Driverless Buses: The Specific Medium Trip Proposition: Luxury and Space

October 18, 2017October 18, 2017 / futuristpaul (Paul Higgins) / Leave a comment

In a previous post, I have explored the problems with short haul bus travel once driverless electric cars are a car ride service. There is a possibility that there may be a sweet spot between long-haul bus and short haul bus services. Bus companies can save significant costs by using driverless electric vehicles. If they use those savings to pamper passengers instead of cutting costs, they may well win the medium haul travel war.

The change of buses to driverless electric buses will make them more competitive with air travel. This is especially true over distances up to the 300-km mark. Most flights in Australia are longer than that, but there are plenty of short-haul flights in other countries. Once the distances get too long the faster speed of planes starts to take a competitive toll. Bus companies might be able to offer a significantly lower price to catch a driverless electric bus from Melbourne to Adelaide (727 km). The problem is that the flight is 1 hour and 20 minutes and the bus trip is around 10 hours depending on traffic. Even allowing for the delays of getting to the airport and moving through through security we are probably talking 3.5 hours versus 11 hours. Only people who cannot afford the fare are going to be taking that bus. Especially when you can get tickets that are sometimes close to competitive with the bus fare if you travel at the right times.

As an example of the medium length trip, let’s take the Sydney to Canberra flight which is 283 km. The flight time is 55 min, and a discount airfare is about $151 plus $25 for a taxi at the other end. Flights to Canberra are often more expensive than most other major city flights in Australia. This is due to the significant demand for flights during the weeks that the Federal Parliament sits. Between the Parliamentary sitting weeks, there are a limited number of flights. According to Greyhound Buses, the bus travel time is 3 hours and 30 minutes to 4 hours.

The reality is that while the flight time is 55 minutes the real travel time is by air is closer to 3 hours. You must be at the gate 30 minutes before the flight leaves. Airport traffic congestion means leaving the CBD at least an hour before that to avoid the risk of missing your flight. At the other end, you need 20 minutes to get a taxi and get to the CBD. Of course, there is some extra time for the bus as well, but it is minimal. So, let’s say it is 3 hours for the flight versus 4.5 hours for the bus. The current saver fare for Greyhound is A$38. If we use our previous assumptions on cost reductions for driverless electric buses (see The Coming Bus Apocalypse) we could get the price down to $23.

You might not be able to attract many more passengers by that cost reduction when the airfare plus taxi is already five times the current bus cost. That is a fair argument. What you can do though is take that price reduction and put it into more comfort and services. This produces a fantastic value proposition when the airlines are just trying to cram in more people. Imagine efficient workstations, Gold Class cinema type recliner chairs, and even nap pods for customers. What about soundproof gaming rooms so your children can game while you relax and take in a movie. Two adults and two kids for $152 for a luxury bus trip versus $625 on the plane sounds like a killer value proposition. The price might remain the same but comfort and experience are much better because the bus company can offer the same price but 60 or 70% more space.
Smaller buses with much better space than planes can come and pick you up from your house or business and take you in luxury. Eliminating the driver from a smaller bus has a much more significant impact per passenger than removing a driver from a larger bus.

Most of the current airline and bus transport models use the principle of maximising capacity utilisation. Most of the costs of driving a bus or flying a plane are fixed costs. Every extra passenger contributes an enormous percentage of their ticket price to the bottom line. Electric driverless buses are likely to head in the opposite direction for journeys where bus trips take not much time than flights.

It is a matter of changing the model where costs per passenger kilometre drive all thinking.

This will have significant implications for bus companies, and bus manufacturers. Bus companies will have to rethink routes and bus configurations. They will also have to rethink customer service. Bus manufacturers will have to rethink bus size, bus interiors, and bus power systems.

Paul Higgins

I am writing a book on autonomous vehicles with Dr Chris Rice . It is called Rise of the Autobots: How Driverless Vehicles will Transform our Economies and our Communities. Follow us here to see more excerpts as we write.

Come visit our website to see more of my work.

Electric Cars – Saving Real Money or Arbitrage Opportunity?

September 21, 2017September 21, 2017 / futuristpaul (Paul Higgins) / 1 Comment

Electrek has reported an amazing set of numbers on a Tesla S:

A Tesla Model S hits 300,000 miles in just 2 years – saving an estimated $60,000 on fuel and maintenance

The vehicle is owned by Tesloop, a company that offers rides in Tesla vehicles.

A large part of this difference is due to the fact that the car is being used within an area that has extensive Tesla SuperChargers. So all the electricity is “free” (paid for as part of the purchase price of the vehicle). Also parts of the repairs and maintenance were largely paid for under the warranty. The powertrain warranty is for 8 years and includes unlimited mileage. This means that at the same annual usage rate the warranty would cover 1.2 million miles or 1.93 million kilometres.

The key question here is whether Tesla is losing money on this arrangement. If so, the savings are artificially inflated. The answer to part of that question is in the pricing models that Tesla introduced early in 2017. Before that date all Tesla S vehicles received free power on the Tesla Supercharger Network. After that date only the first 400 kWh per year are free. After that you get charged a fee for your power when charging . The fee varies between locations.

So there is no doubt that Tesla has been heavily subsiding the Tesloop operating costs. A smart business move to spot an arbitrage opportunity.

