[Auren Hoffman] Welcome to World of DaaS, a show for data enthusiasts. I'm your host, Auren Hoffman, CEO of SafeGraph. For more conversations, videos, and transcripts, visit safegraph.com/podcasts.
Hello, fellow data nerds. My guest today is Byrne Hobart, who is the author of The Diff, a substack newsletter covering inflection points in finance and technology. I'm a huge reader and fan myself. So Byrne, welcome to the World of DaaS.
[Byrne Hobart] Thank you. Great to be here.
[Auren Hoffman] Yeah, really excited. Now, last year, you wrote an article about airline loyalty points, which I found really interesting and fascinating. So, airline loyalty programs have a higher valuation than the airline's themself? They're basically FinTech companies masquerading as airlines?
[Byrne Hobart] Yeah, if you look at how much money the loyalty programs make, and a lot of the airlines have broken this out for reasons we'll get into, and then you look at what kind of valuation would traditionally be ascribed to a company that grows at X percent a year, is pretty recession resistant and has cash operating cash flow Y, you do get to a valuation that is actually in excess of the market cap of the airline. So in theory, the entire business of actually flying people really fast from place to place and allowing humans to transcend our earthly bounce, that actually has negative value and destroys more than 100% of the equity capital you put into it.
[Auren Hoffman] Is that because the airline industry, at least the United States, is just so competitive? Why is the FinTech part of the airline more valuable than the actual airline?
[Byrne Hobart] Yeah, what it comes down to is that airlines are actually this really complicated bundle of different services. What is really unique about an airline is that it has a complicated network, so not just a bunch of direct flights from one city to another, but flights into hubs that then connect to other flights. What's neat about those airlines is that they do actually have these powerful network effects at the hub level, and slightly weaker network effects at the overall route map level. And that means that for certain categories of travelers, flying on that airline is just by far the default compared to using any other airline. And anytime you have a set of people who are regularly spending money on some company, if you're managing that company, you start to think of other ways to monetize that customer relationship. So you mentioned competitiveness and the airline industry. In one sense, it's notoriously competitive in that the costs are mostly fixed. So the marginal cost of an empty seat versus a filled seat, it's basically you buy one more pack of peanuts, you burn a teaspoon of extra fuel, and you've paid for that seat. In theory, at the last minute, an airline should be willing to let you have a seat at basically any price. And in practice, the whole history of the airline industry is this struggle between the fact that at one level, it's a network effects business that has these monopolistic characteristics, but at another level, a totally commoditized business with brutal competition. It sort of cycles back and forth through those states over time, it also cycles back and forth depending on exactly where you are. So if you're in a city that has a lot of different airlines that service that city, then it is a little bit more commoditized. But in some hubs, Atlanta for example, you don't really have a lot of other options. So individual airlines are always trying to extend the part of the map or the set of the market where they do have a lot of pricing power.
[Auren Hoffman] Basically a United, Delta or American Airlines, essentially the airline piece of it has a negative valuation?
[Byrne Hobart] In theory, but the issue with taking that negative valuation seriously is that when you think about what makes that FinTech company grow it is the fact that it has this preferential access to a set of really valuable customers.
[Auren Hoffman] It’s like a loss leader to help the FinTech side of it or something like that.
[Byrne Hobart] Exactly. So one way to look at it, is that what this really tells you is that growing a financial services company is so brutally difficult and that the growth constraint is so dominated by customer acquisition costs that it's literally worth it to start buying planes and flying people around the country, to have this heavily unionized workforce and have all these safety regulations and things like that. That is actually the most cost effective way to sign people up for credit cards.
[Auren Hoffman] If you think of United, Delta, American, they make their money from Chase, when Chase gives somebody points they basically then convert them to United points, or American points, and that's how United makes all this money. Is that the business model?
[Byrne Hobart] Yeah, pretty much, although going back to the bundle argument, there are just a bunch of different things that airlines do that are profitable on the margin. And then there are these really high fixed costs. So it's like any other kind of bundling thing, if you look at the early days of the cable industry: really expensive to dig these trenches, put cable in them, and then cover them up and it was expensive and time consuming to get approval to do all these things.
[Auren Hoffman] The cable industry, if you wired up a small town back in the day, you truly had a monopoly on that town. Yes, they could get some TV over the air or something like that, but you have this 30 year annuity that you're going to be able to get for a very long time, you have pricing ability, etc. The airlines have somewhat of that. It may be if you're in Atlanta or something, but in general, there still is enough competition from these other entrants, they're somewhat constrained, right?
[Byrne Hobart] Yeah. So there are some constraints. So some of the airports are slot constraints, there's not enough runway space/time for as many flights as the airport could support. Airlines do adapt to that by buying bigger planes over time. And by the way, since I'm talking about this as if the industry functions now as it did then. So I'm talking about this in the present tense, you sort of have to take 2020 as this very special slice of history where all the rules got thrown out.
[Auren Hoffman] During the pandemic, you had air traffic significantly down. But how did the loyalty programs do? Were they still very robust? How did that do?
