Richard's and Laura's Blog

A Defense of Bad Profits

info@netpromoter.com — Mon, 09 Jan 2012 23:08:08 GMT

“I’m bad to the bone”
George Thorogood

Investing your entire 401k in Enron stock.

Marketing Las Vegas as a “family friendly” destination.

Microsoft Bob.

Amongst the worst business ideas ever, customer experience zealots add “dependence on bad profits”. For the Net Promoterati, the label of “bad profits” is wielded like a medieval mob scene accusing an unpopular villager of witchcraft. It’s time to break out the pitchforks and torches.

I’m here to tell you it’s all wrong. Leave bad profits alone. What did they ever do to you? (Except reduce your NPS, of course.)

The latest assault on bad profits is from the UK government. Say what you want about murderers or perpetrators of mayhem, the British media hath no fury like a consumer wronged. It is thus that the BBC gleefully informed me that the government is working to stamp out the practice of charging fees that are “in excess”. Consumer groups welcomed the news. “Drip pricing” is going to be regulated. No, we are not charging for drips, it’s the unconscionable practice of revealing more and more incremental pricing as you go through the purchasing transaction. (for a humorous, but rude take on this, see the following Fascinating Aida video).

What’s next? Regulating the shipping and handling when you get “free” additional Shamwow products? Overdraft fees. Interest rates that you might think come with a broken kneecap clause. Exorbitant roaming fees if you use your mobile phone while overseas. The government needs to step in and put an end to it now! Any government, please.

My fists turn white with rage. Well, at least I’m mildly upset. I welcome bad profits. We need them to create opportunity and differential performance: your bad profits are someone else’s large, untapped customer base.

Of course, I’m not in favor of deceptive practices. Forcing transparency is a legitimate role for regulators and nobody would condone dishonesty. But think for a second where “bad profit regulation” leads us.

Take airline fees for bag check-in. Ban them. It might cost the airline $10 to fly your bags from San Francisco to New York. That might even turn out to be the flight you are on (no extra fee, yet). If they choose to charge you $50 it’s time to call in the Feds. Or MI6 perhaps. Surely airlines should only make profits from selling seats on the plane! Overpriced drinks and airplane internet services look pretty profitable also, why are they not free with the flight? Time to force airlines to adopt single-dimension pricing strategies. Then we can get after the banks, no way we should have to pay overdraft fees. Or at least, they should be something more reasonable – after all, providing an overdraft is not really a business good is it? Not like, say, buying virtual livestock on Farmville. Which should also be free, or at virtual cost, while we are at it.

I hope the problem is obvious. What constitutes fees, bundled versus unbundled products and services, “unfair pricing” – what’s fair margin on a Gucci handbag? – all these aspects of good and bad profits need to be resolved by the market, not by regulation. Sure, force disclosure. Ensure costs are not hidden from the customer. But then let customers decide.

Bad profits are a massive source of innovation and entrepreneurial activity. Netflix built a business due to Blockbuster’s overdependence on late fees. Southwest Airlines relies on “bags fly free” as a differential pricing strategy. Skype persuaded us that almost any profits on phone calls would prove to be bad.

If you don’t like the particular flavor of profits you generate for a business, take your business somewhere else. It’s quite possible that others don’t share your priorities and feel that it’s a reasonable way to make money for shareholders and deliver value to customers. The market will decide and, if those profits really are “bad”, you can bet the next Scott Hastings will be building a company to capitalize on them.

Bag Wars III: The Airline Strikes Back

info@netpromoter.com — Mon, 19 Apr 2010 16:22:06 GMT

It was inevitable, I suppose. Spirit Air steps up to the plate with a fee for carry-on baggage leaving passengers no doubt arbitraging between check-in and carry-on bag rates. Weighted, of course, by the probability of enforcement, or your ability to persuade the flight crew that the refrigerator box with a gaffer-taped handle and fake “Tumi” logo will, in fact, fit in the overhead bin. In England, your “bin” means your trash can, which seems very fitting.

Anything you can do, Ryanair can do better. Time to look at charging for using the loo, it turns out. I’m not sure if it’s the money or the symbolism for Ryanair; I sort of imagine a group of execs sitting around brainstorming new cost saving ideas and coming up with that one. “The PR value of the announcement is worth more than the cost of implementation” would seem like a good argument, from the school of PR that suggests any time they can spell your name correctly is good PR….

Our instant reaction is horror. What a recipe for Detractors. If Richard Branson seems to be the epitome of an airline executive who practices an NPS mindset, Michael O’Leary, the highly quotable CEO of Ryanair is his mirror; playing Darth Vader to Branson’s Skywalker. And yes, I know those two ended up on the same side.

O’Leary seems to covet the role of villain. If you ran a root cause analysis on Detractors at Ryanair (I’m not necessarily going out on a limb by suggesting they might not do this), their strict no-refund policy would show up as a key driver. Addressing his #1 complaint, O’Leary framed this closed loop response this way: “… say my granny fell ill. What part of no refund don’t you understand?”

