The Vapid Business Models Of The New Economy
I have been working in the online world in one fashion or another since pretty much before there was an online world. My first business venture with friends was well over 30 years ago, with 300 baud dial up modems and an HP mini computer serving up text based games, chat, and mail. That was a long time before there was a public internet, and just about the same time as the first of the BBS (computer bulletin board systems) came around. The result of all of this is that I have seen business models come and go, some good and some not so good.
One of the things that I have come to realize is that for all the hand waving and cheering, the internet actually isn’t all that good for the economy in so many ways. It’s funny to think that the very thing that has generated so much apparent wealth for founders of companies like Google and Facebook is actually one of the larger causes in my opinion of our current worldwide economic malaise. Simply put, the internet is killing off margins and killing off entry level jobs.
What prompted me to consider this is the recent spate of brick and mortar store closings announced by some of the biggest retailers in the US. Radio Shack is closing a mind numbing 1000 locations, and even premium “category killer” stores like Toys’R’Us are shuttering locations. We don’t have to think back that far to have seen the collapse of national electronic and book retailers as well. The knock on effect here is that retail space was once a premium product, now most companies lease retail space are facing declining revnues, more vacancies, and much less demand. Having all of these locations from Radio Shack, Sears, and others come online in the next 12 months is only going to make this situation worse.
There is a knock on effect on this stuff as well, because generally for every big store in a mall, you have a certain numbers of other stores that are around as well. Your typical small mall may be two anchors (big tenants) and 40-50 stores in the middle, everything from food service and dry cleaning to book and clothing stores. When you lose an anchor, you lose traffic to that part of the mall, those retailers lose public demand, and eventually they too much move or die. When one of those dies, it takes out a job or two or three, and the knock on effect is fully in play.
The other thing that got me of course is the death of record stories, video stores, and a large number of local and regional book stores. These are the places where you see the most obvious effects from the internet. Each of these types of businesses have been lost to a combination of national online retailers (Amazon is a biggie here), along with digital content delivery and the ever present piracy issues. What has been lost isn’t just the businesses, but those wonderful entry level and mid level jobs that kept so many people working and getting paid. Many people made a career out of managing a record or book store, getting a reasonable income and enjoying what they did. That is all but gone now, victims of the margins getting cut out by companies willing to work for pennies on the dollar with as little staff as possible.
If you think that the digital world means it’s all good for electronics and gaming retailers, you would have to guess again. Even massive national brands like Best Buy are having a very hard time to compete against the online world, they are seeing their stores being used more and more for showrooming, which is when people come in to physically look at the product but not buy, and then losing the sale to online retailers who deliver the next day at a lower price due to lower overhead. That is the first place where I realized that there was some pretty vapid business models in play here, because the online retailers model works only because of the physical store retailers eating a lot of expenses to be their unofficial showrooms. Realizing and understanding that very simple point, I came to realize that much of the online world faces the same problem.
Many of the current business models are built on the idea that there is a strong physical world market with lots of margin out there, willing to support all of the things that online companies can’t do themselves. Those higher margin real world companies are suppose to be the ones buy the advertising, providing the show room space, and so on. Yet, most online retailers make their money by gutting real world sales, which takes the very money out that pays for those things. Amazon.com doesn’t have the money, the margin, or the desire to open a showroom in every city and town in America, it would decimate their business. Yet without the current retailers who end up showrooming for many of their bigger ticket items, they would have less chance to sell to start with.
Another gap business model that actually appears to have risk is the video streaming model such as Netflix. Their original market, DVDs through the mail, was a pretty solid direct on competitor for the video rental places, and they did a good enough job that they eroded that business pretty well (and piracy did the rest, it seems). Now everything from the Blockbusters to the mom and pop video stores are basically gone, an entire marketplace killed off. As if that model wasn’t bad enough with a typical 3 – 4 day turn around on DVDs, their newer streaming business model turn the video store of the past into an all you can eat buffet, served up instantly. Oh yeah, for a fixed rate a month. So while a past netflix DVD subscriber might have gone though ten or a dozen videos a month before, now they can watch every night, twice a night, whatever they like, for a fixed price that is about the same as what a video rental place might have charged you for a couple of videos for the weekend. Needless to say, with all of those video stores closing, a whole army of people have been pushed out of work. Moreover, the Netflix models potentially are creating harm to the retail DVD sales market, which was in the past an integral part of paying to make the sorts of movies people want to see. That loss of income is offset to a point by income from Netflix, but it appears on first blush to be trading dollars for pennies again.
The most vapid and most self defeating business model of all is Piracy. You can find plenty of articles that show how pirate sites are making money selling access to content. It always comes with some wag saying “look, why don’t the studios do this and make money?”. Those people of course don’t realize that the only reason a piracy site is profitable is because they don’t actually pay for the products they sell (or sell access to). They don’t contribute to the costs of making movies, they don’t actually put any money into the ecosystem, they just pile their money in their pockets. Selling access to a retail $20 video for a couple of cents will make you a pile of money on volume but what was actually lost on the other side is overwhelming.