[Byrne Hobart] Yeah, the main way to think about the loyalty programs is that the function that they serve for the airlines was that at the depths of the pandemic, the pandemic-induced recession and the drop in travel, airlines could point to those loyalty programs and say “This is a solid business that we know has these loyal customers, and we can borrow against it.
[Auren Hoffman] It drops their interest rates.
[Byrne Hobart] Exactly. And going back to this network effects thing, getting cheap capital in a network effects business during a downturn in that business is actually absolutely critical, because it means that you don't have to trim your route network as much. So when there is a recovery, you don't lose that network effect. There's this wonderful interview that Marc Andreessen gave a long time ago, I think it was a quote in the A16Z blog about network effects, where he said “Yeah, everyone loves talking about network effects. But they work the same way on the way down as they do on the way up”. So that's what the MySpace guys think about network effects, that's the Friendster guys. And that's true of airlines too. So a carrier that has this hub and spoke model, every time they cut a route, they're actually reducing demand on all of the other routes that go into that same hub, because some of that demand is driven by people who are going to transfer. In fact, another wonderful quote from the same from the airline industry, he's now the CEO of United, he gave this investor presentation in 2017-2018 and the market absolutely hated it, but he was right: he said that an airline is actually a network carrier, it's a manufacturing company that manufactures connections. And every time it adds a new route, it's adding demand on every other route that it serves. So if a given hub was profitable, with x number of connections, it's gonna be more profitable with x plus one and even more profitable with x plus two. Some of that is just because of the actual demand for tickets and an increasing amount is because you're capturing a larger set of the spending of people who spend a lot of money, so frequent travelers, the kind of people who actually have to know which airline is the best one to get from point A to point B. If their company's headquarters is in point A and their biggest client is at point B, it's really good to be able to get a royalty on all of the spending that they do. And indirectly, that's what airlines get when they have these loyalty relationships that create demand for points.
[Auren Hoffman] I remember 30 years ago, a lot of people were talking about how these airline rewards essentially could become the loyalty points that every business would use, the phone company would use it, everybody would use these and it wouldn't be like United points, it would be this special class of points that you would go and essentially be this central digital currency in a way to be used in lieu of cash. Why did that vision never materialize? It seems like a really solid idea. And 30 years ago, they were in a better position to do that then than they are today. Why did it never happen?
[Byrne Hobart] So I think there are at least two reasons for that. One is that airlines are in this kind of special category, where if you are a frequent traveler, you're generally spending a lot of money on the airline, you probably have a pretty high income, because the jobs that require frequent plane travel are typically high paying jobs. But when you spend money in the airline, you're generally not spending your own money. So there's this sort of socially acceptable kickback mechanism. Right now, it is a little bit odd that you get these points from spending money, that's not actually your money to spend. But it actually used to be even more extreme. So in the early days of Southwest Airlines, they've generally had this open boarding, every seat’s the same, that keeps our cost structure down. For a while, in the very early days, they actually had what they called a business class ticket. And the only difference was that it was more expensive than the regular ticket, you could expense it and they gave you a bottle of bourbon if that's the ticket class you bought. So it is very much Southwest saying “Please take this bottle of bourbon as a kickback in exchange for giving us more money.”
[Auren Hoffman] These points, are there some sort of IRS ruling where these points are not taxable, right? And so you can accumulate these points, which are very valuable, tax free? I know that the IRS has tried to go after it many times over the years, but it seems to be this sacred cow that we can't touch these points, right?
[Byrne Hobart] Yeah, I don't know the details of how that was negotiated. I would guess that, since it's one of the many cases where you have a concentrated set of interests with one interest, and then you have this very dispersed set of interests, all of us are interested in a tax system that allocates the burden of running the government fairly across everybody. But, anytime that burden gets allocated to you, and you have an opportunity to send someone to Washington, DC and make a really persuasive case that this is just not the way to do things, that's kind of fun.
[Auren Hoffman] And airlines have a lot of clout as well, right?
[Byrne Hobart] They actually have a lot of clout. This is something I learned from a separate airlines podcast, that airlines have one of the few high income professions that’s disproportionately Republican. So pilots, they're unionized workers, they make six figures, but a lot of them vote Republican in part because there is this clear military to working at United or Delta or something. So it is rare to have a group of swing voters with a lot of them being from the military. That makes it a really valuable constituency. Georgia is an important state electorally, you generally want to keep Delta happy. And Delta knows this.
[Auren Hoffman] Delta sends an email out to all their mileage holders being like “Hey, you know, that your mileage might get taxed?” You would see this revolt of taxpayers very quickly.
[Byrne Hobart] Yeah. And there is also some sort of implementation overhead, you get a non cash benefit, and then you get a bill in cash for it. Like usually, the tax system tries to be set up so that you get taxed on liquidity and not on unrealized gains. So you wouldn't pay taxes if you bought stock, it went way up and you didn't sell. Similarly, it’s relatively easy to collect when money is changing hands.
