Last year, Wal-Mart dramatically reduced the number of products (SKUs) offered at all their stores.  This SKU rationalization plan was based upon the premise that consumers wanted clean-looking stores with just the major brands.  Known as brand fatigue, the logic was that consumers grew tired of looking at too many brands on the shelf.

Inherent in the rationalization premise was the notion that consumers could be directed to change their brand loyalties to the choices Wal-Mart put in front of them.  Effectively, Wal-Mart figured that they controlled the customer’s brand loyalty, not the consumer product company.  Wal-Mart figured that once the customer entered the store, the customer had no choice but to buy the items offered.

The plan backfired.  Consumers wanted their trusted brands enough to move their entire shopping list to competitors like Target and Dollar General.    Wal-Mart then reversed direction and brought back 8500 SKUs per store.  This represented an 11% increase in SKUs.

One has to wonder what the logic was for the SKU reduction?  Was it:

• Purely economic- trying to squeeze more inventory turns out by reducing the dollar value of goods per store?
• Trend following- did Wal-Mart fall victim to the latest trend of SKU rationalization and overdo it?
• Arrogance- did Wal-Mart feel like consumers would buy whatever brands they put in front of them?
• Trying to be too much like Target- Wal-Mart takes constant heat for ugly stores vs. Target.  Was the SKU reduction an attempt to upscale the stores?  Who wants a gorgeous store that does not carry the items you want?
• Losing their way- has Wal-Mart forgotten the business model that created the retail powerhouse?

What are the business model lessons for the rest of us?

1) Business model innovations may look great on paper, especially those which reduce costs.  However, when business model innovation jeopardizes sales or customer retention, costs savings do not outweigh the negative effects.

2) Don’t underestimate your customer.  It has to be difficult not to become arrogant when you are the world’s largest retailer.  However, the customer still controls the spend and must constantly be wooed, even if you are Wal-Mart.

3) Know your place in the value chair.  Wal-Mart may control the customer once they enter the store, but powerful brands owned by Proctor & Gamble may have greater sway with the customer.  If one of your partners can exert significant influence on your customer, either wrestle control back or know your place.

4) Realize that everyone eventually forgets how to think like a customer. This clearly happened to Wal-Mart.  Why didn’t someone pipe up and say, “It’s going to tick me off if I go to my local Wal-Mart and cannot find brands I used to find there?”  Clearly no one at Wal-Mart was able to correctly think like a customer and avoid this fiasco.

Let’s give Wal-Mart credit for eating a bit of crow and reversing this decision.  These big boxes are called Superstores for a reason.  Customers expect to find 100% of what they want, not 95%.

You have probably seen H&R Block commercials on television advertising free tax preparation. At the same time, you have probably seen TurboTax commercials advertising free live assistance with their software. There seems to be a perfect storm brewing in the world of tax preparation. As simple tax preparation gets more manageable for the average taxpayer, the competition for fees and revenue amongst these taxpayers gets more intense.

This year, H&R Block lost its teaser item, tax anticipation loans. The federal government clamped down on these loans, and H&R Block's lender HSBC refused to back loans. This forced H&R Block to stop offering the product. The free preparation of 1040 EZ filings is in response to this.

Things are not rosy in the tax preparation world. Unemployment has caused a 1.7% decrease in overall filings, the largest drop since 1971. H&R Block saw a reduction of 6.1% in total returns last year. Combine these factors with more tech-savvy consumers and the general propensity for do-it-yourself in a tough economy, and you see the need for free tax preparation.

This free preparation I H&R Block may be a bitter pill to swallow, but at least it offers the upside of state tax preparation, more complex tax preparation, and addition of younger tax paying customers.   This free taxes move has several potential pitfalls:

• Will free customers buy additional services?
• Will free customers come back next year and pay, or are they only customers if it is free?
• Only 10%-15% of customers are expected to qualify for free preparation, does this leave a bad taste in the mouths of customers that do not qualify?
• For the customers that do not qualify, does the “for you it’s not free” create more bad will than the good will created in the free customers?
• Does doing taxes for free lower the perceived value of all tax preparation?

What does all this mean for the business model of H&R Block and other tax preparation services like Jackson Hewitt and Liberty? At first glance it appears to be the beginning of the bloodbath. This fast and serious race to lower prices and giveaway services does not seem to have any revenue upside only costs, decreased revenue, and lower perceived value for paid services.

