrated into a product, thereby offering firms a great chance to achieve significant savings in terms of inventory. Alternatively, it’s possible to cheaply tag devices with RFID labels and track inventory as it moves around the world, from the factory to the store floor to the consumer. Ideally, this will enable firms to receive vital point-of-sale information in real-time from outlets as small as mom-and-pops—no longer will real-time sales data be something that only the largest chains can provide their biggest suppliers. Because wireless is cheap and easily available, it provides firms with an easy way to ensure that every element of the enterprise benefits from improved communication.
So suffice to say, wireless is pretty cool. However, the two biggest limitations of wireless as it currently stands are the relatively slow spread of broadband (particularly at a consumer and small-business level), and the perceived fact that setting up a wireless network is unnecessarily complicated.
The slow uptake of broadband by consumers can partially be attributed to the fact that subscribing to DSL or cable remains relatively difficult. While things have improved over the last few years—the phone company doesn’t actually have to enter your unit to configure and install an ethnernet card in your laptop, and out-of-the-box solutions for setting up DSL or cable inside your house now exist—setting up broadband is still roughly the same level of complexity as programming a VCR. In other words, acquiring a high-speed connection is just hard enough to make it too frustrating for most consumers, save early adopters and a handful of people who absolutely need it for their businesses.
While acquiring broadband is hard enough, setting up a network is more challenging still, as it requires consumers not only to educate themselves on how to do it, but it also requires them to purchase multiple devices in order to do so. Although the quality of networking gear, and directions for how to set-up a network has improved immensely at the consumer level, setting up a network requires a significant amount of time and effort.
Interestingly, a quick, easy, and cheap solution to the challenges of acquiring a broadband connection, and setting up a wireless network is just starting to hit the market. It’s called Wireless Local Loop technology and although it’s clear that the name of this technology is going to have to change to something more memorable if it’s going to find success, the possibilities of WLL are significant. Wireless Local Loop technology uses the radio waves to “deliver” a high-speed broadband connection to consumers. What’s really cool about this technology is that today’s iterations of it don’t require a line of sight to an unseemly tower, making it consistently stable. Even better, WLL is relatively inexpensive from a service provider’s perspective—in contrast to the high costs of building out fiber optics to individual homes, for a relatively small price (about $25K, and falling), a service provider can place a “box” with a coverage radius of about 1 mile. (The range will improve with subsequent iterations—however, the economics of WLL already make it attractive in large urban areas.)
From the perspective of a consumer, getting WLL is a breeze. Not only does WLL offer speeds of up to 15x’s faster than DSL and cable, it is the first truly plug and play broadband device to hit the market. In San Francisco, users can already purchase a WLL receiver the size of a videotape that plugs into their PC, and surf as soon as the device is plugged into their computer. When the user logs on, they select the speed they’d like (higher speeds cost more per month), and that’s that. No waiting around for the cable guy or the phone company to show up at your house to set things up. Even more appealing is the fact that by this fall, a number of companies will have shrunk WLL receivers to the size of a PCMCIA card that can plug into a laptop, or better yet, come bundled with a new PC. This should dramatically increase the uptake and availability of wireless and broadband throughout the US.
Ideally, the subsequent spread of wireless should increase productivity, cut costs, and create a plethora of new business opportunities in its wake, thereby stimulating the economy. Growing availability of WLL may also be the “killer app” the PC industry so desperately needs to stimulate sales of new PCs (recently, the replacement time for PCs hit an all-time low of 54 months for consumers, and 44 months for businesses), which should help jumpstart the technology spending cycle. Of course, two questions still need to be answered—which companies will capitalize on the potential of WLL, and how should they position WLL in order to gain consumer acceptance. But those are the topics of a different blog, to be coming in the not so distant future. In the meantime, I’ve got to get back to my swank wireless connection…



::: posted by Matthew at 1:02 PM



Monday, February 10, 2003 :::
 
In the wake of Vivendi Universal’s slow collapse, AOL Time Warner’s $99 billion writedown, and the ongoing travails of the media industry in general, it’s become somewhat fashionable for analysts to blame the demise of media on one word, “synergy.” Although synergy is a terrible buzzword—an utterance that sounds like its should be springing forth from the mouths of the Wonder Twins on a Saturday morning cartoon, rather than the .ppt files of corporate executives—it’s also one of the most misunderstood and misapplied buzzwords in media corporations today.
The conventional definition of synergy seems to be something along the lines of creating a product or corporation whose sum is more than the whole of its parts. The ultimate model for this definition of synergy stems from Warner Bros. success with the Batman franchise in the late 1980s, which worked something like this:

1) Warner’s film division decides to make a movie based on a comic book character—Batman—that one of its other divisions—DC Comics—owns.
2) Warner promotes the movie via its comic books, which raises the interest of hardcore Batman fans, and gradually begins to build buzz and anticipation for the movie, raising sales of the comic book in the process.
3) The buzz regarding Batman is further stoked when exclusive news and previews of Batman are written up in Warner’s Time Magazine, which also increases sales of that particular issue of Time.
4) Another Warner property—the artist who was then still known as Prince—is recruited to record the soundtrack for the film, which is of course released on Warner Records, generating significant revenue for that division.
5) The movie is released, and is accompanied by a swarm of merchandise, all available at Warner Brothers stores.
6) Warner creates new properties based on the success of a film: new comic books based on the movie; a best-selling Warner Brothers book of the movie; an animated series which it shows on the TV network it launches years later; etc, etc.


When it works right, synergy can create huge profits, and a virtuous circle where each component of the synergy strategy—a film, a tv show based on the making of a film, an exclusive preview in a magazine, a soundtrack, etc—adds value to the core property. For example, a film like Lord of The Rings or Harry Potter—two of the brighter stars in AOL Time Warner’s firmament at the moment—is infinitely more valuable than a conventional film because its value can be spread across many media, from books to video games to magazines, tv shows, and soundtracks, ad infinitum.

Synergy at its best is powerful and seductive: particularly if you’re a media executive trying to outline a plan for profitability or justify a merger to investors. However, because this model of synergy is fundamentally hit-driven—you need to have great properties like Batman, Lord of the Rings or Harry Potter to make it work in the first place. Secondly, you need quite a bit of luck to pull synergy off effectively: for every Star Wars there’s a Willow or Howard the Duck; for every Eminem movie (Eight Mile) that you use to increase CD sales of a key artist in a key division, there’s an expensive NSYNC movie that fails to do any box office and probably does more harm to the reputation of your “property” in the first place. Consequently, trying to apply this model of synergy to a corporation is about as difficult as trying to capture lightning in a bottle. Moreover, it’s effectively a terrible strategy: not withstanding the fact that it’s overly expensive--it costs a fortune to develop a synergy worthy-property in the first place; it’s risky (only in rare circumstances like Harry Potter can you be sure of a massive return on investment); and it’s exceptionally complicated and difficult to execute with (imagine trying to manage a property across several layers and divisions of a corporation!).

Simply because the “sexy” definition of synergy as a buzzword doesn’t generally work doesn’t mean that the word is entirely worthless as a business proposition. The secondary—and often forgotten or neglected—meaning of synergy refers to the cost-side of the business, specifically in the sense of eliminating duplication or improving operational efficiencies. Usage: “Carly Fiorina expects Hewlett-Packard & Compaq expect to achieve synergies of $x billions from integrating sales forces and combining marketing expenditures.” For media companies, the most effective type unsexy synergies are those that involve achieving operational efficiencies and developing successful customer data initiatives.

In order to explain the unsexy side of synergy and its relevance to the media biz, it’s important to understand how media firms have made money in challenging markets in the past. Consider book publishing, for example, often considered to be the least profitable and most challenging component of the media industry. Book publishers, by all accounts, face a tremendously difficult environment: they’re squeezed by retailers like Barnes & Noble & Borders who can extract ridiculously high marketing payments given their scale. Costs are high and returns are low for most titles thanks to the fact that successful authors-J.K. Rowling, Stephen King, Tom Clancy--who can guarantee a best seller are rare and expensive. It’s safe to say that if you were picking growth stocks, book publishers wouldn’t be among them.

However, while it’s difficult to make money in publishing, it’s by no means impossible, as Bertelsmann proved back in the go-go days of the 1990s. While most people today think of Bertelsmann as the company that made seemingly ill-advised investments in Napster, and lost its CEO—Thomas Middlehoff—in yet another example of a synergy-obsessed media firm run amuck, the reality is a little bit more complicated than that. At a time when most pundits assumed it was next to impossible for firms—particularly big conglomerates like Bertelsmann—to turn a profit in publishing, Bertelsmann devised a data-driven strategy that proved them all wrong.

