Tuesday, September 16, 2014

Strategy is simple...become a monopolist

WSJ has an essay from the head of PayPal who reminds us that capturing value is more important than creating value:

...U.S. airline companies serve millions of passengers and create hundreds of billions of dollars of value each year. But in 2012, when the average airfare each way was $178, the airlines made only 37 cents per passenger trip. Compare them to Google,GOOGL -0.56% which creates less value but captures far more. Google brought in $50 billion in 2012 (versus $160 billion for the airlines), but it kept 21% of those revenues as profits—more than 100 times the airline industry's profit margin that year. Google makes so much money that it is now worth three times more than every U.S. airline combined.

Airline competition is so intense that firms capture only 1% of the value that they create.  Google has far less competition and is able to capture 20% of the value that they create.  20% of their smaller pie is worth way more than 1% of the airlines' larger pie.

MAXIM:  Creating value is only the first step.  You also have to figure out how to capture it.  


  1. The basic strategies to generate superior economic performance are laid out on page 119.
    • Cost reduction
    • Product Differentiation
    • Reduction in Competitive intensity
    In recent times we have seen competition intensify throughout markets. This has been led through the technological push and the need for product differentiation. Globalization has made the balance of resources shift to a more even level. There are no longer any secrets to production.
    At present, we are collectively reducing the elasticity f demand for products and thus exposing ourselves to constant increases in prices as they relate directly to the price over marginal cost. As we continue to push for technological advancements and design enhancements we continue to further remove cost reduction as a way to generate superior economic performance.
    Google is not charging every customer directly and so are able to force price hikes through that would ultimately shift demand if tried within the airline industry. Airlines are facing intense competition in an industry based on costly resources where the end product is homogenous. As the text lays it out, they have no way to secure any sustainable advantage.

  2. The interesting thing about airlines is that they have discovered a new way to generate a terrific amount of new revenues they’ve never had much of before: fee’s. United Airlines for example, collected over $5.3 billion in “ancillary” revenues in 2012 alone. So charges for extra services – food, seating upgrades, baggage and other fees – are the way airlines have discovered how to take additional value and turn into revenues and profits.

    Additionally, the airlines have more effectively marketed added value services and generating new revenues that drive profits right to the bottom line. For example, on United, for an eight dollar fee, hold an airline reservation for up to 7 days. I often pay for that value if I’m trying to book a flight but need to get some additional travel logistics worked out before I pay for the flights (which are generally non-refunable). During the course of booking a flight, I’m asked if I want to “upgrade” to a better seat for a about sixty-nine dollars.

    So for now, the airlines continue to mine value out of the extra services and the fees that go with them.


    Hetter, K. (2013, June 5). Airlines collect $27 billion beyond ticket revenue. CNN.Com. Retrieved from http://www.cnn.com/2013/06/05/travel/ancillary-revenue-fees-airlines/

    Froeb, L.M., McCann, B.T., Shor, M., & Ward, M.R. (2014). Managerial Economics: A Problem Solving Approach. Mason, OH: South-Western Cengage Learning.

  3. Assuming they are worth the money you are paying them, management consultants should advise executives on ways in which they can figure out how to become a monopoly (Froeb, McCann, Shor, & Ward, 2014). A monopoly owns the market and can set its own prices. Since there is no competition it can set a quantity and price that maximizes profits. Google has been able to capture about 68% of the search engine market and has considerably less global advertising market share. Although it would be difficult to define Google as a monopoly, it is able to keep ahead of competitive forces that erode profit and maintain a sustainable competitive advantage. Google CIO Ben Fried explains, that creating competitive advantage is incredibly important, but I think you need to be aware that differentiation doesn’t necessarily have to limit itself to competitive advantage. Competitive advantage is one important way in which a company can differentiate itself. Part of establishing a great company is establishing a unique culture. It’s critical to find what defines your company and makes it different (CIO Insight, 2009). For Google, it’s all about uniqueness and inelastic demand; the more unique your product is relative to other products the less elastic your demand is and the higher margin of price over marginal cost. This is advertising revenues for Google; a highly differentiated product and market share advantages allows Google to set quantities and price.

    Froeb, L. M., McCann, B. T., Shor, M., & Ward, M. R. (2014). Managerial Economics: A problem Solving Approach. United States of America: South-Western Cengage Learning.