[Auren Hoffman] It is interesting, because if I acquire points in a game, for most of these games that are out there, when I acquire points, it's very difficult to sell those points outside of the game and usually the game company itself, they take a very hefty fee when I sell those points, whereas there is a pretty robust market for selling your mileage points. And you could do it outside of United. United doesn't take a fee when I transfer it, etc. And I always found that interesting. You can imagine this really becoming a currency that people use, but for whatever reason, anything else, for example cigarettes and jails, can become a currency etc. But for whatever reason, it never became that and the friction is quite low to move these things around. I'm fascinated why it just never happened.
[Byrne Hobart] Yeah, so that gets into the other argument for why, and it's a couple of things. One is the network effects of currencies. So currencies, I think currencies and languages probably have the strongest network effects of anything in the world.
[Auren Hoffman] So you might as well use dollars or something?
[Byrne Hobart] Exactly. So you know, even though a lot of people want the miles from a particular airline, a whole lot more people want dollars.
[Auren Hoffman] We are taxing those, like if I give somebody a million miles, which is, let's say, equivalent to $20,000 or something. And, if I give him $20,000, they have to pay taxes. If I give him a million miles, they don't have to pay taxes on it. So in some ways, if they were going to use those million miles, or if they could just spend them the same way, like they could give those million miles to their lawyer or something, then they would probably prefer the miles than they would prefer them the money.
[Byrne Hobart] If someone buys out a company for several trillion miles, and then the owners of that company don't pay any taxes on their gains yet, yes, they will.
[Auren Hoffman] I guess the other problem with miles is that they inflate very fast. So the Central Bank of the United Airlines of the Central Bank of Delta does not have the same pressure as Jerome Powell. They can always inflate them at their will and all of a sudden it could be Argentina, and those miles could have very little worth.
[Byrne Hobart] Yeah. And they do strategically inflate. One way to think about it is that they are like a currency, but it's like a currency for an emerging market, whose central bank is very much running for the benefit of that country and not the benefit of people. Outsiders who save in that currency also have capital controls. People do talk about whether they bought points, or they sold points, and their account just got bad, the points got wiped out.
[Auren Hoffman] It's a thing to get banned. Okay.
[Byrne Hobart] Yeah. I don't know how often it happens.
[Auren Hoffman] Because back in the day, I used to buy upgrades from people. You could buy an upgrade from somebody and get a business class ticket. And instead of paying an extra $300 for a business class ticket, you could buy an upgrade for $100, or something like that. And that was a thing, there was like a secondary market for upgrades, which is somewhat similar to points.
[Byrne Hobart] Yeah, you know, it could happen. Basically, the way I think about it is that from the airline's perspective, that kind of secondary market is good if it increases demand for points. It is bad if the cost of that is that people are less loyal. What the airlines seem to really like is that there are a lot of people who want to gain the point system, but don't necessarily do it well. So it's sort of like how casinos in Las Vegas really want people to, a) buy a book about card counting, b) get convinced they are able to count cards and c) enjoy their comped drinks. If you can give someone who walks into your casino a copy of “Beat the Dealer”, and two or three comp warranties, you have a very valuable customer. And they will be convinced until the end of the evening that they are about to come back. So the airlines can have that kind of attitude too where if you try to game the system, do something really aggressive and you fail for whatever reason, then you've spent a lot of money on the airline and, again, the incremental margin on selling one more flight on a non full plane is very high. So they benefit from people overestimating their ability to game the system.
[Auren Hoffman] There are all these weird systems out there. I had a friend in college that basically did like a point washing thing where they would start with, let's say, 100 points in United, they'd wash it through Marriott, they'd wash it to another one and they would end up with like 110 points with United and they just kept doing this every month. And they would earn like 10% interest on their points every single month for infinity. And all these things got closed down over time. But it's an interesting thing, I care deeply about all this stuff.
[Byrne Hobart] Yeah, my favorite of those arbitrages, and this was like 10 years ago, was there was a promotion by the US Mint, it was free shipping on $1 coins. You get your cash back and deposit the coins at a bank. It's legal tender, you can do that.
[Auren Hoffman] And if you make 2% a month or something like that, which is incredibly high interest. That's really interesting. What can crypto currencies learn from airline points? It does seem like there should be a lot of learning that goes across the two, but I don't know if there’s anyone who has ever run airline points and who's gotten super into crypto? So what could they learn from one another?
[Byrne Hobart] I would say, one thing that they can learn is that if you want people to adopt a new pseudo currency, you do need to give it some real world benefit. And so that's something that Bitcoin does not have at all. What Bitcoin does have is that because the creation of new supply is known, you at least know that it's not inflationary. What you learn about Bitcoin is the ways in which it is not like these currencies. On the other hand, one of the things that we do know, from point systems is, someone can always spin up a new one. It is a competitive business in the sense that it's not like anyone will have a monopoly on rewards points. But to the extent that someone does have something close to a monopoly, it is because of this huge investment in fixed real world assets. So it's almost like crypto is the super abstract born as an abstraction idea of currency. And then mileage points are almost at the opposite end of the spectrum, where they are born as something that is a token that represents access to physical goods, and is issued by the creator or by the seller of those physical goods. It's almost like Bitcoin is the most abstract theoretical kind of currency, and then mileage points are the most concrete, real kind of currency. They're both abstractions, they're both these electronic digitized representations of something in the real world.