The real issue is what will these companies do to innovate their business model and recover from this mature market issue? Let's explore some options:

1. Fight the trend as long as possible preserving as much revenue as possible.
2. Attempt to add premium services to upsell customers and get average customer spend back on track
3. Find an alternative to profitable tax anticipation loans. It appears the government views these loans as predatory and will end them all together. They carry an average interest rate of 55+%.  By the same token a percentage of H&R Block's customers are the un-banked. H&R Block had found a profitable method to fill a need of these customers. H&R Block may be able to find a palatable alternative to tax anticipation loans. For instance, a preloaded credit card or similar instrument in which some of the money was delayed might be profitable and meet government requirements.
4. Find a way to capitalize on the millions of customers currently served with other services. Examples might include: payday loans, retail banking, life basic legal assistance like LegalZoom, or other services that capitalize on H&R Block's strengths.

Do you agree with H&R Block's free tax preparation strategy? Is this the beginning of a slippery slope of ever decreasing tax-preparation revenues? What does this mean for H&R Block's business model?

As we review 2011 we can’t help but look at Congress’ performance (or lack thereof) this last year. And while this is not a “political” blog I thought it would be interesting to assess Congress’ “business model” and ask the question, “Is Congress’ business model broken?”

But before we do that we need to answer a couple questions. First, what is the definition of a business model?

Business Model Defined

Business model: the proprietary methodology used to acquire, service, and retain customers.

And remember, there are eight essential areas to every business model:

• Must have excellent margins
• Must be easy to sell
• Must have The Four Capitals©: Intellectual Capital, Financial Capital, Human Capital and Brand Capital
• Must be able to maintain ongoing competitive advantage
• Must have quality customers
• Must have longevity of the industry
• Must provide for the owner’s graceful exit
• Must avoid pitfalls

Is Congress a Business?

Second, is Congress a business? Well…no. It’s a branch of the U.S. government. But it still has “customers” aka citizens and a primary purpose. According to Article 1, Section 8 of the U.S. Constitution the primary function of Congress is:

…to lay and collect taxes, duties, imposts and excises, to pay the debts and provide for the common defense and general welfare of the United States… To make all laws which shall be necessary and proper for carrying into execution the foregoing powers, and all other powers vested by this Constitution in the government of the United States, or in any department or officer thereof.

So if you’ll allow me some leeway here I’d like to submit a working definition of Congress’ business model. Then I want to look at four areas where I believe Congress’ business model is broken.

Congress’ “Business” Model

I would define Congress’ business model as:

The proprietary methodology used to carry out the primary Constitutional functions (as defined in Article 1, Section 8 of the US Constitution) and to service and retain the majority of support from voters.

So in light of the above definition, we discovered four areas where Congress has been failing, especially in 2011.

1. Must Have Excellent Margins

This is one of the most important parts of any successful business model. Since part of Congress’ primary duties is to collect taxes, pay debts and create a sustainable budget, it is only right that the blame be placed on them if they fail in this area.

One of the biggest Congressional debates of 2011 was the US Debt-Ceiling Crisis. Congress had difficulty reaching an agreement to raise the debt-ceiling which resulted in a deal finally being reached on July 31. Four days later, on August 5, the credit-rating agency Standard & Poor's downgraded the credit rating of US government bond for the first time in the country's history.

Now, we’re not going to get into a political debate here but the fact of the matter is the US government does not have excellent profit margins (yes, no profit margin would be considered “not excellent”). No entity can continue to spend more than they make and expect to experience success.

2. Must Have Quality Customer

Customer service is another important piece of any successful business model. As we said earlier, Congress’ customers are the voters and tax payers they serve. Since Congress ended the year with a record-low 11% approval rating I think it’s safe to say they are failing here as well.

Our government is a representative democracy which means we are a self-governed people. If the elected officials are making decisions that upset and anger the people then something is wrong. Either the ones elected are not keeping their word or the people chose the wrong leaders to represent them.

3. Must Provide the Owners Graceful Exit

Since there are no “owners” in Congress we’ll modify this to say, “Must provide the elected officials’ graceful exit.” This would mean Congress could function properly even after key leaders died, lost re-election or decided to move on. If Congress only works when established life-long politicians are in office then we must also conclude that this essential business model rule is also being broken.

