American Airlines forgets their business model

American Airlines announced yesterday that they will pull out of the SAABRE reservations system that they founded in the 1970s.   While my predictions seldom come true, it seems, I’ll predict this is a bad decision for American.

SAABRE is the reservation system that allowed travel agents (and now online booking sites like Expedia and Travelocity) to have a one stop shop for flight searches.

In their decision to withdraw, American Airlines indicated that “air travel is not a commodity, and the current system doesn’t allow us to present our unique value”, to paraphrase.  It’s possible that American will not allow crawlers and meta-search engines like Kayak to search them either.  American Airlines will be an online island – just like Southwest Airlines.

American Airlines looks with jealousy at Southwest Airlines, which doesn’t participate in SAABRE and doesn’t pay its fees.  Southwest does most of their booking through their own website, and Southwest is also the most profitable airline in the industry.  With thin margins for air carriers, American wants to offer, direct to consumers, its “upgrades” including such luxuries as a meal, a second checked bag, and 3 inches of extra legroom in economy.

American Airlines has something very wrong here, and it’s something that many businesses screw up.  American Airlines misunderstands the business they are in.  They believe they are in a brand driven business.  Or they fervently hope they are in a brand driven business.  They are not.  Consumers are perhaps slightly more brand loyal to airlines than they are to concrete providers.  Consumers are instead largely schedule and price sensitive.

Online purchases can be drastically altered by the addition of an extra click or slow screen.  Ask any online retailer, and they can tell you the percent attrition in customers due to the placement of the “buy” button or the speed of their servers.

Southwest Airlines gets people to perform that extra set of clicks for one very simple reason:  Southwest is $50 – $200 less expensive than the competition on nearly any route you choose.  Southwest is essentially paying consumers to come to their website.  American Airlines is not.  American is charging consumers – in time and in dollars.  To believe that the average online consumer will spend extra time searching American Airlines indicates that there are still companies that don’t understand the internet.

My prediction:  in six months, American Airlines will slowly rejoin the fold.  Their revenues will have declined due to consumer’s reluctance to search them out.

The purpose of health insurance = expense smoothing

I recently went shopping for health insurance, and it reminded me of the reason for health insurance.  Health insurance is intended to smooth expenses.

Health insurance is identical in concept to a home mortgage, which smooths the expense of a house over 30 years.  Health insurance is identical in concept to a student loan, which spreads the costs of higher education across 10 years of (hopefully) higher income production.  Health insurance is identical in concept to savings, which can be paid into across multiple years and then used in times of need.

This is true in every country, from Bangladesh to the United States.  Expense smoothing is the purpose of insurance.

Thus, it is not realistic to expect that the cost of health insurance should be less than the cost of predicted health care.  There is no free lunch in this system.  If the last 6 months of life, on average, will cost $100,000 in hospitals, doctors, procedures, and drugs, that $100,000 needs to be paid into a health insurance system for the 30 years before that (or about $333 per month for 30 years in this example, just to pay for those end of life health care expenses).

Health insurance is NOT health care.  Speaker of the House John Boehner’s quote below is indicative of the confusion.  I suspect he is doing this on purpose:

“I hope the House will act next week to repeal the job-killing health care law so we can get started on replacing it with common-sense reforms that will reduce the cost of health insurance in America,” said Boehner.

Health insurance is driven by the costs of health care.  75% minimum of insurance premiums go to pay insurance claims, while 25% is divided between administration and profit.  Perhaps you think we could reduce those administrative costs and profit.  However, even if we removed the entire administrative costs and profit, health care inflation would get us back to current costs in just 3 years.

You wouldn’t want to eliminate all those administrative costs anyway.  Let’s pretend that you and 100 of your friends decided to form your own insurance pool.  Each of you pays $500 per month into a common account, and then you just withdraw it when you have medical needs.  That’s $50,000 per month.  Plenty of money.

But now, out of those 100 people, there will pretty much be someone sick every month.  Based on national averages, your small fund will spend about $38,000 per month on health care, leaving $12,000 per month.  I don’t know how you feel about 100 of your friends, but I would rather hire someone to keep track of 100 people’s doctor’s bills and monthly payments than rely on 100 people busy doing other things.  So that will consume some money, especially if some of your friends occasionally call up to complain.

Add one more small expense.  There is always the chance that one month a lot of your friends will get sick.  Let’s say the shrimp was off at the local Kiwanis club gathering, and a bunch of people showed up in the ER at 3am on a Sunday morning.  Our fund might have enough to pay for such an event.  Thus, we need to purchase “reinsurance” which is exactly what it sounds like.  Our little insurance fund needs insurance to cover it’s variability, or else we might not be able to make our payments at any given moment.

Insurance companies need some administration, and even some profit, to make sure they can give us the service they want.  We can’t eliminate it.

Insurance costs aren’t the problem.  Even health care isn’t the problem.  The problem is us.  It’s complex, but let’s start with the average American male is 25 pounds heavier in 2002 than in 1960.  We are the heaviest nation in the world. That brings all sorts of health issues.

Economies of Small

I’m working on a book, tentatively titled “Economies of Small:  What large organizations can learn from small organizations”.  My agent has said the title will have to change, and I’ll give a free T-shirt to the best idea if we use it.  Here is the teaser text:

Your job is bizarre and you know it.  It’s complete with political maneuvering more akin to the UN, cash decisions that you wouldn’t allow your teenager to make, and a cubicle too small for your pet.

How did we get here? How did we end up where businesses in a great nation (representing 25% of the world’s economic output) are run like the French World Cup soccer team?

And how can we get somewhere else more successful and rewarding?

Economies of Small brings five principles for organizations — gleaned from the “Wild West” of venture capital and start-up companies.  Own More, Do Less, Shrink Span, Starve, and Risk it.  These lessons and stories will help you understand why you feel “cognitive dissonance” — that’s a psychology term for feeling “like your head is going to explode” — and what to do about it.

Build a more successful business — large or small — and a more rewarding career by utilizing Economies of Small.

And here is a little tidbit from the introduction:

The first Economy of Small is “Own It”.  Inside a small organization, each individual can see a fit in the overall puzzle.  They can say “this organization / problem / issue is mine.  I own it.  It’s my responsibility.  If I broke it, I fix it.  I own it.”

A football player on defense can see every mistake and success they contributed.  If football teams were 1,000 players a side instead of 11, the individual player would struggle to see individual contribution.

The larger the organization, the more this “principal / agent” problem rears its head.  You have known about the principal/agent problem for some time.  You’ve lived it.  It’s the reason why the hired employees don’t seem to do the job quite as well as the owners.  It’s why Peter Hodgson of Silly Putty generated a personal fortune while Art Frey (inventor of the Post-it note) got just a raise.

Replicating or imitating small organizations allows every person in the organization to feel and act like an owner, seeing how this defensive play saved a touchdown or that offensive play led to a first down.

And just because an employee owns stock options does not mean that she can tell how today’s performance affects tomorrow’s dollars.  Stock option programs were created to address this problem, but options work better for CEOs than employee number 138,213.

Instead, read further and see how to instill “own it” in an organization.

Faux Profits

I have a new phrase to try out on you, dear readers. What do you think?

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Faux Profits. Noun. Certain non-profits, NGOs, and governments that claim to make “investments”, but have no plan or ability for making profits or achieving a financial exit. Synonyms: social enterprise, social investor. Origin: Sean Foote, after hearing a friend’s description of a haircut as a “faux hawk”.

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I feel a certain need to defend the words “investments” and “profits”.  In my Microfinance and Venture Capital classes I use the following intellectual equation:

Investments – financial exit = charity