Every publisher understands that the most profitable areas of its business are its backlist titles (e.g. older titles that no longer require significant marketing expenditures) and any book sold via a “non-traditional” channel (e.g. books that are sold outside of Barnes & Noble or Borders, and don’t require big marketing expenditures or the risk of returnables.) In this sense, publishing is no different than any other aspect of the media business. Movie studios, video game firms, and the music industry make much greater profits on any DVD, software, or CD that they can sell direct to the consumer, simply because they don’t have to share the mark-up with the middleman (the retailer), and moreover, because they don’t have to build awareness of those products with expensive marketing $. (If you want a CD, book, or DVD that’s more than one-to-two years old, you’re likely a more hardcore fan of that particularly genre, and will seek it out without the assistance of an advertisement.) The hard part with this model is that although your margins are greater when you sell older titles or via non-traditional channels, your total revenues are much smaller.

What made Bertelsmann’s publishing arm—Bantam Doubleday Dell and Random House—unique was that it was able to sell plenty of backlist and toplist (recently published bestsellers) books directly to the consumer, thereby turning a healthy profit on strong sales in the process. It accomplished this via creating a comprehensive series of book clubs that catered to individual tastes—cooking, science fiction, religion/spirituality, etc. By signing up for a book club, customers would receive the books at a slight discount (a discount that still enabled Bertelsmann to make vastly more money than they would if they’d sold the books via a traditional channel like Barnes & Noble, since books tend to have a mark-up of 100% or greater). After it had lured customers to join its book clubs—and it was able to get some 25m to sign up—Bertelsmann developed profiles based upon customer data to offer books that it thought consumers might want based on their purchase history. Bertelsmann’s collection and use of data offered two benefits. First, was able to sell many times more books via book clubs than had ever been accomplished, and it soon applied the model throughout its business.

Secondly, it was able to improve its margins in traditional retail channels, by using sales data to better manage its inventory and run a just-in-time production/stocking model, which held the cost of returnables and marketing expenses to reasonable levels. Bertelsmann’s success gathering data in publishing soon led it to apply the book club model to other aspects of its business from its music division (BMG) to its magazines (Gruner & Jahr, the publisher of Rosie, Fast Company, and Lucky, amongst other things).

Bertelsmann’s commitment to data was what made it unique amongst all media companies. Unlike AOL Time Warner or Vivendi, which focused on the “sexy” side of synergy (making risky bets at cross-platform promotion), Bertelsmann focused on the “unsexy” side of synergy. Bertelsmann was obsessively focused at integrating data from a wide variety of media divisions to develop a more comprehensive understanding of its customers, and further cross-selling to them. This single-minded focus on data was what led Bertelsmann to acquire a 50% stake in BarnesandNoble.com (so as to further understand the purchasing habits of its customers) and acquire Napster—a database of the music-listening habits of 20m+ users—on the cheap after Marilyn Patel had issued an unfavorable judgement against the customer. The whole idea governing Bertelsmann’s success was that it would have such a great understanding of its customers that it would be able to cross-sell anything at a profit to its customer base. Eventually, it might even be able to exist as a high-margin infomediary, spinning off the costly content production parts of its business, and selling the products of those pieces and its competitors, since its core competency would be understanding its customers.

However, as cool as Bertelsmann’s media strategy was, the company on the whole wasn’t so hip to data and the unsexy side of synergy. Bertelsmann’s corporate structure is completely unlike almost every other company on the planet: the majority of the company’s stock is owned by a family-run not-for-profit corporation. Although the owners of the business were happy to see Bertelsmann’s business grow during the boom years, the failure of Napster to deliver an immediate impact in terms of revenues looked to them to be a misguided attempt to be hip in the post-dot-com era. Notwithstanding the fact that the Napster purchase was basically a $20m investment to acquire one of the richest databases available in the world, Bertelsmann’s owners unceremoniously demanded, and received, the resignation of Thomas Middlehoff last summer. This has lead many to conclude that media conglomerates of all stripes—both sexy-synergy and unsexy-synergy obsessed—were bad things and doomed to failure. However, don’t believe the hype: Bertelsmann’s success with book publishing, and its continued success to date (it’s still the only major media firm to be turning a significant profit) shows that a single-minded approach to the unsexy side of synergy—sharing data across divisions—and leadership that can impose the importance of living and breathing that data, provides a model for all media businesses to emulate.