The 400 kWh is estimated to provide power for 1000 miles of driving (1609 kilometres). In Australia the current (sic) charge on the Tesla Supercharger is A$0.35/kWh.(https://www.tesla.com/en_AU/support/supercharging). so the energy cost per kilometre of driving is approximately 8.7 cents. This compares to my petrol Toyota Corolla Hatch at 8.1 cents per kilometre (combined urban/extra urban mileage claim of 6.7L/100km and fuel at 121 cents per litre). Fuel efficiency is worse in urban driving but the Tesla Superchargers are mainly for highway travel so that this is a fair comparison.

Two other comparisons bear looking at. In Illinois the charging rate is US$0.15 per kWh. This equals A$0.188 (RBA quoted exchange rate August 30th 2017) and changes the per kilometre cost to 4.7 cents. Secondly, our current at home shoulder and off peak rates are A$0.1257, which reduces the per kilometre cost to 3.12 cents. Of course we would have to pay for a charging unit as well. If we amortise that cost then the total cost might be 4 cents per km. That is half my current fuel costs, or a saving of about $600 a year on 15,000 km.

If we use 4 cents as a reasonable figure then the cost difference for an electric vehicle travelling 100,000 km a year as a car ride service/taxi is $4,000. That is a significant advantage for an electric share vehicle over a fossil fuel vehicle. That number starts to really add up if you own 20,000 of them in a fleet ($80 million a year).

If we go to the non- fuel car costs. RACQ estimates that the private ownership costs of running a medium sized car in Australia are around 65-72 cents per kilometre. More than 50% of these costs are interest costs (about 8.2 cents) and depreciation costs (about 29.5 cents). Registration and insurance and other on road costs are at about 14.9 cents. This leaves about 7.5 cents for repairs and maintenance plus tyres after accounting for fuel costs. The vast majority of that being repairs and maintenance (median is about 7 cents). In the Tesloop case the scheduled repairs and maintenance costs were US$6,900 for 300,000 miles (482,802 km). This equates to A1.79 cents per kilometre. If we go back to my Toyota which has a fixed price service of A$480 a year then that costs is A3.2 cents per kilometre at 15,000 km per year. The reality is that I drive a little less so the cost is 3.7 cents.

If we go back to the RACQ numbers the Tesla Model S 75 version has fuel costs of 4.73 cents per kilometre. It also has maintenance costs of A8.91 cents. This seems high given the Tesla Loop experience but may just be a function of the much higher mileage.

The Tesla S is a luxury vehicle and so its costs are likely to be higher than a standard vehicle. Lets look at the Chevy Bolt. In this analysis I have been helped by an excellent article by Steven Sinofsky at Learning by Shipping and Insideevs : Chevrolet Bolt Requires Almost No Maintenance For First 150,000 Miles.

The maintenance schedule (H/T Steven Sinofsky) for the Bolt is:

Insideevs estimates that if you do the very scant maintenance yourself the cost for maintenance for the first 150,000 miles (241,000 km) is US$150 (yes you read that right) while Steven says:

“Yep you read that correctly, during my entire three year lease there’s nothing for me to do. I never have to go to the dealer” – Steven Sinofsky

So one way or another routine maintenance is very low.

In terms of fuel efficiency the Bolt is rated at 238 miles (383 km) on a 60 kWh battery although city driving has a better range due to regenerative braking, and highway driving is poorer due to a poor drag coefficient. This results in 6.38 km per kWh and if we use the off peak rate I pay then that is A1.97 cents per kilometre (note Steven was more conservative in his mileage calculations which work out to about A2.39 cents per km using my electricity costs).

This is a lot of figures so as a summary I have made up a small table:

	Fuel Costs	Maintenance Costs	Total

Tesloop Tesla S	0	1.79	1.79

Toyota Corolla Hatch (Mine)	8.1	3.7	11.8

Tesla S (RACQ)	4.7	8.91	13.61

Luxury Vehicle (Ave RACQ)	7.06	10.2	17.26

Chevy Bolt (first 60,000km – but generally representative)	1.97	0	1.97

Now I know that I have not made a fair comparison between the Bolt and the Tesla S. In part because they are completely different vehicles, and because I have only included routine maintenance servicing for the Bolt. There will be non -routine costs in the maintenance costs. The actual costs of those the owner will be in part determined by warranty systems. The RACQ figures appear to include a capped servicing arrangement with Telstra.

What we can say is that there are significant operating costs for the new electric vehicles, as compared to standard ICE vehicles. Even if we add in the Tesloop Tesla S maintenance costs as an estimate for the Bolt’s costs, the Chevy Bolt’s operating cost for fuel and maintenance is still only 3.76 cents per kilometre, compared to my Toyota costs of 11.8 cents. Even though I have only included my fixed costs servicing which is well below the costs shown in the RACQ figures.