[Auren Hoffman] The FED is like in between the two or something.
[Byrne Hobart] So crypto needs to have value, it needs some correspondence to the real world, it needs people who are willing to buy it for speculative reasons, or buy it and use it to buy drugs or whatever they're doing. But it's weirdly untied to the real world. For example, the Bitcoin protocol does not know what it's being used for, it doesn't have any conception of the difference between a speculative purchase or shopping, or just someone transferring things from one wallet to another that they own. In fact, the Bitcoin protocol actually builds on this notion of time, which is really interesting. So you don't actually need even a third party time tracker, who can say that the sequence of events was that this happened and this happened. On the blockchain, each block sort of represents the tick of time. So Bitcoin created its own independent time system, in addition to its own independent transaction system, and its own independent auditing system and its own independent saving system, these are all bundled together in the protocol. Almost everything else that we interact with in the financial world, someone has to tie it to the real world. So like a futures contract is not just a piece of paper, or not just a digital representation of a piece of paper, like it is a promise to deliver, or a promise to accept a certain quantity of physical goods on some date at some time.
[Auren Hoffman] And based on something that actually happens, like some fact or something like that. Yeah, whatever. Are there other geographies or countries where these loyalty points have evolved differently? I know there's this air mile reward program, which is owned by Loyalty One in Canada, which is a lot more than just airline rewards. How have we seen some of these countries evolve differently?
[Byrne Hobart] Yeah. This actually goes back to the economics of credit cards, and specifically the economics of transaction fees. It's a many-sided market, if you consider the financial institutions involved, and in markets that have a lot of different players at a lot of different levels, the economics can settle at very different points. So in the US, the way things have settled is that the cost of immersion for accepting credit card payments is actually fairly high compared to other payment opportunities. On the other hand, the number of people who want to spend on credit cards is also really high.
[Auren Hoffman] In the US, we're talking somewhere between 2 and 2.5%, as the average vig of a credit card transaction but like in even a place like Australia, I think it's like 0.5%. Is there some sort of government mandate in Australia saying we're going to protect consumers more or at lower prices? How did that evolve? Australia also has very wealthy people who use credit cards as well, right?
[Byrne Hobart] Yeah. So there have been interchange caps in various places. Part of what happened with the US was that when credit cards started, it was not trivial to fund the system, you had to actually buy computers.
[Auren Hoffman] Like the Bankamericard in Fresno in the 50s.
[Byrne Hobart] Yeah. So they had meaningful costs, and they needed some way to pay those costs. So a lot of those costs are ultimately tied to Moore's law, so they've been declining really fast since Fresno. So that said, as the cost declined, the three things you can do if you're in a market where your underlying costs have declined, are the following. One thing you could do is just say “Hurray, my margins went up”. And then you suddenly realize your competitors are all eating into your market share so you don't have anything. One thing you can do is cut prices. And another thing you can do is, since it is a multi sided network, you find which side of the network is most sensitive to getting better economics, and you give them better economics. So as it turns out, the spenders were more sensitive to getting rewards than merchants were to paying that high vig. So in the US, we ended up with this equilibrium where, if you are a credit card holder, you get a lot for spending money with your card, and some of that comes out of the merchant margin, but because you're getting a lot, you're more willing to spend with your card. So we ended up with this equilibrium where the fees are pretty high, a lot of it goes back to the cardholder, and then, because of that, we're locked in an equilibrium where merchants can't really say no to credit cards, except in a handful of cases.
[Auren Hoffman] But there could be a government mandate saying we're capping at 1% or 1.5%, or something like that. I do find it odd if you use a credit card, and pay off your balance every month, and you could get 2% back or whatever you can get today, if you use a debit card, same thing, right? And for the exact same transaction, you're paying your Netflix on your debit card, you pay your Netflix on your credit card, you don't get that 2% back. So you could earn a 2% interest rate per month, or whatever that is, it’s an extremely high interest rate that you earn on your purchases. Now, most people don't spend hundreds of 1000s of dollars on purchases. But you know, let's say the average consumer is spending $1,000 a month on purchases, including all their groceries and stuff like that, 2% a month is a lot of money that they get to make on that.
[Byrne Hobart] Yeah, and that's something that keeps those programs popular because it is so much more noticeable to get money after spending money than it is to spend slightly less money. You really won't notice if the cost of a gallon of milk goes down five cents, because interchange fees got compressed. And knowing the economics of a lot of retailers, the price cuts that would ensue if there were a cap on interchange fees, some products would get a lot cheaper, some products wouldn’t get any cheaper, because you still need products that people buy. So like I gave milk as an example, the milk price would probably not change, these are things that people go to the store and buy. And so the grocery store wants to have these things located such that you're walking past just a wall of consumer packaged goods that are basically billboards on the shelf that will get you to buy things.