Why is it that new people who come into office are not able to get the results that the established politicians are? When politicians are rewarded more for “longevity” than “performance” then a culture is created that kills innovation. This can also be seen in many corporations when people who have been there longer receive more pay than the younger workers who actually produce more profit for the company.

4. Must Avoid Pitfalls

Has Congress avoided pitfalls? I don’t know anyone, no matter which side you’re on, that would honestly answer yes to that question.

Falling into pits seemed to be par for the course for the 2011 Congress. The gridlock in Congress resulted in potential government shutdowns, a credit downgrade, and record low approval ratings by the people. If there was a rock in the road it seemed as though Congress was bent on hitting it.

Congress, just like businesses must find a way to avoid pitfalls in the future. While politicians may never agree on anything they must find a way to run this country successfully or they need to be replaced. If a CEO continued to lead his company into pitfall after pitfall he would be fired. Why should it be any different with our elected officials?

Business owners can learn a lot from the blunders Congress made in 2011. We can learn it’s important to have: excellent profit margins, quality customer service, a system that can operate after you leave, and a plan that avoids pitfalls.

After allegedly losing money for the last 11 seasons the NBA decided to alter its business model. This led to a 149-day lockout that claimed the first 7 weeks of the regular season and cost the NBA an estimated $480 million.

As with most labor disputes the issue at hand was money. The players wanted their “fair” share but the league argued that they could not continue operating under the current agreement which was causing them to lose over $300 million a year.

NBA Loses $340 Million Last Year

In an emailed statement to the New York Times, NBA spokesman Tim Frank stated:

The league lost money every year of the just expiring CBA. During these years, the league has never had positive Net Income, EBITDA or Operating Income.

The Knicks’, Bulls’ and Lakers’ combined net income for 2009-10 does not cover the losses of the 23 unprofitable teams. Our net loss for that year, including the gains from the seven profitable teams, was -$340 million.

Before the lockout the terms of the collective bargaining agreement (CBA) gave 57% of basketball-related income to the players. Under the new CBA this was lowered to 51% in order to provide more revenue to the league and close that $340 million gap.

The Dust Settles, Problems Remain

But as the dust begins to settle the question remains: did this change in the NBA’s business model really solve the problem?

Before we answer that question let’s take a step back and look at the numbers. The NBA generates an annual revenue of $3.8 billion (to put this in perspective the NBA is a bigger business than JetBlue Airways). And how do they “rank” in the industry of professional sports entertainment?

Well the NFL generates approximately $8.5 billion annually and Major League Baseball makes about $7 billion in annual earnings. So the NBA is in a distant third place, trailing the NFL by a $4.7 billion. So why is the NFL twice as successful as the NBA? Could it be that the NFL has a better business model than the NBA?

NFL vs. NBA

As we compare the NFL to the NBA let’s remember that a fundamental rule for any successful business model is to have quality customers (in this case, the customers are called fans). The business these companies are in is the sports entertainment business and sports are fueled by competition. Where am I going with this? I’ll show you.

The NBA has always been top-heavy. Out of the 65 NBA championships, 33 of them were won by just two teams, the Lakers and Celtics. And as Howard Beck of the New York Times recently pointed out:

“If Paul winds up with the Knicks and Howard lands with the Nets, 15 of the league's top 25 players would be spread among just six teams. In a league where superstars rule, that is depressing news for the other 24 franchises. Superteams may boost ratings in May and June, but they do nothing to help ticket sales for a Detroit-Charlotte game in January."

Did you catch that? Since there are only 6 superteams in the NBA the rest of the league suffers in ticket sales. As Beck said, this may boost ratings during the playoffs but it hurts ticket sales for the other 24 teams during the regular season.

Hard Salary Cap vs. Soft Salary Cap

But what can be done about this business model blunder? Again, let’s look at the NFL who seems to be doing a much better job than the NBA. One main difference has to do with the hard salary cap the NFL imposes which helps minimize superteams from forming.

This is why in the last 30 years, 14 NFL teams have won championships — the last five by five different teams. The competitive element is fostered by the NFL by providing opportunity to almost any team (despite the size of their franchise) to win the Super Bowl.

Even under the new CBA, the NBA still maintains a soft salary cap which does little to prevent these superteams from continuing as they always have. During the labor dispute the NBA commissioner David Stern stressed that the system needed to be changed to balance the playing field and give small-market teams the same chance as large-market teams to compete for a championship.