That comparison is also unfair as the costs associated with the Tesla S are high due to its luxury model status. You can see the details of the repairs and maintenance receipts by going to : Tesla Model S Hits 300,000 Miles with less than $11,000 maintenance costs and registering for their Google Docs page. These include warranty repairs done at no cost. I was unable to reconcile the costs to the article description as some costs appear to be missing but what is in there is in the following table:

Date	Item	Cost

18/08/2016	Replace 12V battery	171.33

24/10/2016	replace brake pads and rotors	1759.42

4/11/2016	Right Rear Door handle	961.96

21/11/2016	left front door handle	962.18

20/02/2017	wheel liner, rear diffuser, front aero shield, water ingress on headlights	2176.2

7/03/2017	Air conditioner , other pages to receipt are missing	2800.12

15/03/2017	Air conditioner, passenger door handle	656.64


	Total	9487.85

As you can see the majority of the maintenance costs excluding the issue with the headlights and brake replacements related to the air conditioner and door handles. Some of these are likely to be costs associated with the luxury/technology parts of the doors, and early model issues. I would expect that costs for a standard production model would be much lower.

The point of all this analysis is work for our book to look at adoption timelines and business models for electric and autonomous vehicles.

In this case it is the headline number of how much it takes to run your car. That is because people get this in their face every week whereas the main costs of finance and depreciation are more removed from their experience. Once we move to the full question of costs we have to look at those more closely. we will do that in the next few days. Then we have to look at fleet options versus personal ownership.

We will do some more sophisticated modelling as we firm up the assessment for the book.

I am writing a book on autonomous vehicles with Dr Chris Rice of the University of Texas Austin. It is called Rise of the Autobots: How Driverless Vehicles will Transform our Economies and our Communities. Stay tuned for more excerpts as we finalise the book.

Sell Your Crash Repair Business Now*

August 14, 2017August 14, 2017 / futuristpaul (Paul Higgins) / Leave a comment

*this should not be taken as financial or business advice. If you own a crash repair business please take professional advice before making any decisions.

I am just going through the process of getting some minor damage repaired on our car and have been ruminating on the future of the insurance and repair model when we have driverless (autonomous) cars. This was also prompted by a couple of stories in The Age here in Melbourne:

Crash repair: How Ray Malone became head of ASX-listed company AMA Group

and

Driverless vehicles technology to roll out on the Tulla under trial

The first story describes how Ray Malone has built a Australia’s largest crash repair business, and is aiming to grow it even further. That would seem to go against the title of this post but it actually feeds into my thinking because Ray’s company provides wholesale service aftercare which will be vital in the scenario I am describing.

The second story is about how trials of driverless cars are starting here in Melbourne. This follows a large number of trials that are being conducted in various countries around the world.

Once we move to a reasonably widespread adoption of autonomous/driverless cars the local crash repair business will basically disappear except for a few large operators like Ray Malone but even his business could be under threat . The key reasons for this are:

1/ It has been forecast that autonomous cars will significantly reduce the number of car accidents that occur. This is based largely on the statistics that human error causes more than 90% of traffic crashes. So if we can eliminate the crashes caused by idiots, people under the influence of drugs and alcohol, and people driving tired or angry (Police looked into the deaths of 86 people on Victorian roads last year and found that in more than 10 per cent of cases the driver had experienced a traumatic or upsetting event.) we can significantly reduce the number of accidents.

Against this argument is that autonomous cars supplying a transport service may result in people travelling further and perhaps take more risks. Certainly it will allow elderly people who cannot drive, and young people who do not have a licence to travel in cars more than they otherwise would. There have also been arguments that because we feel safer we may take more risks as pedestrians or cyclists. If we are conservative and say that only 50% of accidents caused by human behaviour will be eliminated we still have a significant fall in accidents.

2/ It is highly likely that we will see large fleet models emerge where large numbers of people choose not to own a vehicle. If the overall travel costs are lower than owning your own vehicle, and you can get a vehicle anytime you need one then the convenience of transport as a service outweighs the personal ownership model. The economics for fleet owners are different than for individual owners when it comes to crash repair services. Fleet owners will want large scale service operations to reduce costs or will pay far less for the services of smaller scale operators. This feeds into a large supplier (such as Ray Malone’s company) snapping up more business. Larger scale crash repair businesses will benefit from the economies of scale that allow them to use new technologies such as robotics to increase throughput and reduce costs.

3/ The model for crash repair business location will change. Currently crash repair businesses are located in scattered locations throughout the suburbs and inner city. This is because if I want to take my car in for crash repairs there is a significant time cost for me to take my car to a location that is not near to my house or business. I have to travel to the crash repair business, and then get back to my home or place of work. So I want the crash repair business to be reasonably close. The location is mainly driven by the customer. If my personal driverless car needs crash repairs it can drive itself to the crash repair site, and a fleet service or a shared personal car service can replace my transport needs in the meantime.

If I was asked to drive my car (actual damage pictured below) to a service centre 40 km away I would not be very happy, but if my car can take itself then location becomes much less important and the costs of the business become far more important. Locating the crash repair business in areas of lower property costs with good transport links makes far more sense. It also means that the employees of the business will have lower property costs if they live locally. We already see this model in light manufacturing and food processing/handling facilities locating around hubs on ring roads, away from inner suburbs with high property prices.

If a fleet ownership model predominates over personal ownership this effect will be even higher as large scale fleets look for cost reductions through economies of scale.

So if we summarise all the factors together if we assume a 45% reduction in total accidents (50% of human error crashes) and a tripling of scale that comes from the changes described above we get an 82% reduction in the number of crash repair businesses in any city. I believe that the changes in scale may be even higher and we may end up with only 5-10% of the number of current crash repair businesses being economically viable.