[Auren Hoffman] There are some things I can pay by credit card. Most things you pay by credit card, I can't get a cheaper price if I wrote a check or wrote you did a wire or something like that for it. But there are some things where they're essentially saying “hey, if you pay by credit card, you have to pay an extra 2.5%”. So if I'm going to pay my kids tuition or something by credit card, they charge an extra 2.5% to cover the fee. Whereas if I pay my groceries by credit card, or not, I don't have a different price. Why is it that the credit card companies allow one, not the other, etc?
[Byrne Hobart] Yeah, so they used to really frown on that. So you know, if you're paying rent or something, you just wouldn't have the option to pay by credit card because your landlord would not want to eat that cost. And the regulations on that have changed. So it's a lot harder for them to just say no. That said, for merchants there are benefits because their cost structure is not just interchange fees. And it's not just inventory and rent. Also the marginal cost of just paying people.
[Auren Hoffman] It's worth it because it could be $1,000 a month or something like that.
[Byrne Hobart] Yeah. So for a lot of them, it's not even worth it to give people the option. I'm sure someone like Walmart runs the numbers, and they do the math on if everyone in line stops for 10 seconds, think about this. And we know that line length is one of these chaos theory driven things where you have these little delays that just ripple through the entire system and add extensive delays, they might actually realize that they save X and interchange fees, and then they have to spend 2x on additional people to manage the checkout process. And, they have the actual risk of balance checks, and they have to count the cash, etcetera. So the costs are not super obvious. There's a wonderful anecdote that’s in a couple books on the history of the credit card industry where during the Fresno drop or soon after, that someone from Bankamericard visited, I think it was a pharmacy, and the pharmacy had three full time employees whose job was to collect receivables from people.
[Auren Hoffman] Because they used to let people buy on credit anyway, back in the day, right? You would go there, and they would write it in a book or something, right?
[Byrne Hobart] Yeah. So there were these people who were using mechanical calculators, and they're sending out a bill, you know, Mr. Smith, you owe $2.37, please pay within the next 30 days. That is just brutal for any business. I mean, among other things, it means that if you lose one of your three collection people that suddenly your receivables are ballooning, because you're not collecting fast enough. And now your business is much more capital intensive than it used to be. And banks should be in the business of extending credit, that's something they're actually pretty good at. So if you move that back office process and that balance sheet on to a bank instead of a retailer, then you have this nicer division of labor, and the pharmacy can focus on actually selling medication and food, and the bank can focus on managing credit lines and consolidating these bills. So instead of owing $5 to each of 20 merchants, you owe $100 to one bank. And if you can't pay that right now, then the bank can lend it to you and you pay interest on that. And it's a whole lot easier to do the interest calculation one time instead of 20 times, especially when people are still hand cranking these calculators to actually run the numbers.
[Auren Hoffman] Going back to the other question about things outside the US. So what you're saying is the US is a little bit odd, because the US has these very high interchange fees, which can pay for all these points, whereas a lot of other countries have much lower ones. Are there countries that have similar interchange fees where they have the similar opportunities?
[Byrne Hobart] I don't think other places have really hit the same equilibria. I could be wrong about that.
[Auren Hoffman] Is the interchange fee based on the card holder? Or is it based on where you spend your card? Like if I go to Europe, where the interchange fees are lower, and with my own credit card, how does that work?
[Byrne Hobart] I actually don't know how the international interchange fees work exactly. I know that the credit card companies do talk about making a lot of money from cross border transactions.
[Auren Hoffman] There's an FX fee that they make money from. Okay, got it. So that makes sense that they're there. You can lose out on the 2% FX. So that's probably how they’re paid for it.
[Byrne Hobart] Yeah, yeah. And it's always a bundle. So yeah, they find some way to monetize. I don't know off the top of my head how that interchange fee is set up when it's international. So it's going potentially across different subsets of the same broader network. What is worth pointing out is that there is sort of an analogue to loyalty programs in countries that are underbanked, which is that a lot of times if there is an app that just gets a lot of people spending money digitally for the first time, it will expand into being a financial services super app. So some of the ride sharing companies in Southeast Asia, they've gone from just being ride sharing companies to also having banking services. If you're giving people rides in your car or your ebike, now you can borrow money to buy a better car insurance, you can get life insurance.
[Auren Hoffman] Nothing different than Amazon giving their merchants loans, they become these lenders and stuff. Right? Shopify, similar, right?
