How successful, profitable companies don’t really sell what we think they sell

Most big companies start with a fairly simple product or service. It has a utility, and enough people buy it to make the company rich. Then it diversifies to include things that it initially never thought it would sell.

Amazon is clearly the most famous example of how inception doesn’t control evolution.

It began as a mere online bookseller in 1995. Amazon’s cloud-computing business now generates more than half its total operating income. Buy anything from Amazon or not, if you use Netflix, Airbnb, Coursera or SoundCloud, or even see exciting images from NASA’s Mars Curiosity Rover, you probably add a dollar to Amazon’s kitty.

Facebook’s former head of growth and now a vocal investor, Chamath Palihapitiya, said, of all the money that he invests into companies, about 16 per cent goes directly into Amazon’s coffers for data hosting. Despite being very complex in its structure and range of activities, the logic of how Amazon makes its billions is comprehensible. So is the same for Apple, Microsoft, Facebook, Google and most companies in the world.

But this linearity of make/invent stuff and sell stuff to make money is a reductionist model of understanding how capitalism works. Bill Gates once mentioned at the Economic Club of Washington DC that being the product guy who loved creating real software for computers, he was at first highly sceptical of meeting with Warren Buffet, because buying and selling stocks wasn’t a real value-addition activity for him. They later became great friends, with Warren Buffet now regularly donating to Gates’s philanthropy foundation.

Especially for those of us who grow up in resource-scarce societies, making sense of where the money comes from is one of the first questions.

Our model for thinking about wealth is that of a kirana store (grocery store): you sell at more than what you bought for or incurred to produce. Utility and unit economics are not exactly bad questions, but they can be misplaced in the series of steps towards building businesses. The Hong Kong metro system versus the Delhi Metro can help explain the case.

The basic function of any mass-transit system is to help people move around. We pay for the ticket, and the transport authority uses the money to keep the system running. The conundrum with this is that the per-passenger costs of a well-maintained metro system are pretty high. Even at high-capacity utilisation (Japan rush-hour videos anyone?), you will need to charge a price that badly pinches the middle-class pocket. And if most people can’t afford your metro, what’s the point of running it anyway?

But this is the least creative way to understand a business model. The amount of money recovered from tickets for the operation cost is called the farebox recovery ratio (FRR), and this is just one way of making money from a mobility system. Apart from an FRR of over 150 per cent, the Hong Kong metro, run by the Mass Transit Railway (MTR) Corporation, owes its spectacular success to the unique “rail-plus-property” model.

In a dense urban area, transit can be of special commercial value. Half of the system’s eighty-seven stations have buildings at the top, amounting to 13 million square metres of floor area. The company captures a good part of the wealth by acquiring land-development rights from the government for areas surrounding the station at pre-metro rates. After building the rail line, it partners with developers to create infrastructure on that land.

According to a McKinsey report in 2014, MTR paid $590 million in dividends to the government. That’s half a billion dollars while providing a utility service. Despite being one of the cheapest in the world, it earns on every ticket sale. Plus it also earns from managing other metro lines for foreign clients and running bus-transit systems.

Yet, adjusting for all parts, India’s largest mass-transit system barely breaks even, when it isn’t busy making losses.

To increase the revenues from other streams, Delhi Metro sold the naming rights of its stations too. The private players who get to rebrand the stations take care of maintaining its aesthetic facade, thus saving costs for the company while earning up to Rs 3 crore per year per station. That we would have government entities bidding to claim another government company’s advertising offering is an unexpected outcome.

Now, amongst others, there’s an ONGC Shivaji Stadium station, an Indian Oil Green Park station, a Bank of Baroda Sikanderpur station and a LIC Vaishali station. This is our money changing pockets.

Government-run public services have a distinctly bad name in developing economies like India. Our national airline, Air India (originally a private carrier that was nationalised after Independence), has a debt over Rs 50,000 crore and has been up for adoption for several years. It might find a reluctant buyer by the time you read this book. The lesson though is simple – it doesn’t have to be so. There are profitable government-run enterprises throughout the world.

Jio disrupted India’s telecom services with nearly free data, but BSNL serves the regions where the economics of private players simply wouldn’t work. Even in a wealthy economy like the US, around 40 per cent of Americans in rural areas still don’t have access to high-speed Internet because the major for-profit internet service providers (ISPs), like AT&T and Comcast, don’t have a financial incentive to invest in the infrastructure of sparsely populated areas. In contrast, India has far less area to cover and far too many people to serve.

When everybody thought the average revenue per user, from providing telecom services to Indian consumers would be too low for them to be sustainable and affordable at the same time, we saw operators getting innovative.

You might not like to pay more for every call, but data shows Indians love downloading Bollywood numbers and making them their caller tunes for a monthly subscription. According to a Department of Telecommunications report, in 2013, money made from caller tunes from 2010–13 alone made telecom companies over Rs 8000 crore!

Those of us whose love for expressing ourselves helped the companies keep their call rates low for the ones who couldn’t even pay the call charges. Not all public utilities are meant to generate instant cash for the government, of course. MTR Corporation shows how the failure of many public services to break even is due to the lack of creative business models. It is possible to do good and make good cash at the same time. We are just a bit lazy.

Excerpted with permission from Now That We’re Here: The Future of Everything, Akshat Tyagi and Akshay Tyagi, Penguin Books.