This week I am in Silicon Valley, hosting the Technology Services World conference. There are over seven hundred professionals representing 200+ technology companies at this gathering. In my opening keynote, I again warned that the business models of tech providers were on the verge of dramatic change. The new consumption based pricing models will surely force this change. And we can look to other industries to see how new consumption models disrupt legacy business models.
The Record Industry
The chart below was published by Bain consulting and it maps the revenues of record companies over the years.
When the CD was introduced, customers were given a killer advance in listening technology—and they responded by buying tons of albums. However, ever since music became available one song at a time, record company revenues have been declining. Yes, piracy is a challenge. But you have to recognize that record companies had legacy business models built on making, marketing, and selling albums. As a listener, it did not matter if you only liked two songs from that new group. You were forced to purchase the entire album. When songs were decoupled from albums and customers were given the ability to only purchase the songs they really wanted, the business model of record companies imploded. New consumption model. New business models required.
The Airline Industry
In the airline industry, low cost carriers have always been around, nipping at the heels of established legacy carriers. However, the rules of consumption changed for the airline industry with the advent of web sites like Expedia. Suddenly, consumers were able to see the price being offered by all carriers, side by side, to fly to a location. To compete in this model, legacy carriers like American Airlines were forced to strip out various services that were previously bundled in the cost of the ticket. In this way, American could at least stay competitive on these web sites when customers shopped for an air fare. The challenge is that American did not strip out enough cost. They still needed to charge for these services. The graph below shows how much American charges for add on services vs. low cost carrier Jet Blue. As you can see, American is charging much more for the same services.
If you look at the business model of American vs. Jet Blue, you see that American spends more money (as a percentage of revenue) on only one category: labor. Those higher labor costs drive American to charge higher rates for the same services.
Charging more for the same thing is never a winning strategy. The brutal lesson from the airline industry: Your higher labor costs are not the customer’s problem.
When Consumption Models Change
The consumption models in the technology industry are changing at a high rate of speed. In my opening keynote, I referenced the dramatic pricing move made by Adobe. Adobe software that previously cost $2,600 per user is now available for $50 a month. At some point, the Adobe management team realized they had no choice but to adopt their business model to align with the new consumption models in technology. At some point, every technology company will need to cross that same bridge. Cross that bridge, or follow the record companies and airline companies that did not truly change their business models when customers changed their pattern of consumption.