If I own a crash repair business in any suburb in any of our major cities I will come under pressure from a high scale panel beater business set up on the fringes of the city with lower property costs.

So, if you are a crash repair business:

Assess whether now is a good time to sell to someone else who does not understand these changes.
If you think I am wrong then you should suspend that thought for just a few minutes and think about what it means to your business and your assets if I am right. Even if you think that chance is only 5% you should set up a series of questions for yourself to monitor in coming years so that you can change your mind if the changes start to happen. Those questions include:

Is the practical outcome of accident reduction matching the rhetoric of the technology experts and the modellers? Look for signs of early change, cities where adoption is at the forefront of the change and make an assessment as to whether the predictions on accident reduction are true (or even going to be exceeded) and then think about the timing of the implications.
Look for areas or cities where the first full scale mass adoption of driverless cars might take place. For example Singapore, with a small land mass, and a relatively authoritarian government might be one. This will give you early signs of what larger scale adoption might look like.
Is the adoption model going to be a personal one or a mass fleet one? If the model is primarily a personal one then you should be thinking about whether you can become one of the new mega panel beaters on the fringes of the city that will survive the change. If the model looks to be a primarily mass fleet adoption one then there are less possibilities. Those fleet operators will either run their own operations which are standardised and mechanised or they will use their economies of scale to drive down margins in the businesses that supply them. You can still run a good business that way but the opportunities will be limited and will require lots of capital to create the volume throughput and economies of scale required. You will have to compete with the Ray Malone’s of this world.
Are any early models of very large scale, city fringe located crash repair businesses starting to emerge anywhere around the world? Are they successful?
Are car companies changing their business models for car repairs. For instance electric cars have far less moving parts than internal combustion cars. Does that make a difference to your business model? Are modularised car construction and repair systems emerging that will increase the capacity to adopt robotic repair and maintenance systems that will advantage large throughput car repair and maintenance systems?

While these changes may take 15 years to start to significantly impact on the crash repair business, once they become obvious the window to realise the business value by sale will quickly snap shut.

This is just one of the many implications of change from the widescale adoption of driverless cars.I am writing a book on driverless vehicles with Chris Rice (@ricetopher). It is called “Rise of the Autobots: How driverless vehicles will transform our economies and our communities. Stay tuned for more writing as we develop our thinking further.

Paul Higgins

The Future Competitiveness of Corporate v Individual Medical and Veterinary Practice Models. Is AI the key?

May 1, 2017May 1, 2017 / futuristpaul (Paul Higgins) / Leave a comment

Before Christmas I did some work on the future of veterinary surgeons and the education and regulatory changes that might have to occur to move with those changes. One of the things that occupied my mind with that work was the issue of artificial intelligence systems on the competitive position of veterinary practices. My belief is that artificial intelligence augmentation of medical/veterinary capabilities is coming quite quickly and a large scale corporate practice model has significant advantages in this space over the individual practice.

Increasingly we have seen a more large scale corporate model in the veterinary practice market in Australia and around the world. Examples in Australia include Green Cross for major city practices and Apiam Animal Health in rural practice. This has followed similar trends in medical practices where you have organisations like Medical One and Tristar which started out in rural Australia but has expanded into the cities as well.

The basic business model and value proposition of the corporate model is:

Presenting a single branded product almost like McDonalds so a patient or client can be confident of going to the practice no matter where they are.
Increasing purchasing power of all of the back end parts of the business from pathology services down to supplies of bandages, etc. This is more important in the veterinary model where practitioners are able to prescribe and supply vaccines and S4 drugs and make a profit from them.
Taking over the administrative and compliance parts of the business to allow practitioners to focus on patients. This can include the standardisation and delivery of training requirements, building management, OH&S requirements etc. It can also extend to the supply of consulting hours as a service package.
Networking and support for practitioners in smaller practices.
The spread of investment and risk over a larger geographic range and customer base.
A much more secure retirement/part time/business sale option for owners and practitioners. On a personal note my previous long time GP semi-retired by moving into a Medical One practice and then progressively handing over his clients to the other doctors in a very caring and professional manner.

These models have expanded quite significantly over the last decade which speaks to the financial viability of the model and while there has been the odd flare up and accusation of over-servicing in general the models seem to have worked. I originally started my working life as a general practice veterinarian and the corporatisation of veterinary practices is a hot topic at the reunions I have attended.

The competitive position of the individual practice has been built around personalised service and attempting to be portrayed as caring more for the animals they serve than the big corporate competitor. many of these practices are still doing quite well but the trend is towards the corporate practice.

Which brings us to future competitive positions. I believe that we are rapidly heading towards a future where augmentation of medical and veterinary skills via artificial intelligence is going to be a ticket to play in the game. This is going to be a narrow focused intelligence rather than a general intelligence. In the medical space we are seeing story after story emerge of new models where AI systems are getting as good as human doctors or have an edge over human doctors:

This AI Can Diagnose a Rare Eye Condition as Well as a Human Doctor

Predicting non-small cell lung cancer prognosis by fully automated microscopic pathology image features

AI is nearly as good as humans in detecting breast cancer

Self-taught artificial intelligence beats doctors at predicting heart attacks

All of the examples above are based on variants of machine learning and one of the defining characteristic of machine learning artificial intelligence systems is they need large data sets. In the heart attack example above the artificial intelligence trained itself on almost 300,000 case records. As we currently understand artificial intelligence, that system is not transferable to cancer diagnosis, it remains a specilaised cardiac application. The non-small cancer system above was trained on almost 3,000 images and subsequent patient follow up records.