The funniest part for me is people who say “make it up in volume”. This is perhaps the most dishonest argument around to support a business model, because it ignores two very baic things: There are a limited number of consumers, and they have a limited amount of time to enjoy the content. While the step up in consumption on the Netflix model from a half a dozen to a dozen or move movies a month is possible, it doesn’t scale. If you stop selling $20 DVDs and start streaming them for even $1, you would need the public’s consumption to rise well more than 40 times to see the same sort of net income, once you allow for costs like accounting, distribution, and processing. That would be an absolutely stunning increase in the amount of public consumption of content that does not compute well against our limited free time.
Now, in the limited scope of Netflix versus video rental versus DVD purchase, there is some space here for a market. Most of the studios have allowed for it to some extent, signing agreements with Netflix for certain amounts. The amounts appear to be much less than the retail DVD sales, but it is some income and in the face of piracy (the other side of the game), something would appear to be better than nothing. Cannibalizing the rental market and the retail DVD market is the price paid.
However, things won’t stop there. The acceleration of internet speeds and the fact that almost everyone in the US now has a digital hi-def TV starts to pick away at the market for the movie theaters. While the industry has covered up a nearly consistent decade long slide in attendance at the movies by selling more higher cost 3D and Imax tickets, the “record sales” ring hallow when you realize how many people just don’t go to the movies anymore. Making money money from less people is the sign of a product where more and more people don’t see the price point as being acceptable. While we aren’t there yet, it’s clearly possible, probable, and almost inevitable that first run movies will start to be streamed directly to the consumer, and no doubt it will be at a price point many times lower than the current theater ticket prices. This is doubly painful as theaters charge by the head to get in, where as streaming charges per view (or per block) so when you have movie night at home with 4 of your friends over, and the cost is half of a single ticket price… you can see where things go poorly. Again, there is no infinite number of people to steam these movies, the public is a limiting force, and moreover the public that is interested in the movie is an equally limiting force. SO there may be 300 million or so people who COULD watch the movie, but maybe only a few million who are interested in the product. When two of them watch together on average, that potential market gets smaller, not larger.
Put another way: Just because a movie is streaming doesn’t suddenly mean that the market became infinite, nor did demand suddenly increase so much as to make up for what is lost on the other side.
Now, the real pain of the internet isn’t just in what happens to the the movie companies, it’s all down the line, from the theater owner to the high school kid working as an usher to the guy who delivers the popcorn and soda. Their market diminishes, they lose their jobs, and there are no jobs out there to replace them. The videos are being streamed from another part of the country, there is no local market. They can’t go back and work at the mall because the stores are closing. They can’t go work at Mcdonalds either, because even the restaurant business is suffering because people don’t have money in their pockets to spend.
Where does the money go? Well, for companies like Google (who sell ads all over the internet including on this site), their income doesn’t stay in the US and create US jobs, it usually gets moved offshore, held in countries with low tax rates. That money isn’t going back into the US economy, it’s going away and it’s not coming back. Even when the money stays in the country, it doesn’t stay in your town or city. It doesn’t drive the local economy.
This is actually pretty much on par with the industrial revolution of 120 or so years ago. The difference this time is that the driver is vapid business models that cannot work without the existing economy actually paying for things. The business models are low margin, high volume concepts that don’t actually earn enough to pay for the products they sell, rather they count on the real world stores and business to sell to some consumers at a higher price, effectively subsidizing their low price models. Without movie theaters, the Netflix model wouldn’t work because they just don’t have enough income to pay to have the content created at it’s current levels. Moreover, the hard hits on the economy with all of these failing retail business and creative businesses is that fewer people even have the money to pay for even the low dollar service. Like a snake eating it’s own tail, there is a point where thigns get too tight and bound up, and things stop.
Another interesting example of this is the idea of Uber and other driver services. They are turning the taxi, livery, and even limo markets on their ear, but they can do so only because they are ignoring the rules that exist for such services. They are also generally driving the price down, because their pricing doesn’t really have to have anything to do with anyone making money – they are making a flat percentage. Shaving 20 or 30% off of the standard cab fare for them is not a big deal, as they make up in volume what they lose in lower fares. But since the services don’t appear to be creating long term new taxi users, the net effect is very likely less total income in pool for all taxi drivers. For those who play ball with services like Uber, it may mean more fares, but with the decrease in revenue, it’s very likely that the cabbies are taking home less, not more – and working harder and using up their equipment faster.
It’s easy to be cheaper, especially when you ignore the rules and don’t worry so much about the net profitability of an industry. Short term, it’s impressive – long term, there seems to be a truly negative effect on the whole economy, as we see price deflation that is unrealistic compared to the costs of providing these services. Cars aren’t getting cheaper. Gas isn’t getting cheaper. It looks like the only thing left to be cheaper are the workers.
