We may be nearly 30 years into the internet era but nearly every asset, product and service in the global economy remains an offline asset. From cars to farm tractors to apartments to storage spaces, the truth is the vast majority of the world’s productive economic assets are offline. We don’t know if they’re busy or not, if they need maintenance or if they’re available to be rented. We can’t even find our car keys.
That’s going to end soon. In the coming years, a combination of blockchain, wireless networks and internet of things (IoT) is going to start connecting, digitizing and tracking the world’s stock of productive assets. Every piece of capacity can be represented as a digital token on a blockchain, accessible through smart contracts, and managed and available based on IoT-enabled connectivity. The impact is going to be enormous; some industries are going to be turned upside down overnight, while others might not change much at all. How will we be able to know and predict what will be impacted and how? I suggest a brief study of history.
While the possibility of true digitization has been around for about 30 years, we still have a long way to go. One case study worth considering is the airline industry, which was one of the very first to be fully digitized and has had, to put it mildly, a very rough ride along the way.
In the fall of 2005, I remember landing at San Francisco International Airport on a flight from Dallas. Over the PA, the flight attendant thanked us, as usual, for choosing her airline. She concluded her message with a line that made the whole plane laugh: “We know you had a choice of bankrupt airlines for your flight today and we thank you for choosing us.” At the time, nearly every major U.S. airline was under the protection of Chapter 11 bankruptcy. For some of them, it was their second visit in less than a decade.
While the immediate cause of this particular wave of bankruptcies was a combination of the dot-com collapse and the Sept. 11, 2001, terrorist attacks, the financial situation of the major airlines had been dire for a long time. Since airlines were deregulated in 1979 there has been a steady stream of bankruptcies and mergers as the industry consolidates. This isn’t a story about deregulation, however; it’s a story about digitization.
The airline industry offers a unique and interesting real-world experiment in what happens when you digitize an industry. What makes this industry particularly interesting is that it’s possible to look at the impact of digitization as having effectively taken place from one moment to the next. This is because although digitization of the airline industry took more than a decade, regulations that governed where airlines could fly and how much they could charge meant that no real impact on pricing or economics could be seen while the industry was regulated.
Starting in the 1960s with American Airlines, airlines began a process of converting their reservations systems to fully digital, online systems. By the 1970s, every seat on every flight in the U.S. was part of a continuously available digital market. Travel agents (and eventually consumers) could search the entire national inventory of flights and seats, compare prices and issue tickets entirely online. Though it wasn’t until the 1990s that electronic tickets were implemented, the reservation and purchasing process was nearly completely digital end to end by the mid-1970s.
During this period of digitization, the industry economics remained largely unchanged, thanks to the regulatory environment. Prior to 1979, the Civil Aeronautics Board (CAB) regulated airlines, determining where they could fly and how much they could charge. The CAB also guaranteed a reasonable rate of return, provided there was sufficient passenger demand and limited competition between carriers. The result was an orderly national growth of air travel and a proliferation of different airlines, many of them profitable.
From the end of 1978, the Airline Deregulation Act rapidly phased out most price and route restrictions, and suddenly we had a free and open marketplace in which all the capacity was visible. The result was a bloodbath. Between 1981 and 2000, more than 30 major U.S. airlines declared bankruptcy and most of them never returned. Famous names from the earliest days of aviation disappeared, including Pan Am and TWA. Many of the others merged with the stronger survivors – "strong" being a relative term because nearly all of the industry’s “winners” spent a stint in bankruptcy as well.
The economics of air travel are challenging for a couple of reasons. First and foremost, the marginal cost of flying an additional passenger on a plane is nearly zero. Selling that ticket for as little as a few dollars is better than leaving the seat empty. And because seats cannot be filled after take-off, there is always a “final sale” going on. This often leads to airlines selling seats that are at the margin, profitable, but are on average far below costs.
Perhaps most painfully for airlines, and despite decades of work on everything from service quality to scheduling analytics it turns out most consumers buy their plane tickets based on only one major criteria: price. And though at times it may seem like the entire world is addicted to frequent flyer miles, they turn out not to be a strong enough lure to sustain substantially better pricing over a long period of time.
The result: Prices trended towards marginal cost of flying one more passenger (which is nearly zero) and far below the actual average cost whenever the industry has excess capacity. The industry has historically been good at creating excess capacity by both ordering more planes and getting much more efficient at flying those planes. Nor is parking the plane an option, not when they cost up to $100 million each and are purchased with borrowed money.
Finally, and this is where digitization is so powerful, the structural elements of the ecosystem (high fixed costs, low marginal costs) are amplified by the digital marketplace. Every seat on every flight is instantly visible, making comparison-shopping and capacity-planning very easy. That leaves no quiet, profitable corners of the market hidden from view.
And now as digital rolls forward, there might be many more similar industry experiences in multiple industries. IoT is going to instrument a lot of industrial capacity, much of which is presently both idle and invisible. Just like the airline industry, once a huge amount of idle capacity becomes visible and bookable online, the likely effect is a plunge in pricing. How many idle MRI machines or pieces of mobile, heavy construction equipment are out there?
Which products and industries are most at risk? Not every product is easily subdivided or shared, but those with capacity that can be shared are at higher risk than others. Industries that have low asset utilization are also at risk. Even before COVID-19, most offices sat idle much of the time. Movie theaters are empty during the week. Classrooms are quiet three months of the year. What if all these facilities and assets could be managed, booked and utilized online?
Many people are rightly skeptical about how transformational this technology might be – does anyone really want to use a theater during the day? How about a classroom on the weekend? But again, there are some interesting lessons from the airline industry. In the U.S., the CAB promised airlines they would receive a 12% return on invested capital for routes that operated with at least 55% capacity utilization. Airlines often assumed that mid-week flights would run nearly empty and holiday destinations would have weak performance in the off-season.
In the decades after deregulation, airlines discovered they could fill mid-week flights and off-peak destinations to the brim if the price was right. In 2018, the average U.S. airline had a load factor of 83%. That means, as many have experienced, full planes, seven days a week, 365 days a year. With the proper incentives, we should not be surprised if, a couple of decades from now, new movie theaters or classrooms are easily reconfigured into offices or meeting spaces, and MRI services are open 24 hours a day.
Can enterprises prepare themselves for this future of digital disruption? They can start by getting a much deeper understanding of their assets, which ones are essential, how much they are really being utilized and how necessary they are for operations. We’ve learned the hard way in the last few months that we probably pay for much more office space than we really need. What’s next?
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