There are two ways to get a large data set to train on in the medical/veterinary field. The first is to work on aggregated image and case records as in the examples above. That will certainly be a major part of the market. Large capital expenditures will be required to assemble the required images/case files and process them in a way that improves patient diagnosis and outcomes when used in conjunction with human doctors. So we will see services offered for specialised areas such as heart attack prediction, organ by organ cancer diagnosis, etc. As always the areas that have the largest and most affluent markets will be the services that are first offered.

However we are also moving in to a world where artificial intelligence systems can be harnessed by smaller players at much lower cost. Take this example of How a Japanese cucumber farmer is using deep learning and TensorFlow:

The son of a Japanese cucumber farmer (who admittedly had some very good tech skills) built an artificial intelligence based cucumber sorting system for his parents. The problem was training the system required a lot of images and the process took a lot of computing power. More and more in the future you will be able to plug into a cloud based machine learning platform that will enable you to harness much more computing power that is specialised to do this sort of a job for you.

So a large network of medical or veterinary practices could offer services that are not offered in the general market by collecting all the data on their patients across all their practices and using machine learning platforms to train a system that is specific to their patient database.

This will be impossible for the individual practice to match. Is this the killer application for the corporate model to almost completely squeeze out the individual practice?

If so I will be watching for models emerging in the veterinary space because the regulatory hurdles and insurance requirements are much lower. If they are successful then I see those sorts of models flowing into medical practices.

The Future for Accountants

April 10, 2017April 10, 2017 / futuristpaul (Paul Higgins) / Leave a comment

The story for accountants the last few years has been increasing levels of outsourcing tasks to low wage environments such as India, and increasing levels of automation for their tasks and their clients. The early stage of that process has been the automation in accounting software systems such as QuickBooks and Mint. Increasingly this automation will move into more and more of the accounting space including real time artificial intelligence auditing systems, automatic preparation of increasing complex tax returns, and structuring credit arrangements.

These things generally start out small and at the less complex end of things and accelerate into more complex areas before people realise it has happened.

So where is the new value for accountants. Primarily this has to be in the process of value creation for clients. Therefore accountants need to move up the value chain and Examples include:

1/ Transformation of business processes around technology changes and the re-training of staff for their SME clients.

As I wrote in Questions on the Future of Work a recent McKinsey report has stated that

“According to our analysis, fewer than 5 percent of occupations can be entirely automated using current technology. However, about 60 percent of occupations could have 30 percent or more of their constituent activities automated”

This supports the notion that apart from a few isolated cases (e.g. truck drivers with driverless trucks) technology does not replace jobs but replaces particular skills or tasks. More importantly business processes and the ways in which we serve customers are changed by the introduction of various forms of artificial intelligence into technologies. This can be a customised approach for vendors like Salesforce Einstein which is adding AI services to its sales, and customer service offerings at around US$50 to US$75 per user per month. Or it can be more fundamental changes to value propositions and business models and the underlying capabilities required to deliver them.

Either way we appear to be entering an era where the jobs people will do will change even more rapidly than they have over the last 10 years and will constantly change rather than be part of a single change management process. In my experience most organisations with under 1,000 employees have little idea on how to approach this problem. This is a huge opportunity for accountants who already have close contact with their clients.

2/ Assisting clients with understanding their strategic landscape

In a world that is moving faster and changing more rapidly than ever before operators of SME businesses are facing greater uncertainty than ever before. They are also facing a paradox. The pressure on them means that they must spend more time focusing on the operational matters in their business but they are doing so right at the time that looking around to see what is happening becomes more important. Just last week I was working with an SME business that is very well run and focused on all the right things that need to be done for the next 12 months. At the same time they were not thinking very deeply about the future and that their decisions (that were absolutely correct in a short term sense) might mean for their long term future.

This means that there is great value for an independent adviser that sees a wide range of other businesses and can:

Provide a better strategic understanding of the industry in which the client business operates. Examples include looking at possible industry scenarios for 5 years time and trying to understand what the interim competitive position might be.
Cross pollinate ideas and ways of doing things from other businesses in other business sectors. Sometimes very simple tools and approaches from somewhere else can significantly improve a businesses bottom line.
Look at the business from a dispassionate but involved perspective and ask questions the business is not asking itself. Examples might include – does your logical short term investment in cost improvements weaken your balance sheet and capacity to respond to x/y or z which are significant risks? OR What custom built systems are you using which can be supplied via industry standard products or new utility services.
Run a structured red team/blue team process to attacking and defending the business from an outside perspective.

3/ In the future: utilisation of AI to augment their own capabilities

The reality of artificial intelligence is narrow expertise systems rather than a general intelligence. So we will see artificial intelligence systems that can aid sales people and customer service people but cannot do other things (see Einstein above). We will see narrow artificial intelligence systems that can assist doctors but not do much else. The list goes on.

