Disruptive Businesses and Stock Values

The Chicago Tribune featured a news item yesterday – “Microsoft tests subscription pricing for Office”. It’s no secret that Microsoft is moving Office from a software to a service platform to ward off competition from other services like Google Docs, Zoho etc. Now, instead of paying USD 150 and upwards for an Office Home edition, people can subscribe to Office on a pay-as-you-go model.

I don’t think Microsoft will be successful at penetrating the market with this paid subscription model, especially in a scenario where competitors like Google Docs are offering the product free-of-cost and allow an offline/online service. There is no differentiation here.

For a value investor, other than assets, and price-earning, the business model and consequent advantages are very important. Warren Buffett found brilliant business models in GEICO and NetJets – bigger moats than PEs or NCAVs by his own revelation. As I question Microsoft’s business model (and it’s advantages) on launching a subscription based model … the importance of pricing comes to the fore-front.

Pricing innovations have been in plenty in the Indian market –
– Reliance Communication’s Rs.500-per-month mobile pricing plan
– Deccan’s low cost venture caught Jet Airways and Indian Airlines off-guard
– Reliance Money flat fee broking accounts gave sweat beads to established players like ICICI Direct and Indiabulls
– ICICI Money2India remittance services played similar tricks with free money transfers from US (at the expense of money transfer branch)

Notice the common thread … all four examples listed here are services (or products converted to services).

So if Xerox could lease their copier machines and charge a royalty .. why cant a similar thing happen in the consumer durable space? Why cant an LG start installing air-conditioners at residences on a pay-as-you-go model? Say, consumers pay Rs. 1,000 per month (for a Rs. 20,000 unit) and LG will take back the unit when the consumer doesn’t want the “service” any longer. The consumer always has the option of keeping the entire unit for himself at a certain agreed price, which can further be financed.

Similarly, let me use the Reliance flat broking fees model on say, movie theaters. So the next time you go to a PVR, you don’t need to buy a ticket. You can flash you Rs. 600 per month movie pass and walk in. Of course, you will need to book a seat in advance using the PVR website. From a PVR point of view – they get fixed rental income for their theater seats (now, not worrying about capacity or selling seats at a lower cost). For one, I don’t understand why anyone can’t enter a movie theater without purchasing a ticket. Can’t I just walk in for having a cup of coffee there? (especially when everyone is watching a movie). Incidentally, this also means more revenue for theaters !

A case study : Netflix and Blockbuster

Alternate pricing models are not new, but what scares me is it’s ability to disrupt industries (and more importantly, my stock value). Take the Netflix v/s Blockbuster case. In May 2002 Blockbuster was trading at USD 30.00, when Netflix (with a USD 76 mm revenue and a disruptive business model) brought out it’s IPO. By Dec 2002, the Blockbuster stock was down to USD 13.00 and by Dec 2006, Blockbuster was trading at USD 5.00.

Currently the stock is priced at USD 2.88. This is irrespective of the fact that Blockbuster makes 4 times more revenue than Netflix and makes 400% more EBITDA. Inversely, Blockbuster’s m-cap trails that of Netflix by over 40%.

Ironically, 5 or 10 years from now, it’s quite possible that nobody will be renting DVD from a website (Netflix) or a store (Blockbuster). Today’s cable companies seem to have a powerful distribution network via the on-demand model, and there is no reason to think that every movie that Blockbuster and Netflix have could be part of a mass digital library, accessible to every customer who has a cable box. That’s the next phase of disruption!

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