[Byrne Hobart] Yeah, but it actually ties back to the idea that customer acquisition and finance is really hard. And for a ride sharing app or like the video game that C Limited has created, it just acquires so many customers that it's almost a business imperative to maximize the value of those customers by turning them into financial services customers, instead of ride sharing or video game customers. So it is kind of analogous in that you have this business that creates access to a set of customers and then you can sell them financial services, but the difference is in countries that don't have a huge consumer banking system. So in a lot of countries, banking systems are a lot more weighted towards business rather than consumers. So it's fewer mortgage loans and credit cards, a lot more of “we get deposits from this tin mining company and we lend the money to a railroad or a steel mill”, or something. So a lot more just b2b type banking. With the b2c thing, you need some reason for consumers to use digital payments and not cash, or you need some system that acts as an interface between digital money and cash. And once you have it, then you can build a consumer facing banking product very quickly. The main analogy is super apps are to the underbanked developing world as loyalty programs are to hyper financialized developed world.
[Auren Hoffman] And one more thing on the airlines. They're increasingly also becoming cargo companies, right? They're increasingly making money from cargo, which is obviously a good business if you have empty seats during COVID. How is that changing over time? And are we going to see United also becoming like a cargo company over time?
[Byrne Hobart] Yeah, so that is another part of the bundle. Planes are big and there are parts of planes that have room for things other than human beings and their comfort animals. So if you fill up a plane with more stuff, then you make more money. And there have been planes that have been retrofitted to be pure cargo planes rather than passengers plus cargo. The convenient thing about the passenger plus cargo model is that typically, if you have a city that has a lot of people who want to fly in and out, those people also purchase goods, so it's convenient to use the same planes to fly those goods. So if planes fly from LA to New York, it's gonna have a lot of people who want to go from LA to New York, but there are a lot of ports in LA, and then they've got to get to New York as quickly as possible. The cargo business, what are the interesting trends is that Amazon, not just the fact that Amazon is growing, but it's flying its own planes more, and is offering faster shipping, which tends to mean they need a shipping logistics network that can handle these last minute shipments. Air freight is very expensive, but it is very quick compared to a truck or a boat. So that's one factor. But what's really interesting is that Amazon has been striking these deals with airlines, where Amazon agrees to buy their freight services and to ship stuff on these on their planes. One of the things that Amazon gets is a warrant to buy stock in the airline at a fixed price. And what's really cool about these deals, some countries talk about this in their prospectus, is that the vesting schedule for the warrant, so when Amazon is actually able to exercise the warrant, and how much of that warrant they get, is a function of the shipping volume that Amazon does with that airline.
[Auren Hoffman] So the more business this company is doing with shipping, like Sun Country or something like that, one of these airlines, probably also the more valuable they are. And so Amazon gets this double dip essentially on the business.
[Byrne Hobart] Exactly.
[Auren Hoffman] And it's always like a rebate that they've negotiated. But they negotiate the rebate in March.
[Byrne Hobart] Yeah, so basically, the implication of this is that what Amazon thinks is, that the cargo business is actually going to become a huge business such that Amazon will not be able to catch up just by buying bots multiplying. So yeah, there are lots of things that you could buy now, but Amazon is still taking this equity stake in airlines that is structured so that Amazon owns more of the airline if it ships a lot more. So Amazon is basically saying, “we actually don't think we can buy a fleet of planes fast enough to catch up with the growth in air cargo”. And that's a really interesting, implicit claim that they've made. Either Amazon is doing something really weird, where they're speculating in a bunch of different cargo company stocks, or they just think that eventually, air freight is going to be a much bigger business and a much more profitable business. And it's actually going to be constrained by the availability of planes for people to fly them.
[Auren Hoffman] Interesting. Well,I have a couple of personal questions for you. I know that you made a decision to write full time. And you basically make probably a majority of your living from your subscriptions of your newsletter The Diff. How do you see the economy of these people who are writing page newsletters, you were definitely one of the more earlier people, but it seems like a lot of people are now starting their own newsletters and stuff. How do you see that evolving over time?
[Byrne Hobart] Well, I would say that every new business actually turns out to be an old business and newsletters are no different. There are a lot of huge companies that were originally newsletters including things like the Wall Street Journal. I would argue that Bridgewater Associates was originally Raised Thoughts, and that evolved into the hedge fund business. Charles Schwab was also originally a newsletter. Newsletters have been around for a long time, especially finance newsletters, and it does talk a lot about finance. And part of what's changed is just that it's gotten a whole lot easier to set up the business and collect payments. And that is nice, because there are a lot of people who like to write and are good at writing, but they're very bad at sending invoices and collecting and I'm like that too. So that is one piece of it. And then the internet has just made it easier to find people who have very narrow specific interests, and to follow them and see what else they have to say. And a lot of what I do when I write issues of the newsletter, is I pick some topic that I know a little bit about, or I've seen some hints that it's interesting. And then I try to learn everything I can.
[Auren Hoffman] Like airlines. And then you go super deep.