The modern approach to artificial intelligence systems is basically on of machine learning which requires large training data sets and a large market to justify to expenditure on development and training. Therefore we will see AI systems developing in markets where there are either a lot of customers, or high margin customers, or both. Given how many accounting practices there are around the world the accountancy business is one that is ripe for such a development.

Are The Two Major Supermarkets in Australia Doomed?

November 6, 2016November 6, 2016 / futuristpaul (Paul Higgins) / 6 Comments

Yes but it will be a slow train crash

Following stories in the Australian Financial Review and News Limited last week (Amazon delays Australian launch to September to include fresh goods and Amazon to ‘destroy’ Aussie retail ) I decided to complete this analysis which has been kicking around in draft form on my system for a few weeks.

It is not just Amazon that is the problem. A combination of threats on margin, volume, and customer traffic is threatening the existing business model of the major supermarkets. Not all have to be successful for there to be major effects. To understand how that is happening we need to understand the business model.

A long time ago I tried to get ex Woolworths Chief Executive Paul Simons to come on board to market Australian Pork by becoming Chairman of the Australian Pork Corporation. That bid failed but something he told me about the supermarket business when we met has always stuck in my mind. Paul told me that there were five things that attracted people into supermarkets and while they were there they bought a heap of other stuff. Those five things were discounted bacon, Coca Cola, Pal Dog Food, fresh meat and fresh vegetables. A quick look at the Woolworths weekly specials catalogue for Victoria for the week starting August 31st (when I first started putting together this article) shows discount bacon, a discounted leg of lamb and a discounted whole duck front and centre on the first page. That is followed by a full page spread on fridge mate packs featuring Coca Cola and two full pages of double points on fresh fruit and veg.

woolworth special august 31 2016

Source: Woolworths

Given that was the early nineties we could probably add rotisserie chickens, specialty pet foods, Huggies, petrol vouchers, and reward points to the list. That does not change the point that there are major group of items that get us in the shop and we buy other stuff when we are there. We certainly might buy half price Edgell Red Kidney Beans when we are there over another brand or product because they are on special but it is not going to get us in the door.

Later I chaired a board where a senior executive of one of the major supermarkets was also a board member. He told me that the supermarkets did not make money out of selling things. Their main two sources of income were the cash difference between when customers paid and when suppliers got paid and selling prominent shelf space to suppliers. While the story is illustrative of the business model rather than a statement of fact it does help understand the model.

If we look at the cash from customers as a source of of revenue then inventory turnover is important. The faster the inventory turnover the more money the supermarkets get in before they have to pay their suppliers.There are various numbers available for supermarket inventory turnover rates. The Inland Revenue Department of New Zealand reports median turnover of 14 times with a range of 10-19 for large supermarkets and grocery stores). The ratio of sales to inventory in the Woolworths annual reports 2011-2015 vary from 12.46 to 14.81 although these are affected by their non supermarket sales. Because this is not an investment analysis I think that it is safe to assume that the inventory turnover for Woolworths and Coles supermarket business would be at the higher level of the IRD estimates. If we use 16 x turnover that is equal to turning over inventory every 22.8 days. If the average payment terms to suppliers is 90 days (personal experience) that means that on average the supermarkets have customer cash for 67 days before they have to pay suppliers. With daily sales of Australian Food and Liquor of $115.4m that is a whole lot of cash in the bank. Of course lower interest rates will have damaged the revenue the supermarkets receive form having that cash on hand.

When we look at paying for products to be on shelves and supplier rebates it was reported in The economist last year that In Australia supplier rebates had boosted margins for the major supermarkets by 2.5% point to 5.7% over the past five years (Buying up the shelves)

The other part of the business model puzzle is that the supermarket business is generally a low margin business once all costs are taken into account, although margins in the Australian market have been higher than the rest of the developed world. The Woolworths five year financial summary to 2015 shows that margins for the Australian Food, Liquor and Petrol operations have been between 6.63% and 7.20% before interest and tax. While this is generally a low margin for businesses it is 30-42% higher than the margins in the Woolworths New Zealand supermarkets in the same report.The margin before interest and tax for 2016 fell dramatically to 4.43% as Woolworths lowered prices to compete with Coles and Aldi. The margins before interest and tax for Coles supermarkets in 2016 and 2015 were 4.73% and 4.67% respectively ( http://www.wesfarmers.com.au/docs/default-source/Quick-guides/2016-full-year-results-shareholder-quick-guide.pdf?sfvrsn=2).

While this net margin is quite low the gross margin is much higher For example the gross margin for Woolworths was 25.37% and 26.19% for 2016 and 2015 respectively ( Woolworths Financial Reports (pdf )) .

The gross margin is essentially sales minus the costs of purchasing goods for sale. This means that the difference between gross margin and net margin is all the other costs such as property leases, energy, staff, etc. This is a critical point because it means that the contribution to profit of the last customer or the extra sale is much higher than the average across the business. What this means is that if I drive down the road and turn left to shop at Woolworths or turn right to shop at Coles the loss in sales to the one I do not choose is very high. Whether I turn right or left both those businesses still have to pay their staff, pay their energy bills, pay their property leases, etc. That means that if roughly 18% of customers disappear and they cannot adjust their costs then their profit disappears, and adjusting high fixed costs like leases, staff and energy is very difficult.