    GOOGLE it: IT'S COMPETITIVE ADVANTAGE. (2009). CIO Insight, (110), 24-27.

  4. Traditional airline pricing models are so much different from Google. Airlines tend to be both elastic and inelastic depending on seat arrangement while national and regional economic conditions play a strong role on airline travel that also effect pricing. Google on the other hand derives revenue from advertising and licensing in most part using an infinite customer base that they allow to use their portals freely. Their customer access and activities creates datasets for analytic modeling by every industry (including the airlines) which used to increase revenue-seeking activities. National borders or even most economic conditions rarely influence google usages while even historical usage becomes valuable to all industries as well as governments.

    Airlines or even the broader industry of transportation mainly has derives its revenue from transporting customers and products of customers from point “A” to point “B” in the most cost efficient manner while heavily relying on accounting methods such as depreciation and government subsides policies. The economic argument especial behind subsidies is that it will insure airline operation continuation even at low marginal revenue returns during declining regional and national economic conditions. Even the price of fuel going up can dramatically affect how long an airline can keep operating due to the low threshold expose by marginal cost exceeding marginal revenue in a very short time span. Without a robust airline system, the broader economy would decline and eventually effect most industries including Google.

    Can the Airlines imitate Google’s capacity to capture value, probably not, should it be able too, certainly but that would have to include a new and increased product offering that will cause increase capitalization requirements. Should government subsides underwrite the capitalization is a debated choice so continued consolidations and even entry of new competition will shift the pendant for investors and value retention.


    (Froeb, McCann, Shor, & Ward, 2014)

  5. While Google and airlines may not be in a direct line of competition with one another, it is suggested that capturing value is determined by competition. Competitors within any organization are constantly seeking options that will allow them to pull ahead of the rest and capturing value is one possible advantage. Think about any successful organization, They may produce and sell a very popular product that many consumers seek, let's take a cell phone for example. While there are many competitors in this market, there are only a few who are the ones out there creating the value, while the others are taking those same ideas their competitors are using and making them available within their own products. That first organization is the one developing and design the new idea/product, while their competitors are reaping the rewards of the new offerings, without having to put in the full amount of work required. However, just because all of these organizations are offering this product/service, it does not necessarily mean that they are all going to profit on it. It is important that each firm attempts to minimize expenses in order to maximize profits. A few ways that some firms may do this is to capture value by either force of competition or by persuasion.

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  8. Is Netflix a monopoly? They have stiff competition from powerhouses like Hulu, Apple and Amazon, but they seem to be the service provided of choice. To keep one step ahead of the forces that erode profit, firms develop strategies to gain sustainable competitive advantage. Firms have a competitive advantage when they can a) deliver the same product or services benefits as their competitors but at a lower cost or b) deliver superior product or service benefits at a similar cost (Froeb ET all, pg. 126, 2014). That’s what our book says. Taking into consideration the popularity of the original programing available on Netflix, it is safe to assume that they have created a sustainable competitive advantage. It seems to me that everyone knows what Netflix is; it’s become a house hold name. I know people that generally refer to all VOD as Netflix, regardless of the actual service provider they are speaking about.
    Netflix is the big cheese of subscription VOD. There’s no argument that Reed Hastings and company have built a huge lead in the sector, with more than 40 million global subscribers. Now some analysts believe Netflix is on the cusp of cementing its No. 1 position for good with potential to have monopoly like control of the market. But it’s unlikely that the house that “House of Cards” helped build will occupy the SVOD throne forever, vanquishing any would be rivals forever (Spangler, 2014). So right now they are defiantly sustaining competitive advantage, but can anyone actually pass them up. How much original programming can its competitors actually obtain, how much original programming can actually be created? Half of the original programming that is available in the world is niche reality type shows worthy of binge watching only. That is the truth, these shows are really not all that valuable. Netflix has the lock on quality scripted and star powered programing that has true value. This type of programming is extremely expensive to produce and not something that everyone can actually create, making it rare also. Anyway the next decade or so should be very interesting as the future of home entertainment continues to transform.
    Froeb, L.M., McCann, B.T., Ward, M.R. & Shor, M. (2014). Managerial Economics: A Problem Solving Approach. Mason, Ohio: Southwestern Cengage Learning.
    Spangler, Todd. January 6, 2014 “Hollywood Won’t Let Netflix Become a Monopoly” retrieved on October 29, 2015 from www.variety.com