[Byrne Hobart] I can cheat a little bit there. Before I was in the newsletter business, I worked in finance. And at one point, I was analyzing airline stocks. So I did have an early start to understanding airlines. But there's nothing written in the newsletter, I had no idea what I was talking about until I started reading about it. But what my newsletter lets people do is outsource, dive in on these various rabbit holes. Because I thought when I worked in finance, there were times where, I was a long short hedge fund trading equities, mostly internet, media, Telecom, etcetera, I was an analyst there, and you'd have a set of big themes, really important things happening in the world, instead of things that are changing right now. And then you have the set of “here's what we think about this Doc, and here are the catalysts”, etcetera. I always found that some of the big themes, I always wish that I had more time to explore them, some of the more 12 month themes, also you had to you had to do triage, you had to say, “here are 10 ways the world is changing this year, and I have enough time to figure out three of them, so I hope I picked the right three in advance”. I always liked doing more of that kind of work. So now I just do it. And some of my readers are hedge funds, and so there will be a trend that they know has been happening for a while they haven't had a chance to dive into and I'm able to do some of the early work for them, point them to sources. I think part of the value add for the newsletter is that if I do a deep dive on something, I will read a bunch of stuff and I will tell people what I read. So they can reconstruct the work and they can go deeper on any sub topic that they care about.
[Auren Hoffman] Back in the day like Grants Interest Rate Observer or something, I believe all their newsletters are paid? It's not like he was putting out, or maybe he was, like a lot of free content. Whereas it seems like most of the people that write popular newsletters, including yourself, there's a lot of free material that's out there. And there's some sort of incentive to put really good stuff out for free to help you get paid people, right? In some ways, that's the way beside doing these podcasts, maybe you get all these paid subscribers that come on. So how does it work? Because like, in some ways, you may have this incentive, your best stuff is free. So all these people come in, and then maybe like the super niche stuff is paid? Or how does that decision tree happen?
[Byrne Hobart] Yeah, I would say you're right, that forward emails are a huge driver, like probably half of my income comes from the forward button in Gmail indirectly.
[Auren Hoffman] That's just like a hedge fund person sending it to her colleagues or something, and then they subscribe or something.
[Byrne Hobart] Yeah. And that's one reason that I do actually like having financial industry people because they usually have relationships with people at operating businesses. So if I write about 20 different topics in a month, the ideal reader is someone who forwards each issue of The Diff to a different person who would care about that specific topic. So that allows me to talk about a lot of things and sort of have generalist subscribers and then more domain specific readers beyond that point. In terms of how to decide what's free or what's paid, I guess there are a couple ways to think about it. One of which is, if I don't have a huge backlog of ideas, or if I know that part of my backlog, I just can't get done in time for the next issue, I just write whatever I can write next. And sometimes I have to structure my time so that I get certain research done in time to write about it. So, in some ways, it's hard to really plan this ahead. I am taking three or four pieces of the puzzle out of the box at a time and fitting them in where I can. But I'm not looking at the entire set of pieces, because I don't know what I'll be writing back. So that constrains it a little bit. What I try to do is, if I'm writing something I know will be broadly interesting, then it's more likely that I'll make it free. If it's broadly interesting and very timely, that's another reason to make it free. So yeah, when a big company goes public, I try to write an early, test one tear down and just explain the business as best I can. So that's more likely to be free. But there's also stuff that is a lot better if it's paid. So one of the nice things about a paywall is, and the subset people have pointed this out, you can have hate readers on a free blog. They read your stuff because it makes them mad, and then they send you really angry emails. No one pays to be a hate reader. I actually had one guy who he did say that he subscribed specifically to leave me a comment to tell me I was wrong about something. But it was actually a really thoughtful comment. And you know, it channels hate into something much more constructive.
[Auren Hoffman] At least you're making money from the hate.
[Byrne Hobart] Yeah. But what it really does is it allows you to say things that, if you wrote this online, 99% of people would interpret it the way that you mean it, and 1% of people would take the dumbest possible interpretation of it. And there's a chance that one of those people would have 500,000 Twitter followers, and they briefly ruin your day. That's a risk when you're writing stuff on the open web, it is really not a risk for paywalled stuff.
[Auren Hoffman] You can be a little bit more free with your thoughts or opinions as well. You might not have to censor yourself as much. Okay, that's actually a really good reason. So there's been this kind of unbundling of writers in a way you used to write, someone used to write for The New Yorker, and now they can make money going direct to people. But it's hard for even a very wealthy person to pay for a newsletter that starts to add up really quickly. Yours is $20 a month, right? So that starts to add up really, fast for you for people? Is there going to be some sort of rebundling where I can buy this finance bundle, and I get burned and get like all these other things together? How do you see that evolving?
[Byrne Hobart] There have been some interesting bundles. One of the constraints on bundling is that the biggest cost of a newsletter that talks about finance and tech, the trajectory is the opportunity cost of your time. And it's the same for the dip. It's the same for money stuff. So bundling solves one problem. It is annoying to pay $2,000 a year for all of your newsletters. I do pay a whole lot of money for newsletters and newspaper subscriptions and things like that, but it is all work expenses, so you get the tax deduction. I do read the stuff. So that is one problem. But the other problem is the time shortage. And actually bundling makes the time shortage worse.