The same applies to sales volumes. If the same amount of customers go through the door but buy 18% less in volume the supermarkets do not make 20% less profit, they make virtually nothing if the same costs structure remains in place.

So the supermarkets run a high turnover, low margin, high fixed cost business where they make lots of money on inventory turnover and payments/rebates from suppliers. This gives is the basis to look at their strategic future. Attacks to their profitability can come from primarily three points:

Lower margin business forcing them to reduce margins as Woolworths has done in 2016 to combat the threat of Coles and Aldi in particular. This may be extended further in a major Amazon push into fresh produce.
Customers being drained away so the high costs structure causes problems for profitability.
Customer numbers staying the same but buying less every time they go to the supermarket.

Lets look at each of those individually:

Customer numbers staying the same but buying less every time they go to the supermarket.

This is the most serious threat to the long term viability of the supermarket businesses. The threat is analogous to guerrilla warfare or asymmetric warfare. Only some of the attacks need to be successful for the supermarkets to be in trouble. People will still go to the supermarket but there purchases will be reduced.There have been lots of efforts to look at direct delivery models with varying success but we are now reaching the point where multiple models are developing that have a good chance of being successful. This is devastating for the supermarkets because if 40% of people reduce their purchases by 30% that is a 12% reduction in overall sales. But the supermarkets will still have to operate their existing business model to retain the other 60%of customers as well as to be able to retain the people that have reduced their purchases but are still coming into the store. Lets look at some of their threats:

Dollar Shaver Club

dollar-shaver-club

These guys run a direct delivery service for razors direct to your door. They combine an irreverent marketing attitude with social marketing that gives you free blades if you recommend a friend. They promise to reduce your costs of shaving and take all the friction out of the process. I don’t use a razor any more as I use clippers to manage my George Clooney like designer stubble, but if I did use razor I would sign up today – no longer buying that product from the supermarket. A small individual purchase perhaps but they start to add up.

Blue Apron

blue-apron

Blue Apron promotes direct delivery of all the ingredients you need to prepare a healthy great tasting meal. I met with one of the Nokia trends scouts in Austin Texas a few weeks ago and she is an avid fan. As Blue Apron delivers the exact amount she needs to make a meal there is no waste and she said that the service is not costing her any more money than shopping for the ingredients. It is estimated that Australians throw away about $8 billion dollars of food a year (fact checked by the ABC) so certainly there is a cost saving there. While they are not yet in Australia the business model is one that is easily transferable here.

Youfoodz

youfoodz

Youfoodz is a company that will deliver a week’s worth of fresh (non frozen) meals direct to your door in Australia. You can choose all meals or a proportion of meals and snacks. I have done a cost comparison on their service and while they are slightly more expensive than making your own food for quality meals the difference is not large. Again there is no waste and for the time poor there is no shopping or preparation to be done. For people working long hours or running their own businesses where more time means more money this is a very viable alternative.

Amazon Dash

Amazon Dash is a programmable button that you can put in your house. The example here is one of putting one on your washing machine so that when you run out of washing powder you just push the button and washing powder is delivered into your house. It takes all the friction out of buying and I imagine them building in services integrated with Alexa (the interactive home system) so that rather than just buying your normal brand the system can queue up order requests and talk to you about special offers, etc at your convenience. Once adoption gets high enough then Amazon can use its considerable logistics and information system to package up multiple orders, supply weekly orders based on your usage, and give you special offers. It has not really caught on yet but the system is adding more and more brands and Amazon is pushing it out to more countries (Amazon triples Dash Button brand lineup, orders surge 75% in Q1 andAmazon brings its Dash buttons to the UK, Germany and Austria for ordering staples with one touch). It has the smell of a long term strategy to harness all of their capabilities into an offering that makes sense, especially for dry goods.

So if we think of an example household of an above average income couple (the most attractive customer) that are busy with work or their own business you can imagine a combination of all of these services. They use a service like Youfoodz to have a couple of meals pre-supplied on their two busiest days of the week when a combination of work and commitments for kids activities have them stretched. They use a service like Blue Apron once a fortnight for a lunch or a dinner where they want to cook but want to eat healthy and not think about recipes or shopping. They use Dollar Shave Club for monthly supplies of razors. They install Amazon Dash buttons for washing powder, toilet paper, paper towels, dish washing liquid, and cereal and it all gets delivered. Gradually Amazon influences them through their Alexa to buy more dry goods because the marginal cost of freight is so low the system is cheaper. Convenient and lower cost is a killer combination.

They still go to the supermarket they always went to but slowly but surely the amount they buy there until it is down to 50%. Some families at that level then start questioning the trip to the supermarket and start changing their total shopping habits.

The problem with all this from the major supermarkets point of view is that they don’t really have a strategic response that makes sense because of their legacy model. They cannot abandon the majority of their customers so their model stays the same and their margins get steadily eroded.

If they reduce stock lines then they slide more towards an Aldi/Costco model and they don’t want to go there. If they move to more and more online systems they can sort of compete but they still have to supply their standard customers and that model is based on big stores based in solid catchment areas. If they close one of them or move to a small store model a lot of customers probably end up with their competitor who did not close. So neither wants to be the first to do that. It is a little like the banking branch model problem. Less and less transaction are being carried out in branches but people will not travel far to conduct those less frequent transactions so banks keep branches open for fear of losing customers.