::: posted by Matthew at 1:11 PM



Friday, January 24, 2003 :::
 
When I opened my inbox this morning and started my daily ritual of deleting spam, I was struck from a notice from American Airlines, regarding “By Invitation Only.” (I think this note was lodged between an offer for a great mortgage offer from “Julia” and another message from “Reggie” about something lascivious...y’know, the usual stuff.) Since the note was from American, I opened it, possibly hoping that inside lay some great offers for cut-rate travel driven by American’s less-than-stellar financial results earlier this week (a $1.4 billion loss and a sense that things are going to get a lot worse for AA before they get better...). Instead of cheap fares, however, I found something far more interesting.

The email informed me that American, Hilton HHonors, Delta, Hertz, Blockbuster, and Vail Resorts are in the process of banding together to offer rewards for reading email, and that since I was an American Advantage Platinum member, I was invited to join. The value proposition? I’d receive free frequent flyer miles. Since I’m curious about marketing promotions and customer data-initiatives, and since I’m about to drop down from Platinum to Gold status, and am desperately trying to retain my privileged flying status, my ears perked up at this offer. I clicked through to the sign-up page, and was presented with an application form to something called “E-Rewards.com.”

E-Rewards.com is pretty ingenious. It was founded by Hal Brierley, who’s famous primarily for coming up with the whole concept of frequent flyer and customer loyalty programs in the airline Industry, and is backed by another Briereley business, and the WPP group, home of Sir Martin Sorrell. The basic principle governing it is as follows: you fill out detailed surveys about yourself on a semi-regular basis, and E-Rewards provides this information to its partners, thereby allowing its partners to market to you more effectively. In exchange, E-Rewards provides you, the customer, with small financial rewards (coupons) that can be redeemed on the website for things like frequent flyer points, free hotel stays, free movie rentals, etc.

The idea behind E-Rewards isn’t wholly new: two companies called Beenz.com and Flooz.com tried to do something similar a few years ago, by attempting to lure you to click banner adds in exchange for virtual cash (embarrassingly called “Flooz” or “Beenz”) that you could spend at similarly lame dot-com partners. However, the execution is vastly superior: first and foremost, the “rewards” for participating (frequent flyer miles) are much more enticing than, say, a lame $20 gift certificate to pets.com. Secondly, the amount, and depth, of information they collect is hugely valuable: over the course of the survey, I was asked the standard demo questions (age, sex, profession, income, zip code), followed by a few pages of questions assessing where I was in my life today: e.g. how many trips I make, what types of major purchases am I planning to make, and when, the relevance of certain leisure & work activities to me, etc. In other words, their survey was written by somebody who not only knows the right type of questions to ask, but somebody who values long-term data. This information was subsequently handed over to American Airlines so that they can market to me more effectively (by sending me better promotions, travel offers, or selling my information to partners who might find somebody with my interests a better prospect than they do.)

What I like about E-Rewards is that its business model naturally creates a virtuous circle of customer data collection. They initially grab a ton of information about potential high value customers, which they can subsequently supply to their partners for marketing purposes. With each survey they do for each partner, their level of knowledge of you becomes more complete, and more accurate, thus increasing its value across the board. This should enable them to attract more partners, and consequently more rewards (or incentives) for you to participate with them, thus raising switching costs (if all of your rewards are located with E-Rewards, it’s theoretically less likely that you’ll switch to a competitor), thereby erecting a nice barrier to entry for competitors. Moreover, their business neatly sidesteps many of the privacy concerns that a substitute product—something like American Express Rewards—faces. Unlike AmEx Rewards, which runs a similar program with its partners—pay a fee, and AmEx supplies your basic demo information to marketing partners in exchange for points that you can use to purchase rewards (good ones—things like decent TVs, stereo equipment, or coupons for Blood Bath & Beyond...), E-Rewards makes it clear that it is giving up all of your information to its partners from the get-go, and you get to choose what you provide. American Express can’t share—although they’d like to—the really great information they have about your purchasing behavior, because of The Privacy Act and concerns about consumer revolt; E-Rewards collects less sensitive, but still equally valuable data from you, and gets you to volunteer it over to there partners...Nice and slick-like, huh?

