There is no such thing as a product

How do you manage, or even think seriously about, profitability in an online business? Traditionally you tracked profitability by product, but in the online world this may simply not be possible. The article looks at why this is so, and how the same factors which create the problem also create new opportunities. Learned Publishing (2002)15, 113–116 Alastair Dryburgh There is no such thing as a product 113 L E A R N E D P U B L I S H I N G V O L . 1 5 N O . 2 A P R I L 2 0 0 2 form. This year’s subscription rate for these two journals is £1,000 each. You agree that for £2,600 they can continue with the existing subscriptions but also add electroniconly access to another three journals. These journals have published electronic-only subscription rates totalling £1,250 so that the ‘list price’ of the bundle is £3,250. Now how do you allocate the revenue of £2,600 over the five titles ? One approach would be to say that, had the library continued as before they would be paying £2,000 for the two original journals, so allocate £2,000 of the revenue to them. The remaining £600 relates to the three additional journals, so allocate £600 to them, or £200 per title. An objection to this would be that you are making a sale at a discount, and this discount should be applied equally across all titles. The £2,600 you receive represents a 20% discount on the total ‘list price’ of £3,250, so apply this discount to all the titles. This means £800 for each of the original two and £1,000 for the extra three together, or £333 each. An objection to this objection would be that this is an accountant’s way of looking at things and that the correct way to do it is to understand what the customer values. There may be one journal in the bundle which the customer values very highly and would in fact pay £1,500 for. Conversely there may be another which is of little interest and is only there because the publisher threw it in as part of the package. The customer may be happy to drop it in exchange for a small reduction. To make things even more complicated, the library will almost certainly find that use of the new titles increases substantially now that they are available, so that their perception of the relative value of the five titles will change over time. So we have two different approaches, each apparently quite sensible and completely objective, producing revenues per journal different by 20%. This is even before we enter the complex and subjective area of assessing what the customer really values. Revenue from the other products could be allocated more easily. Sales of individual articles and the generalized subscription could be allocated to the titles based on the numbers of articles involved. The same logic would probably apply to the customized journal, although here it would be a valid objection that the customer is buying a package and may put very different values on different parts of it. Think now about the cost associated with each product. Any individual article can appear in any product; it can be in a title which is part of a consortium deal, it can be bought individually or it can be part of a customized journal or it could be chosen by the holder of a generalized subscription. It should be possible to track where, and how often, it is supplied or accessed so that the cost of creating it can be allocated. Costs of storage and costs of access can then be allocated across the number of items stored and number of accesses. This would be possible in theory, if very difficult in practice. The real problem is that it would have no value. To see why this cost allocation has no value, consider what would happen if, after all this work, you were able to identify a product which was losing money. If you couldn’t increase the price or sell more, you would eliminate it. The problem is, in the electronic world, what costs does this save? You do not save on storage or access costs, since these are fixed over a quite wide range of volumes. You do not save on the cost of creating the material for that product, since it also forms part of other products which you still offer. In attempting to eliminate a loss-making product, all you actually do is eliminate a small amount of revenue. This is the crucial point; in the electronic world the cost of making an additional supply to a customer, the marginal cost, is very close to zero. This undermines the whole concept of product profitability analysis based on allocation of costs. The conclusion is that electronic developments are taking you to a point where you cannot meaningfully talk about product profitability. You may already be there. The consequences are profound; if your profitability is below par, how do you identify where the problem is so as to take remedial action? If you want to launch a new product, how do you create a plan if you cannot talk about profitability? There is an answer to how do you create a plan if you cannot talk about profitability? 114 Alastair Dryburgh L E A R N E D P U B L I S H I N G V O L . 1 5 N O . 2 A P R I L 2 0 0 2 this, but it is best found by looking outside the publishing industry altogether. For many industries, near-zero marginal cost has been a fact of life from the start, and strategies for dealing with it are well established. Consider some of them, and how they operate. Telephone companies reduce call charges at weekends when business users are not at work. Hotels and airlines offer cheap rates off peak. Cheap airfares require a stay over on Saturday, thus excluding the business traveller who still pays the full rate. What these people are doing is using the fact of near-zero marginal cost to make additional money in marginal markets without creating cheaper options for their core, high-priced customers. Now in fact low marginal cost is not unknown in publishing – in scientific journals, for example, about 70% of the total cost is incurred up to the production of the first copy after which additional copies are very cheap. What has been missing until now is a way for publishers to divide up their markets and create low-priced segments without customers leaking from high-price to lowprice segments. Online can change that. This concept of using product design to separate out and separately exploit submarkets is called versioning and is discussed at some length in Varian.1 It is interesting that although he is writing about publishing, he has to take most of his examples from elsewhere – he clearly feels that the possibilities within publishing are far from being fully developed. One particularly interesting concept is ‘subtracted value’ – rather than strive to add value and hence increase revenue from existing customers, look at