ICAS: Tutorial 3 Questions + EasyJet

Context: EasyGroup Cinemas Case

What are the sources of scale, scope, and learning economies in the cinema industry which sources are not relevant?

Sources of Scale Economies: 

Scale Economies at an industry level generally present themselves when there are high fixed costs/indivisibilities. The cinema industry has high fixed costs - opening a complex entails an investment of 15000000 pounds. The more customers use the cinema the more diluted these fixed costs will be, and the lower the AC curve will present itself. 

At the time of the case the cinema industry was becoming more capital intensive with new technology (internet, automated gates, booking systems). More capital intensive industries tend to benefit more from economies of scale. 

Special sources of economies of scale: 
Advertising can and does have a scale advantage in the cinema industry. Larger cinema chains boast higher bargaining power, and acess to first-run movies from distributors, this in turn increases the number of customers which increases the dilution of fixed costs. (These are pecuniary demand side scale effects via higher utilization)

Sources of Scope Economies: 

Economies of scope are present if a firm reaches savings as the variety of goods and services increases.

For the Cinema Industry, cinemas are used as conference rooms, sometimes cafes, bars. The total cost would be higher if these activities where practiced in different spaces, rather than on the same space.

There are also Economies of Scope when the brand is under a known name, Easy Jet for example is getting less total costs when using the same known brand name - as iit would using different names for all the activities (or so goes the theory).

Sources of Learning Economies

Learning Economies are cost saving that emerge as a result of cummulative experience in the industry. 

In the cinema industry, knowing what type of movies should be displayed, at what times they should be displayed (programming), the segmentation of the customer base etc are all sources of cost saving in inneficiencies that only come as a result of cummulative experience/ trying a lot of strategies and landing on ones that are better through trial and error. 

In the cinema industry learning economies are more prevalent in increasing revenues, not decreasing costs. 

What core capabilities did easyGroup transfer to the cinema business? To what extent could the diversification into the cinema business benefit from scope economies?

Core capabilities:

1. Yield Management system: Easy Group was trying to create a more dynamic pricing approach, depending when variables such as demand for the movie, time of day, how filled the cinema is etc.

2. Internet Business Applicability: Easy Group was trying to leverage their already posessed knowledge of online sales to the cinema industry .Making sales easier, faster, reducing the necessity for a physical counter (and creating a symbiosis with yield management system - as information for the YMS is faster and easier to compile through a website)

3. Cost-Cutting (no frills culture): Easy Group was trying to leverage their already tried and tested agressive cost cutting methods - reducing staff , and automatizing processes, as well as simplifying the business (no frills), with examples such as allowing outisde food, no publicity before movies - in essence removing everything that EasyGroup believed was  superfluous and an exploitation of the client. 

4. Brand Image (Umbrella branding): The EasyJet Group image (low cost, efficient etc) would pass onto the EasyCinema image.

Scope Economies: The scope economies mainly pertain to the umbrella branding - especially the low price image that is well recognized by the general population from EasyJet that would pass onto EasyCinema. 

What efficiency and non-efficiency reasons apply to this diversification decision by easyGroup? Which reasons are less applicable?

Efficiency Based Reasons:

Scope Economies: There is real and potential value from the economies of scope created by the diversification - umbrella branding (although not clear in the case), and the utilization of underutilized resources (centralized personnel could be used for marketing, financial reasons etc | once again not clear that this is the strategy in the case)

Internal Capital Markets: It is possible to make the case that easygroup could use its vast resources to make the “potentially profitable investment” into EasyCinema. However, it is not clear in the case that the cinema industry is exposed to hard capital markets - as it is not explicit that the investment was made by EasyGroup - rather it was made by Stelios himself. 

Diversifying risks: Legitimate reasons for the spreading of risks. However, the case can be made that shareholders don´t really need companies to diversify their portfolios.

Non-Efficiency Based Reasons:

Managerial reasons for diversification: A lot of overconfidence (what works for one business works for all). A lot of Empire-Building type of diversification approach (relatively little consideration of actual added value).
Cost of diversification through the spreading of resources: It is not clear whether the EasyGroup will actually achieve economies of scope through the utilization of underutilized resources, and therefore it is not clear if the diversification won´t end up spreading resources too thin.

Compare the applicability of the easyGroup business model in the airline industry and the cinema industry. To do so, systematically apply Exhibit 18 (in particular the items related to business model requirements) to the two industries. Also make use of Exhibits 6 and 8. What problems do you see for the cinema business?

Business Model Requirements:

Have unit cost savings of 50% compared with the best in the industry: 

Airline Industry: EasyJet was able to cut close to 50% of  unit cost savings by eliminating In-Flight Catering, Business Class cabin crew, Travel Agent comissions and Ticketing costs. Easy Jet also reduced costs in advertising, Airport and landing fees and aircraft non-utilization. 

Cinema industry: EasyCinema would have dificulty cutting 50% of costs per unit , 27% of costs (in film rentals) would be innevitable - given the relative power in the value chain of Hollywood distributors, 21% of costs (in staff costs), could perhaps be reduced but not eliminated (law requires 1 personnel per screen), depreciation is also innevitable 9% (natural to all companies). The innevitable costs round 57% - very diffiicult to shake 50% of unit costs. 

Have zero or very low marginal costs:

Airline Industry: Dominated by fixed costs, and very flat variable costs - Marginal costs are generally zero. 

Cinema Industry: Dominated by fixed costs, and very flat variable costs - Marginal Costs are close to zero. 

Be possible to yield manage: 

Airline Industry: Probably the first industry where internet data and yield management were correctly used - and incredibly useful.

Cinema Industry: Theoretically possible, as there is enough routes for customer segmentation and dynamic pricing. But more difficult as people don´t buy tickets in advance (time popularity), and there isn´t really seasonal discrimination.

Have the potential to significantly increase utilisation rates compared to the industry: 

Airline Industry: Huge potential when low-cost airlines stated to appear. 

Cinema Industry: Huge potential (utilization rates around 20%). 

Problems with the cinema business: 

The most clear one is the cost cutting potential. For the easy group formula to work, the cost cutting has to be around 50%. In the cinema industry, both regulations and the relatively low value capture that exhibitors have compared with distributors in the value chain (low bargaining power with suppliers) - make cutting costs to that degree extremely difficult.

Why did easyGroup fail in the cinema business? Evaluate all relevant factors. Which are most important?

Reason 1: The system does not fit even by EasyGroup standards

The EasyGroup formula works when severe cost cutting can be acheived - given the bargaining power and reliance on suppliers (distributors), the expectation of cost cutting to that degree was unrelialistic. 

Reason 2: Even if the model could be implemented, would the client want it?

Short answer: No.

Cinema is an experience, most people don´t go to the cinema to simply “watch a movie”, they go for the experience, for the popcorns, for the confy seats - they like the frills. Price elasticity of demand seems to be innelastic.