So the system (aka business model) was changed but not according to Stern’s statement. Fans lost 7 weeks of play, the NBA lost revenue and the salary cap is still soft. What really changed?

Like this post?  Join our discussion group on LinkedIn http://www.linkedin.com/groups?about=&gid=4171511

This summer, Blockbuster was full of glee. Titled “Blockbuster Rescues Furious Netflix Customers,” a press release in July promised to give Netflix customers an oasis after their upstart competitor blundered with its failed Qwikster service. The company launched a promotion to lure customers aware from Netflix and back to the once ubiquitous national movie rental chain, which had made a somewhat successful transition from brick-and-mortar to online and mail distribution off the heels of Netflix's explosively popular service.

The promotion was ambitious, offering Netflix customers a 30-day free trial of Blockbuster's Total Access plan, which which Blockbuster touted as a flexible approach to movie rentals that combines receiving movies by mail and through retail stores, although the company has closed hundreds of stories in the past couple of years.

Partly because of its dwindling retail presence, the company's lure to Netflix customers was largely unsuccessful, and the company kept closing retail stores throughout 2011. A number of other missteps led to Blockbuster's failure to capitalize on Netflix's big gaffe of 2011, creating a lose-lose scenario for the movie rental industry this year.

A Failure to Remodel

Aside from convenience, one of the most attractive parts of Netflix's business model was the low cost subscription service. This flat-fee pricing model is appealing for its transparency and straight-forwardness. Additionally, the lack of late fees removed the naughty-schoolboy feeling that customers had grown accustomed to when bringing back their rental to Blockbuster a day after the deadline. Many customers felt that Netflix was fairer, which accounted for the company's enormous success in its early days. By word of mouth, news of Netflix's convenient and hassle-free business model spread throughout the country.

In 2011, Netflix lost that sense of fair play with its customers, giving Blockbuster the chance to take it back by remodelling its pricing structure, terms of service, or delivery methods. The firm failed to capitalize on these opportunities, partly because its parent company was already in the process of downsizing Blockbuster's operations.

In April, Dish Network purchased Blockbuster for $320 million in a bankruptcy auction. Instead of aggressively investing in the brand, the network continued to close stores throughout the U.S. and Canada, while its rules about renting new releases intimidate and alienate many customers. The rule is simple but poorly defined--rent too many new releases and a customer's account will be throttled, meaning that new releases will be mailed more slowly than before. This business model made many customers feel like a liability to the company.

Additionally, there was the frustration that not all Blockbuster stores allowed exchanges of mailed discs, and discs obtained from in-store exchanges could not be returned to another store. To many, the retail tie-in was an added layer of frustration.

This is on top of the fact that customers have grown used to instant gratification thanks to streaming video solutions such as Netflix's popular offering. Returning to a largely mail-order system with the so-called "convenience" of driving to retail locations to exchange or return rentals was no longer acceptable in 2011. In short, Dish Networks was relying on Blockbuster's old business model long after that model had remained attractive to customers.

At the same time, Dish Network's broadcast experience meant that it was in a perfect position to push its Blockbuster On Demand service. Yet this streaming service was a sluggish entry that was simply too late to the party.

Is it Too Late for Blockbuster's PR War?

Blockbuster has attempted to revitalize itself by "borrowing" the kiosk-based retail model that Redbox began a few years ago under its Blockbuster Express brand. Blockbuster also offers video game rentals--which Netflix does not--and its price for two DVD rentals per month is actually lower than Netflix's. And with its kiosk services and retail locations, it has a greater physical presence in American neighborhoods than any of its competitors.

Despite the company's sizable assets, it faces an uphill battle in reclaiming its top spot in the movie rental industry even after Netflix's embarrassing gaffe caused a still-open rift between it and its customers. There are three major lessons for business owners from all of this:

1. Complacency destroys success. Blockbuster did not see the mail-delivery and streaming services on the horizon even when they should have been obvious after the DVD made movies lightweight and broadband made streaming virtually instantaneous. Blockbuster's earlier complacency ended in a humiliating bankruptcy and the closing of over a thousand stores. 2011 was a chance to reverse that complacency with renewed vigor, but instead  Blockbuster launched a PR campaign pronouncing how wonderful it already was instead of convincing customers that it could be better.

