In this 3-part series, we dissect the failure of Boeing's inflight satellite-based internet service, Connexion by Boeing. In part one, we examine the faulty analysis that resulted in a business model that was impossible to execute. The type of innovation represented by the Connexion service, and how the business model came to be is typical of large-company thinking, and why disruptive innovation so rarely comes from incumbent industry players.
Part 1: A business model that couldn't take flight
On July 17, 2006, Boeing announced the discontinuation of its in-flight "hi-speed" internet service. A quick analysis of the business model shows that this dodo was doomed to extinction before it took its first flight.
Why it had no chance - by the numbers
Connexion offered a satellite-based internet connection which enabled internet connectivity even on transcontinental flights. Started with plenty of fanfare 6 years ago, Boeing's Connexion service won the "World's Leading High Speed Inflight Internet Service Provider" award from the World Travel Awards organization in London for 3 years running.
Said Connexion by Boeing president, Laurette Koellner, "Winning this award for the third consecutive year is a welcome validation of our success." That was in November 2005, just a scant few months ago.
Exactly what success was being validated though?
Service Usage
According to data released by Boeing, "more than 20,000 passengers have used the Connexion by Boeing service during its first year of availability." 20,000 certainly sounds like a big number, but as an absolute number, it is free of context and that context is important. Anyone who knows how to make statistics lie would agree that the best way to distort the meaning of figures is to offer them without context, or juxtaposed in the wrong context.
In truth, 20,000 was the only number that Boeing could have published that made things look positive. In a separate announcement, Boeing offered other data which tells a more complete story.
A corporate backgrounder published a few months later in early 2006 shows that Connexion was available on 180 flights daily. That is 65,700 flights per year, give or take a few.
Assume that a few more planes were outfitted between the time of these two announcements, and perhaps the run rate was 60,000 flights per year at the time Boeing said 20,000 passengers had used the service. That is one person on every 3 flights using the service. Not such a stunning success anymore.
So, lets be generous since we don't know the rate at which service was added during the period when Boeing had 20,000 users. Maybe it was actually 1 person every two flights. Hmmmm. Still not much of a business model.
Revenue Streams
Now let's look at revenue, and assume that everyone who used the service paid the top daily rate during that first year of $30. 20,000 paying customers at $30 each is a grand total of $600,000 revenue.
We know, however, that prices were reduced during this period, and many of these passengers likely opted for the lesser priced packages, so lets give a nice round number and say they had $500,000 in air-time revenue from end consumers. This for a technology that cost over $500,000 per plane to install. I'm starting to smell some really rotten fish. (140 aircraft had been outfitted at the time this backgrounder was written.)
Of course, there were other revenue streams from government, ship traffic, corporate jets, branding fees from airlines but it's clear that this business model and the cost structure was based on hefty uptake from business travelers. The WSJ says Connexion had $25M in revenue, but also notes that over $1B was invested over 6 years.
Profit Potential
What about potential for profitability? We know that there were very high fixed costs associated with this service including expensive satellite bandwidth purchased from several providers, roaming agreements with land-based providers to ensure smooth logon and hand-off of communications, and payroll for 560 employees, the majority of whom required expensive technical knowledge to do their jobs.
Boeing didn't break out Connexion separately in its operating statements, but lumped it into a category called Other which was mostly Connexion. In the most recent quarter, Other showed a loss of $90M for the quarter (improving from a loss of $110M in the quarter a year earlier). Let's be really generous (and for the sake of nice round numbers) and say that only $50M of that loss is directly attributable to Connexion.
Again, for the sake of round numbers, let's say that the losses due to Connexion were approximately the same every quarter, or $200M annually. To generate $200M in revenue and break even, Connexion needed 400x the usage they were getting at last year's higher prices. (Since these are quick calculations, we aren't considering that higher usage would also mean higher expenses).
At that rate, instead of 1 person every 3 flights, what was actually needed was an average of about 130 paying customers on each and every flight.
Where Was the Gut Check?
That stunning calculation leads us to the first great "Aha". What marketing/business genius put together a plan that could only succeed if a very large percentage of the target customers on every flight had so great a need that they would be willing to pay almost as much for a single flight as the cost of a month's broadband access on the ground?
Even if there are some Fortune 500 companies that would be willing to allow that as an expense, I certainly wouldn't want to be justifying more than 1 per month of those to my boss or the corporate controller. I might be able to get away with it, but it's a nuisance factor I don't need.
Another indicator that these round numbers aren't so far off: Boeing anticipates $0.15 per share benefit to next year's results coming from this decision, which at the current number of shares outstanding is over $113M in increased earnings. Since most of Connexion's staff will be moved into other jobs at Boeing, and therefore the majority of payroll expense will continue, that seems about right.
Questions
- why was there no business model experimentation to determine whether the market as envisioned would or could ever materialize?
- how were the usage, revenue and profitability projections determined?
- how did Boeing manage to scale this service to require massive fixed costs and 560 employees to support the service before determining product/market fit and the real size of the likely market?
- were any of their assumptions realistic, and if not, how did they miss such a gaping hole in their business plan?
- can a big company realistically behave like a startup to test business models in "fast-fail mode" before scaling?
In Part 2
In Part 1, our quick analysis of the accounting clearly shows the magnitude of the miscalculation implicit in the Connexion by Boeing service. It looks as though it had no chance to reach profitability ever. So, how did this come to be? In Part 2, we examine the marketing mistakes that contributed to this colossal failure.