So that’s conclusive, book closed. We, the judge jury and executioner of performance in NPS land can confidently predict that they are out of business. And we should assume Spirit Air is going the same way, after all, they seem to be following the same logic.

Except that it works for Ryanair, and it might just work for Spirit. Works? It works spectacularly. Ryanair market capitalization exceeds that of BA, Lufthansa and Air France (although admittedly, that’s not a strong industry group for shareprice and profits have been beaten down recently). So NPS must not work. Ryanair MUST have low NPS and yet they are winning.

Perhaps it’s the exception that proves the rule?

Possibly, but you can build a plausible argument that both Ryanair and Spirit are right in their choices. The governing factor of course is price – providing the ultimate context for NPS.

Here’s how it works. NPS is measured by individuals in the context of expectations; we have a notion of what we expect based on marketing and prior experience with products and services. This is not the same as what we want. I want my cable guy to show up 10 minutes after the my request to fix my service; I expect him to show up on a scheduled date as promised. Actually, for my cable guy I expect him to randomly arrive exactly when I’m not available … but I digress. What we expect is the context in which NPS gets formed.

And we know that expectations get shifted by many factors – but price is the biggie. Shift the price, shift the expectations - after all, it’s the only numeric comparative component we have for products and services. Ryanair and Spirit are embarking on a strategy to reduce price so dramatically that their expectations are rock bottom. In this instance it might be “Ryanair will phyically move me to my destination safely, at some time during a given 24 hour period”. These expectations may be elegantly aligned with a $5 airfare. Against that expectation – bingo – Ryainair exceeds and creates Promoters.

Baggage policies on the surface however, look like bad profits. However, that’s only in the context of prior industry expectations. There is no logical business reason that you should have a bundled baggage allowance; I say bundled, not free, as you are paying for it somewhere in the ticket price. The reason it’s a change at all is simply because airlines traditionally – in an era of much less competitive prices and costs – bundled a lot of services (including use of the toilet). Our expectations have been formed on that traditional industry model, not for any inherently logical reason but just because of tradition. In fact, you could make the argument that it makes more sense to charge for carry on bags, as you are simply segmenting your customer base and providing a discount for customers who don’t use that facility! In fact, many of Spirit’s customers wrote in to favorably make exactly that point…. activated Promoters in action?

The bad profits argument can be overplayed. Just about any type of fee or charge could be considered bad profits, yet logically there is no reason we should penalize one particular pricing mechanism – unbundling in this case – from another. Rather, I would suggest we gauge bad profits against the measure of transparency and expectation. On both counts, you could build a case that Ryanair is in good shape. You could argue their website is one constant upsell game, but where is the crime there? On the contrary, you could argue that Ryanair comes closer to transparency in their brand promise than full service airlines that advertise the opportunity to fly in a state of nirvana as you are pampered by exemplary service.

Many companies understand that the best way to create an army of Promoters is to change expectations in an industry. Usually that’s upwards – through creation of a breakthrough product or service. In the airline industry, it just might be downwards through expectation reduction and low fares.

As O’Leary puts it: “The European consumer would crawl naked over broken glass to get low fares.” Sounds like low expectations of service that perhaps even Ryanair can deliver on.

Another Hazard from Bad Profits: Uncle Sam

info@netpromoter.com — Fri, 22 May 2009 23:30:13 GMT

If the market doesn’t punish you for bad profits, Uncle Sam might.

Wall Street is scrambling to understand the financial implications of the Obama administrations new policies towards credit card companies. Reading the definition of revenue sources that will be restricted in the future, it reads awfully like a list of classic bad profits. According to the Wall Street Journal (subscription required), the credit card companies most affected are those who rely on “… portfolios that are skewed toward late-payment fees, over-limit fees and penalty repricing”. Yup. Sounds like bad profits to me. Sounds like they are getting what was coming to them.

But hold on.

If this practice was so bad, why did the market not simply take care of the issue? The argument for government involvement is usually around market failure; why did the armies of detractors of these credit card companies not bring them to their knees? Faced with such disaster, wouldn’t the executive leadership eliminate this scourge of their business?

From our studies in the credit card space, we do know that these practices create detractors, churn and low profits. One plausible explanation of the industry failure to self-address, is the absence of players who have chosen to capitalize on an alternative competitive strategy. In the airline industry, one airline charges for bags and another instantly responds with advertising that it is “bag charge free”. This has not happened to the same degree with credit cards (although I would welcome examples to the contrary). It’s plausible that the segment of customers who are being hit with these bad profits are either so unattractive that the high NPS players don’t want them, or they self select bad profit providers through lack of financial understanding (hence the argument for regulation around opaque rules by the issuer).

At a more macro level, the response to Blockbuster Video’s “late fees” was the creation of Netflix. If existing competitors don’t want to eliminate bad profits, sooner or later new entrants will. It would be ironic if the US government’s efforts to eliminate bad profits simply displaced new entrants into the market.