2. When your competitor trips, step up. Instead of reversing its downsizing of its Blockbuster operations when Netflix tripped, Dish continued to close Blockbuster stores. It rolled out the On-demand Service and kiosks too slowly, and failed to streamline Blockbuster's return policy and pricing model. Had it lowered prices or introduced new services just as Netflix rose prices and made its products inconvenient, Blockbuster could have delivered a knock-out to its stumbling competitor. Instead, Blockbuster continued on its previous track.

3. Your customers are partners, not liabilities. The golden rule of business is that customers choose businesses because of the price, quality, and convenience of their products. The foundation of any successful and sustainable business is the choice of its customers. No matter how big a company becomes, it should respect its customers for making the choice to do business with it. Here Blockbuster failed in a big way. In the minds of customers, Netflix had transformed late fees from a necessary evil to a nasty punishment to bad customers, which meant they were no longer acceptable. Blockbuster failed to recognize this in time, and thus failed to steal customers' affection for Netflix.

Netflix saw a meteoric rise in its stock price in 2010 after successfully weathering the devastating financial crisis that stifled wages, depressed consumer demand, and threatened just about every other retailer in existence. This was largely thanks to its relentless investment in video streaming and rising broadband access throughout the country after inventing a new way to distribute movie rentals--by mail--that crushed Blockbuster's traditional business model and forced independent movie rental shops to close across the country.

The company could do no wrong at the beginning of 2011, as it saw its stock price surge. The company was even outperforming Apple and Google. By summer, there was a real possibility that Netflix's stock price would surpass Apple's.

Then it all collapsed.

Now, Netflix trades around $70 dollars per share, down over 60% from the beginning of the year. This precipitous drop began in the middle of September, shortly after the company announced that it would be splitting its DVD delivery and streaming services. The new DVD delivery service was to be rebranded Qwikster, which was abandoned within a month with a quick mea culpa from Netflix chief Reed Hastings. "There is a difference between moving quickly--which Netflix has done very well for years--and moving too fast, which is what we did in this case."

The half-apology did little to placate investors as Netflix continued to hemorrhage users. It did not hold a monopoly on video streaming, with Hulu.com, Apple iTunes, and Blockbuster providing consumers with a number of options--not to mention the growing Video on Demand industry or, for that matter, illegal ways to download movies for free.

One of the reasons that Netflix had remained more popular than its competitors was its large selection and convenience. Netflix had access to thousands of movies, television shows, and other videos that users could request to watch immediately or add to their Netflix queue, essentially reserving the title for future viewing. At the same time, Netflix expanded to a variety of platforms--Netflix streaming was available on the Wii, Playstation 3, and Xbox 360, as well as several other popular devices, like the new Apple TV, Roku box, and Tivo DVR.

The firm's broad market exposure and cozy partnerships with several competing vendors allowed consumers to choose not only what they could watch, but when and how. Combined with an easy-to-use interface and smart algorithm for recommending related titles that subscribers could watch, Netflix had utilized every technological edge it could to make itself a household name much faster than Blockbuster--its closest competitor--could catch up.

So when Netflix decided to divide its two delivery systems, it infuriated consumers who had chosen the company for its video needs because it empowered users with a variety of choices. All of a sudden, and without a clearly articulated reason, the company was taking much of that power away by forcing users to choose between conventional DVDs and the newer streaming technology.

Netflix's apology that it had moved "too fast" hardly placated users and it certainly hasn't impressed investors (the company's stock is down a further 50% since Netflix reversed its decision). One analyst has called the company's business model "broken". We would agree.

What's worrying is that Netflix CEO's statement that they had moved "too soon" is a subtle threat that Qwikster might rear its head again, robbing consumers of the choice that broad them to Netflix in the first place.

The Lesson

While some could dismiss Netflix as acting too quickly, there is a much more significant lesson to be learned here. When a business provides consumers a product, there is a marginal product being offered at the same time. In Netflix's case, the company's explicit product was movies, but its implicit product was convenience. This marginal product was the real reason why consumers had chosen Netflix, and by abandoning its very successful business model, Netflix was robbing consumers of the one thing that drew them to the company in the first place.

Business owners should understand why customers are choosing them over their competitors and ensure that their business model maximizes the incentive for that choice. Likewise, they need to consider how any change to their business model will make the business more or less attractive to customers before acting. Only then can business owners begin to change their operations.

Netflix, tragically, acted without considering how it would affect customers' perceptions of the business, and is now paying the price.

Bank of America may have committed the #1 business model blunder of 2011for their $5 debit card fee.

