Friday, August 17, 2018

Start with a Large One

There’s an old, old joke about how to make a small fortune on speculative investments: start with a large fortune. We’ve seen a lot of examples of this principle over the years, but I have to admit that the recent rise and fall of the parent company behind the “Movie Pass” subscription service is so extreme that it is genuinely hard to believe it is really happening. And the fact that apparently there are still investors out there who are holding on to the company’s stock in hopes of it making a comeback takes us well past the point where the whole things sounds like satire…

If you’re not familiar with Helios and Matheson Analytics, don’t worry about it; their business is almost entirely built around Movie Pass. If you’re not familiar with Movie Pass, the basic idea was that users would agree to pay a monthly fee for a specified period, in return for which they would be able to go to an unlimited number of movies. The number of movies per month was later lowered to a specific number, but regardless of how often you were allowed to use it, the business model was clearly based on having more subscribers who pay for the service and never use it than subscribers who go to the movies all of the time…

Now, we should probably concede that there have been many other subscription businesses based on this same model that have succeeded very well over the years. A familiar example would be “health clubs” – private gyms – that offer memberships at somewhat less than the actual cost of providing service to an additional customer. Since a certain number of their customers will sign a two-year contract and then use the facility less than a dozen times – in some cases the number of customers actually going to the gym has been recorded at less than 25% of those paying for the privilege – this model can be highly lucrative. Unfortunately, it is much easier to go to the movies than it is to go to the gym, and attendance was correspondingly higher…

Without auditing their books I can’t tell you how much of the resulting operations failure was predictable, but one fact that stands out in the Market Insider article and other accounts of the company’s failure is that Helios never managed to negotiate a discounted high-volume rate for the movie tickets it was providing to its subscribers. If the company had obtained such a rate – say $5 per movie – and then offered customers five movies per month for a subscription of $30 per month they would have made $60 on every customer who attended all 60 movies over the 12 months, and more than that on anyone who attended fewer than that. Meanwhile, if movie tickets cost from $10 to $15 each, the service is still a good deal for the customer, since they will break even if they go to two shows a month, and save money after three…

Marketing a service that provides a finite number of movies, even at a remarkably good price, would have been much more difficult than just advertising “unlimited” movies and hoping that the majority of your customers don’t attend more than a few movies each year, of course. By the same token, it would probably have been a good idea to get the bulk discounts on movie tickets before you started offering the service to the public, and it probably would have been an even better idea to figure out what would make movie studios want to offer you bulk discounts in the first place…

Given all of these issues, I’m not sure why investors are continuing to hold onto the stock when Helios has seen its stock value drop from somewhere over $100 a share to somewhere under 10 cents a share, but then I can’t explain why people would keep buying more shares as the company was leaning further and further into its death spiral, either. It’s possible that people don’t really understand how sunk costs work, or what escalation of commitment means…

But that’s a discussion for another day…

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