ways to address more marginal markets with a lower-value product that represents value for money for them but not for the existing core market. Varian quotes the example of a laser printer which printed at 10 pages per minute and sold for $1,000 to the office market. The manufacturers also offered a version which printed at 5 pages per minute and sold at $500 to the small office/home office market. The only difference was some additional lines in the software to induce a wait state. Already, looking around the publishing industry (broadly defined) there are examples of this approach. Perhaps the oldest established example is the trade publisher publishing a new novel first in hardback and only later in paperback. The price differential between hardback and softback is not accounted for by higher manufacturing costs – it is a way for the publisher to extract a premium from that part of the market which wants the book as soon as it is published. The journal Nature applied the same logic when it offered an electronic subscription with the news and views section embargoed until six weeks after the publication of the paper version. Again, there are now any number of websites where one can obtain stock prices for free, but they are all delayed by at least 15 minutes. This makes the information useless on a trading floor, thus protecting the suppliers’ existing revenue from supply of genuinely real-time data at high prices to active traders. Markets can also be segmented by the content which is made available. Database publishers can create different portals for different groups offering access to larger or smaller subsets of the data. Versioning shows us the way out of the product profitability problem; as it becomes harder and harder to make sense of our business in terms of products, a customerbased viewpoint makes more and more sense. We have to develop an understanding of all the different customer groups we serve, or could potentially serve, and understand their priorities and willingness to pay. Markets that until now have not been attractive because of their unwillingness to pay the full price could become viable for a subtracted value version. In assessing these markets, the factors to consider are: d the additional revenue; d additional costs in configuring content for the market; d the cost of reaching and servicing the market, i.e. marketing and customer service; d the amount of revenue lost by customers migrating from higher-value offerings – ‘cannibalization’. The most crucial elements are likely to be the cost of reaching the market and the risk of look at ways to address more marginal markets with a lower-value product There is no such thing as a product 115 L E A R N E D P U B L I S H I N G V O L . 1 5 N O . 2 A P R I L 2 0 0 2 cannibalization. In reaching the market, learned societies may have a significant advantage over commercial publishers in that they have an established relationship with members who have a clearly expressed interest in the subject but may not be substantial journal subscribers at current rates. If you decide that you do want to apply a customer-group focus to your operations, how would you go about it ? The first thing is to proceed cautiously. I am not suggesting that the existing journals business is about to fall off a cliff. If the core of your business today is peer-reviewed journals sold to institutional libraries, then in three or five years’ time that will probably still be the case. What you are looking for is an additional 5% of revenue per year to compensate for continued attrition, price resistance, and the costs of going online. First consider how much of an issue this is for you. How much of your revenue comes from difficult-to-allocate sources subject to the sort of problems discussed above? How is this proportion changing? What proportion of your costs is in difficult-to-allocate areas? This is probably increasing as you move online; traditional costs such as printing and typesetting are easy to allocate to specific products, while costs of such things as databases, servers, and access control systems are not. The next step is to ensure that you understand enough about your existing and potential market – their preferences, openness to new offerings, and willingness or ability to pay. Which are the markets that are interested in your offering, but not at the prices you currently charge? Would they be interested in a subtracted-value version? This article is about finance, not marketing so I will not say any more here, but clearly this is fundamental. Thirdly, ensure that you really understand the costs of reaching and serving the different customer groups, i.e. marketing and customer service. Costs of customer service may be a particular issue, since by their nature they are difficult to analyse by market or customer group. You may need to consider whether your existing arrangements are sufficiently low cost to be viable in some marginal markets, or whether you need a fully automated, online-only system for these. Fourthly, do not lose sight of costs. Editorial, storage, or distribution costs may no longer be subject to the discipline of product profitability monitoring, but that does not mean they will become less significant in your profit and loss account. You will need to ensure that these functions continue to be handled cost-effectively, although this may have to be done by benchmarking with other organizations or constantly seeking reductions. This could in fact be a stronger discipline on costs as you will be working towards lowest possible rather than low enough to give decent profitability. Finally, you will need to consider how to decide the viability or otherwise of proposed new customer groups. You will have a procedure for deciding to launch a new journal or expand an existing one, and a publishing proposal system for books if you produce them. You will need something analogous for new customer groups. This will focus on the marginal costs such as marketing and customer service, and, crucially, the amount of cannibalization expected. In the coming years publishers, particularly those primarily active in primary journals, will be challenged to maintain the levels of profitability they need to remain in business. Technology offers an almost bewildering range of possibilities, most of which are being tried by someone somewhere. What is needed is a conceptual framework to give an editorial, marketing and financial perspective on the technological possibilities. If the result is an approach based on development of new markets and a more profound and detailed understanding of the needs of each individual market, this can only be to the benefit of authors, publishers, and readers.