First, let’s get some background. Spoiled U.S. banks have become so addicted to high-profit fees that they seem to have forgotten the customer. The average bank earns over forty percent of its profit from fees. These include, swipe fees, account fees, loan fees, statement fees, overdraft fees, balance fees, and more. Prior to Wall Street reform, banks averaged $0.44 per debit card swipe. Banks are now capped at $0.24 per swipe. According to The Nilson Report, banks took in $48 billion from these fees before the reform. Assuming the banks did not get tricky and add peripheral fees, this still translates to $26 billion in swipe fees.

In the old days, the banks’ business model required them to:

1. Provide free checking accounts.
2. Handle lots of cash, coin counting etc instead of electronic money.
3. Process billions and billions of checks by hand. (In fact, I personally know of a check processing center for a large bank that employed 250+ people for 24/7/365 solely to enter check amounts and account numbers into their system. Electronic commerce has made this center nearly obsolete.)
4. Charge the customer $0 for writing a check.
5. Have human tellers wait on you instead of ATMs and the internet.

It seems to me that banks have successfully leveraged technology to eliminate tellers, check processors, branch costs, and more. In one of the most brilliant business model moves ever, banks have not only lowered their costs through technology, but they have charged EXTRA to the users of the cost-lowering technology.

 Banks used to let consumers write a check at Wal-Mart, spend tons of money processing the check by hand; send the physical check back to the consumer; keep a scan of the check for years; and generally have a painful and expensive process. Debit cards dramatically lowered the cost of the bank’s business model. It seems that the banks should be paying the merchants and card holders to use debit cards, not charging for them. Forget consumers revolting and changing to a credit union, what if Americans revolted against the banks and started writing checks again?

However, none of these factors stopped Bank of America from trying to add a $5 per month debit card fee. Technically, Bank of America did not try to change the business model. Bank of America was simply trying to preserve the existing business model with complete disregard for the customer’s hot buttons. Customer reaction to the fee was swift. There were protests, petitions, and even a National Bank Transfer Day. As a result, many other big banks cancelled plans to institute a similar debit fee.

In fairness to the banks, it costs an estimated $350 annually to maintain a consumer checking account each year. This is according to Chase’s Jamie Dimon. This covers services such as a 24-hour call center, anti-fraud protection, ATMs and online bill pay, he said.

Let’s also include Washington in on this mess. The new law effectively transferred an estimated $16 billion from banks to retailers by forcing the swipe fee lower. Now the banks are scrambling to replace the revenue. In this game of financial musical chairs, the consumer has ended up becoming the only one without a chair. It would seem that this debate would have been better left to the free market. Wal-Mart has plenty of leverage on Citibank and vice versa. What is an average consumer to do for leverage against a bank or retailer?

So what are the business model lessons learned from this fiasco for both banks and non-banks?

The Lesson

Understand your customer’s hot buttons and understand when you have had a windfall. As technology rapidly changed banking, a rare window of opportunity opened for institutions to not only lower expenses, but charge for the enhanced service level which this technology provided. However, this window is now closing or closed. Banking technology is ubiquitous and expected. Banks will need to find other methods to cover the ever-increasing cost of checking accounts without starting a customer revolt.

What do you think Bank of America should have done differently?

In the world of the web, it is widely understood that you must ethically bribe your visitors with electronic goodies in order to get and hold their interest.  In the good old days of the internet, these free items may have been as simple as a quick quiz, a newsletter, or a short eBook.  As the sophistication and competition on the web has increased, so has use of the free bar as a business model.  Today, a web user can find more free and valuable web content than they can use.  Why buy a newspaper when cnn.com or usatoday.com if free?  Why pay for a research report when so much content is available for free?

In order to gain or retain a prospect’s interest, some gurus claim you must give away an item with a $50-$100 perceived value.  Successful website operators do just that while other web operators wonder why visitors quickly exit their sites or why no one signs up for their newsletter.  Unfortunately, the free bar is here to stay.   The traditional logic has always been that digital goods are effectively free to distribute, so why not utilize them to gain sales momentum.  Interestingly, the free bar may not be a web-only tactic.

Superstore operator Meijer now offers free antibiotics like Amoxicillin to shoppers vs. the $5 or $10 a customer would pay at CVS or Walgreens.  Most insurance companies have a maximum allowable cost for Amoxicillin of $2.10 or so.  Let’s assume this is close to the wholesale cost.  This means that Meijer is giving away goods and services with actual hard costs on the bet that the consumer will spend enough in their superstore to justify the customer acquisition cost.