The best part of E-Rewards, as I see it, is that it provides a way for other, smaller companies to compete with the vast depositories of information that a firm like Amazon.com, or Wal-Mart, has. Customer data will prove to be a powerful competitive advantage, if only because it’s so hard for competitors to acquire from a financial, technological, and organizational perspective, and because it’s vital to your success. And knowing who your key customers are not only helps you keep costs down (by marketing more efficiently), it also helps you build a brand (rewarding those who are most likely to be your best customers). E-Rewards provides a nice way for a business to get up to speed relatively quickly, and although I’m sure their prices are low right now—given the fact that they’re just starting out—they’re going to be steep indeed in the future, when more businesses have wised up and signed on. Cool beans indeed.


::: posted by Matthew at 1:39 PM



Friday, January 10, 2003 :::
 
Ages ago, I promised that I’d write a blog about the virtues customer data can confer on a business. I was derailed by several projects, scribbling the first few chapters of our book (hopefully to be completed by July 2003), and the cold onslaught of Christmas holidays. (Not that I’m complaining about being busy, especially given today’s wintry economic climate... In any event, I’m still convinced that in the long run, companies that are able to institute effective customer data collection programs, and effectively manipulate the data they find are likely to dominate their respective industries.

Customer data is important primarily because it enables a firm to know the needs, fears, and desires of their customers from a quantitative perspective, and up-sell or cross-sell products and services more effectively. “Knowing” your customers better than anybody else has always been an effective competitive advantage, but with the rise of technology, it’s become feasible to know your customers to such a fine detail, and manipulate this knowledge as to create virtually infinite possibilities for outmatching your competition. Most obviously, being able to effectively collect and mine customer data can enable you to increase your marketing effectiveness (by allowing you to tailor online promotions or email marketing more effectively, or even allowing you to shape offline promotions—direct mailings, catalogs, etc, thereby increasing ROI). Moreover, by providing your customers with more relevant marketing messages and/or promotions, you can garner several intangible benefits for your business—increased customer loyalty, a superior customer experience, even becoming integral to your customer’s lives.

Although there are several companies that have achieved success by orienting their corporate strategy around the importance of customer data, my favorite example is Amazon.com .The fact that Amazon.com stands on the cusp of profitability—it’s expected to turn its first ever yearly profit on January 23, when it releases its results—is in large part due to its ability to capture, manage and manipulate data better than virtually any other company, whether it’s retail or non-retail, online or offline. And it’s clear that despite some missteps through the dot-com bubble—ill-advised forays into selling e-commerce unfriendly items like rakes and construction equipment, that took hours to package, and were exorbitantly expensive to ship, for example—a retrospective examination of Amazon’s strategy reveals that there’s been a method to Amazon’s madness all along: hitching their wagon to customer data.


Amazon’s most famous “killer app” is its famous “recommendations” system. This system enables you makes recommendations as to what you might like to purchase based on what you’ve bought in the past, and how much information you disclose to the system. When it first launched in 1997, it looked somewhat gimmicky and even cheesy—sure, it’s great to know that customers who bought a DVD of Goodfellas also bought the Sopranos—but the sophistication of this feature (especially after five years of constant refinements and upgrades) is what truly sets Amazon apart. First and foremost, it facilitates lots of cross-selling opportunities, which allows Amazon to consistently increase revenue and the likelihood of its consumers purchasing. Because the tool has become so useful—it can be used as a way for music afficianados, DVD buffs or avid readers to discover new things that they may not have heard of—it increases the chance of impulse buying for those individuals, as well as provides them for incentive for repeat visits (thereby establishing the basis for brand loyalty). But most importantly, it creates a fantastic virtuous circle for Amazon, wherein each sale or store visit increases the amount of data that Amazon collects about each of its shoppers, thereby enabling Amazon to paint a more complete picture of each shopper meaning that it becomes easier for Amazon to offer relevant products and a more personalized experience to that individual, consequently increasing sales, loyalty, and starting the cycle over and over again.