[Auren Hoffman] Because you’re getting all this extra stuff, right? And then you'd want an editor to basically tell you what the best stuff to read. And now all of a sudden, you're going back to the old newspaper days, right?
[Byrne Hobart] Exactly. So I think bundling is a tougher proposition for people who have some kind of unique value proposition that appeals to people who have a high opportunity cost for the time, especially if the time is time that could be worked on, then you do have this implicit question of “is this the most valuable thing I'm gonna be doing for my job right now, reading this thing?”. Some newsletters sometimes are more for leisure reading, and they don't really they don't suffer from that problem. But a lot of the best of the leisure reading newsletters, they also link to a lot of long form stuff, so it's still fairly time consuming to actually read them thoroughly.
[Auren Hoffman] I mean, if you want to read money stuff every day, that's a serious commitment to go read. I mean, some people do read it every day, but I can maybe get to one a week or something, even though I want to read it. It's a really big time commitment. The last question we asked all of our guests. So if you can go back in time, what advice would you wish you could give your younger self? Let's say the 18 year old Byrne?
[Byrne Hobart] What is good advice for a young person? One of the things that I have gotten better at over time is a combination of cutting losses and having some sense that I think pursuing happiness and avoiding suffering, or actually, everyone does that to some extent. But they're pretty poor priorities. There's a sense in which you should almost think of having a happiness budget. If you're too happy while you're accomplishing things at the time that you're working, you probably could be working harder, and someone who has a higher tolerance for misery will probably accomplish more than you.
[Auren Hoffman] There’s some Laffer Curve there, right? If it's too much misery, you'll never do it, because you won't be motivated. But if it's too happy, maybe someone's going to work harder. So there's some sort of medium place for you to be, right?
[Byrne Hobart] Yeah. So I mean, maybe if I had read Starting Strength that much earlier in my life, I would have internalized this because powerlifting is definitely one of those domains where, if you're not suffering somewhat while you do it, you're not getting any stronger. On the other hand, if it's really painful, you're probably doing something wrong, you're probably going to hurt yourself and never be able to squat again. So you do want to balance that. But I do think that having some sort of target level of suffering, or like having a target level of trade offs, where you say someone who's really committed to accomplishing this, here are some things that they would be willing to sacrifice to do it. You want to make a list of those potential sacrifices and say, if I'm not making the sacrifice, I'm probably not trying as hard. So I think Patrick McKenzie had this line, and this was probably five or 10 years ago when Game of Thrones was huge, instead of being totally culturally non-existent. He said something like, “if you if you know what a Khaleesi is, then you actually had enough time to learn how to code, but you just didn’t. And I think that's true, that there's a super abundance of leader opportunities. And there's a super abundance of useful things to do. And Alt Tab, there's a lot of muscle memory there, Ctrl T and then typing in reddit.com, a lot of muscle memory there. It is really important to resist that stuff, because it is a continuous tax on your ability to accomplish things. And on the other hand, this is a this is a good reason to do things like buy physical books, buy physical magazines, is that if you can force yourself to focus for a while you can get you get nonlinear benefits from learning a whole lot about narrow topics, and then taking new topics using analogies from the previous ones and accelerating your learning from there.
[Auren Hoffman] Cool. This has been great. Thank you so much. Now please tell us where we can find you on the internet.
[Byrne Hobart] I'd be delighted. So my newsletter is at diff.substack.com.
[Auren Hoffman] Okay, awesome. Well, Byrne, thank you so much for joining us. Thanks. This was great. This is awesome. All right. This is great. Thank you. So this is awesome. But really, I learned a lot. I don't think you said anything too confidential. But if you have thoughts about it later, let us know. This is probably six weeks away before launches or something. But we will give you plenty of time to let you know and everything like that.
[Auren Hoffman] That sounds good. I don't think I said anything terrible or dumb. I wish I'd known more about the interchange regulations around the world. I don't know what Australia did. But I'm sure that's not a big deal. And when the episode goes live, what I usually do is I link to podcast appearances and external media stuff in my newsletter in the link aggregation section, so we're gonna link there.
[Auren Hoffman] Cool. That's great. All right. Well, thanks. Alright, bye.
[Auren Hoffman] Thanks for listening. If you enjoyed this show, consider rating this podcast and leaving a review. For more World of DaaS (DaaS is D-A-A-S), you can subscribe on Spotify or Apple Podcasts. Also check out YouTube for the videos. You can find me on Twitter at @auren (A-U-R-E-N). I’d love to hear from you.
Byrne Hobart, Author of The Diff talks with World of DaaS host Auren Hoffman. The Diff is a top newsletter that covers inflection points in finance and technology. Byrne previously worked in data-driven equity research and online marketing. In 2020, Byrne published an article stating that airline loyalty programs are worth more than the airlines themselves. These programs have been key to the airline industry's survival. Byrne and Auren dive in. They break down the mechanics of airline loyalty programs, reveal how airlines survived the pandemic, share lessons that cryptocurrencies can learn from airline loyalty programs, and more.
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