Meijer has always been a business model innovator.  Meijer is credited for opening the very first hypermarket in 1962.  However, this Meijer business model change may not be as innovative is it appears.  For years, supermarkets have enticed shoppers with loss leaders to lure them into the store so they could purchase higher margin items.  A skeptical view if this business model would be to simply view free antibiotics and an extension of this model.  However, there is a big difference between cutting your margin and giving away a needed and valuable item like a prescription.

This also leads to some interesting side discussions.  Does Meijer treat the free Amoxicillin customer differently?  For instance, does Meijer immediately fill the prescription while the free customer waits or do they send them shopping for twenty minutes?  Does Meijer or should Meijer track the ticket average of the free prescription customers?  According to the Food Marketing Institute, the average consumer spends $26.78 per grocery store visit.  It is safe to assume that Meijer’s ticket average is higher since they offer clothing, toys, hardware, etc.  Would you expect Meijer’s ticket average on the Amoxicillin customers to be lower or higher than an average customer?

How can Meijer’s business model gamble best pay off?  What percentage of Meijer’s free drug giveaways are to the desirable family with kids?  What percentage of the giveaways is to hyper-sensitive retirees looking to save $3 vs. the Wal-Mart prescription plan?

Do you think Meijer is wise to bribe customers with free goods or is this simply an extension of the loss leader principle?  Do you see this trend continuing or expanding?

Since bridging the gap between full-service and self-service legal in 2001, LegalZoom has grown to the nation’s best-know legal services organization.  Now LegalZoom is toying with their business model by moving from form filling to prepaid legal plans.  LegalZoom is offering individuals and small businesses a basic legal plan for as low as $15/month.

These plans offer assistance from a local attorney on various legal issues such as contracts, collections, or intellectual property.  You can see the plans at http://lztrk.com/?a=3454&c=177&p=r&s1=

While this prepaid business legal plan from a trusted name is a viable offer, is it too much of a shift from the self-service, no lawyer approach that made the business model so popular?  This move is either a brilliant line extension to core clients who are inclined to do it themselves vs. hire a lawyer, or it is a boneheaded shift of focus away from a still-growing business model.

What do you think?  Will these plans strengthen Legal Zoom’s business model or weaken it?

Southwest Airlines recently reported their first net loss since Q3 2009. Southwest claimed the losses were primarily due to fuel hedge issues. However, I believe there may be a larger issue at play. While most other airlines have increased net revenue by nickel and diming their customers, Southwest has done the opposite. Last year, US airlines collected $3.4 billion in bag fees and a further $2.3 billion in ticket change fees. At the same time, Southwest Airlines attempted to endear itself to travelers by allowing them to check in up to two bags free with each ticket purchased. You have to commend Southwest for going against the crowd on this one.

The real issue here is whether the forfeiture of hundreds of millions of dollars in bag fees pays off in increased ticket sales. In 2010, Southwest carried 88 million passengers. Let’s assume that half of them would begrudgingly pay a $20 bag fee. Over a five year period, this equates to $4.4 billion in pure profit to Southwest if half of their passengers checked in one bag.

Southwest makes approximately $6.25 in profit per passenger trip. Therefore, in order for Southwest to justify no charging bag fees, they must sell over 140 million additional tickets each year. Do you think this is happening? I am not convinced that US travelers are giving Southwest as much credit for free bags as Southwest thinks.

Ryanair is one of the fastest growing airlines in the world. Ryanair recently removed all but one restroom from their flights and charges fliers $1.50 to use it. They are also debating installing standing room seating, and charging customers $47 to print a boarding pass at the airport. Ryanair is charging customers for everything imaginable but it is still growing; how can we reconcile the Ryanair business model with Southwest's business model? It’s simple: passengers only look at the ticket price and don’t consider add-ons when shopping around for a plane ticket. In my mind, Southwest is fighting basic buyer psychology, no matter how silly that psychology may be.

I predict that Southwest Airlines’ business model will eventually shift to the nickel-and-dime model used by the rest of the industry. Passengers can complain all day long about fees, but until they vote with their wallet, the Ryanair business model will rule the sky.  KZGDXAX253EC

Do you agree? What changes do you see in airline pricing models?