The sheer amount of data that Amazon has accumulated on its customers has placed it an enviable position of being able to potentially act as a broker between its fiercely loyal customers and any business that wants to sell or reach those customers. When Amazon becomes permanently profitable in the next few weeks, a large part of its success can be attributed to the fact that it’s increasingly becoming to slip into the wide-eyed parlance of New Economy celebrant Geoffrey Moore, weightless. By making the capture and manipulation of customer data its core competency, and by ensuring it knows more about the customers in an industry more than its competitors do, Amazon has been able to sell itself to its competitors as a partner and gateway to the online market. In the last two-three years, Amazon has partnered with such firms as Circuit City, Toys R’Us, Virgin Megastores, Borders (!), the Gap, Marshall Fields, and Office Depot in agreements where Amazon uses its “online retail expertise” (read: ability to sell via customer data) and its fulfillment capabilities to sell the merchandise of those firms online. In exchange, Amazon receives much superior margins (not having to hold or sell the inventory of its partners), while also gaining access to a broader array of products and services to sell (without the risk), that further provide Amazon with a means of expanding its virtuous circle of customer data collection (more opportunities to sell), thus increasing its partners dependency on it (Amazon now knows even more than its competitor/partners about their consumers). Amazon has been gradually evolving from a retailer to a middleman, with all the higher margins and financial rewards that position implies.

So how come Amazon’s model hasn’t been copied by virtually every retailer under the sun? Or alternatively, how come Amazon’s brick-and-mortar competitors—e.g. Target (now an Amazon partner), Sears, Barnes & Noble, Tower, Walmart, Virgin (also an Amazon partner)—didn’t get to Amazon’s position as a middleman first? At the risk of oversimplifying these questions, I’d argue that a significant part of what enabled Amazon to lead the market was its organization-wide focus on customer data collection. Although you’d think it would be a fait accompli that any retailer could copy Amazon’s success, it’s actually much harder than it appears. First, a good customer data collection program is the product of something that’s called in the zany world of personalization software and database management, this is something called “Collaborative Filtering.” Basically, this means that you not only have to develop or buy customer relationship management (CRM) software that runs algorithms that facilitate the comparison of purchases, in order to understand what to “recommend” or cross-sell to your customer base. However, you also have to make certain that the data you have is useable—data that’s in old databases (called “warehouses” in the industry) will rarely play nice with the newer CRM software without several million dollars of upgrades; moreover you must design and organize processes and positions to ensure that each transaction you complete returns data to the customer data collection you’ve designed. Finally, you’ve got to be willing to fight a war for market share from the get go, just to ensure that your database is as large or larger (and therefore more rich and valuable) than your competitors.

Amazon’s success with customer data, therefore, is as much a result of solid organizational leadership (all hail Jeff Bezos and his management team!) In order to ensure that Amazon accomplish genuine success via customer data, strategies and belief in the value of customer data had to be established from the get-go. For example, Sears has one of the largest repositories of data in the world through its Sears Credit Cards—something like 40 million Sears Card holders have made purchases over the last 10 years, which makes a very rich database indeed. Unfortunately for Sears’, that data is largely unuseable, locked away in “legacy” databases that could not easily facilitate one-to-one customized marketing promotions, campaigns, or a rich individualized customer experience that builds loyalty and sales. Contrastingly, Amazon’s data was designed to be useable from the get-go: not only did they work to capture the right information, they ensured that the information they captured was useable (maintaining a legion of database management people, for example) and rewarded people accordingly for using it. This commitment to data fueled Amazon’s flight from dot-com folly to dot-com success.

When Amazon reports its profitable Christmas season in a few weeks, you’ll probably read and hear alot about how this past Christmas was particularly good to “online retailers,” as Americans stayed away from traditional brick-and-mortars, and preferred to simply shop via the Internet. Keep in mind that implicit in these statements is the idea that Americans shopped online because of the greater relevance and superior customer experience of AAA online retailers like Amazon.com, an experience that by and large has been fueled by an ongoing commitment to knowing its customers via capturing customer data.

Next week (or thereabouts), I’m going to write about how a commitment to customer data collection is going to be vital for the survival of media & entertainment industry. (Just because next week is the Annual Celebration of Hyperbole in Iceland). But anyways, be sure to check in regularly—we’ve devised a schedule that should ensure that our blogs are going to be published more frequently, and more regularly. Ideally, we’ll have new ideas and opinions for you each and every Friday afternoon.





::: posted by Matthew at 2:18 PM

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Ruminations on competitive strategy, culture and customer value from the members of Peacock Nine