At every step of the way their business model is eroded:

Lower customer traffic/less spend per customer reduces cash held in the money market.
Lower customer traffic/less spend per customer erodes margins as there are less customers/customer dollars to spread non cost of goods costs over.
Lower customer traffic erodes the capacity they have to charge for shelf space. It is a bit like television advertising rates. If you have less eyeballs watching your shows you cannot charge as much for advertising.

The final straw in this nightmare scenario for the major supermarkets may be Amazon moving its vision to applying its impressive logistics and intelligence systems to support a national network of independent specialty shops. This is where the high margin customer of the future, who has already reduced their supermarket purchases as described above, may be headed. If that is the case then the major supermarkets are caught trapped in a legacy business model they cannot get out of and assailed on all sides.

Only 5% of each attack has to be successful. No-one has to destroy them.

Why is the EU Acting Like a Meat Wholesaler?

July 5, 2015July 5, 2015 / futuristpaul (Paul Higgins) / Leave a comment

For a long time I was on the board of an unlisted public company that wholesaled meat. The Chairman had a very simple attitude to debt collection. If someone owed us $20,000 then he would spend $50,000 trying to get it back. That may not seem to make economic sense but it made sense when you think of debtors as a network. He simply wanted to send a message that we were not to be screwed with, and that we would chase you to the end of the earth. In the meat industry if you got even a whiff of a reputation that you would not collect your debts then people very quickly stop paying you. This very simple strategy worked very well. On annual turnover of $80-$100 million a year we very rarely had bad debts in total over $25,000 and there were years where we had none at all.

This strategy seems to be echoed in the approach the EU is now taking to Greece. I have done quite a bit of reading and thinking about the issue over the last week or so as understanding geopolitical and economic risk is important to my work as a futurist. I am going to use some of the details in a workshop on uncertainty that I am running later in the month. One standout feature seems to be that the EU is concerned that if they go soft on Greece then Spain. Portugal, Italy and others may feel emboldened not to pay back some of their debt and the problem will spread.

However the story is much more complex than that and the details are an object lesson in the fact that social, political and economic issues are intertwined in these sorts of issues, often at a very personal level of the decision makers. They also demonstrate that once stories are embedded in the collective consciousness they are hard to shift. The first rule of politics is that it is always easier to convince people of something they already believe. I am writing this as the Greek referendum is taking place and I think it is worth putting some of the facts on the table.

When I have spoken to people in Australia about the Greek situations they have defaulted completely to the story that the Greeks over borrowed and have been profligate and undisciplined in a fiscal sense. That story is certainly true but it is the facts of a long time ago and the lenders were certainly complicit in lending the money. When you tell people that most of the bailout money has gone to pay out private lenders and that over the last five years the following has happened they are totally surprised:

“Since 2009 the Greek state’s deficit has been reduced, in cyclically adjusted terms, by a whopping 20 per cent, turning a large deficit into a large structural primary surplus. Wages contracted by 37 per cent, pensions by up to 48 per cent, state employment by 30 per cent, consumer spending by 33 per cent and even the current account deficit by 16 per cent.Alas, the adjustment was so drastic that economic activity was choked, total income fell by 27 per cent, unemployment skyrocketed to 27 per cent, undeclared labour scaled 34 per cent, public debt rose to 180 per cent of the nation’s rapidly dwindling GDP”

From: http://www.irishtimes.com/opinion/yanis-varoufakis-a-pressing-question-for-ireland-before-monday-s-meeting-on-greece-1.2256339

This is even more dramatically shown in the following graph:

via Interfluidity (see below)

This is all part of the argument around whether austerity works or whether austerity contributes more to the problem. Apart from the fact that if you are measuring risk as a ratio of debt to GDP then crashing the GDP makes the problem worse, it is obviously very hard to pay back debt if your economy is suffering in this way. This is compounded when the predictions by the lenders are continually optimistic and completely wrong:

Via interfluidity – see below

It is easy to see from these graphs and the reality of unemployment and economic depression why the general person in the street in Greece might be disillusioned at the moment.

If I was a Greek voter right now I would be inclined to vote against the proposal to agree to the new lending and austerity measures because I think there is still a path of negotiation via that route. My concern about the opposite vote is that we will see significant political disintegration in Greece that will feed into radical political movements and that the long term future of the EU will be threatened both from without and within.

Beyond the financial implications of being “soft” on Greek debt I think that there is a large piece of decision making that is occurring here because of personal political considerations and entrenched positions of bias. That is always a poor environment for clear decision making and timely reminder when we try to analyse these issues we must always ask the question of a story that is being told : “who benefits from the story being told now or in this way?

If you wish to be further informed on these issues I suggest you read:

Where did the Greek bailout money go?

interfluidity » Greece

Schaeuble Popularity Soars as Germans Doubt Greece’s Euro Future

The Road To Grexit

I would encourage people to point out where they think the information I have provided here is incorrect or presented in a biased way. We are all better off when we see issues from multiple points of view.

Paul Higgins

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Yes but it will be a slow train crash

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