Why Behavioral Economics Makes Helios & Matheson’s (HMNY) Moviepass a Misunderstood Buy
April 17, 2018
HMNY and Moviepass is a hotly debated battleground stock. Moviepass provides a product that seems too good to be true. It is loved by consumers who see a fantastic value proposition, and it is despised by those who think it diminishes the value of going to the movies and will hurt the industry over the long term if the company does not survive.
The key reason the company has been so hotly debated by investors is the divisiveness of its unusual business model. Investors either see it as a product that is too good to be true – and thus will not exist as soon as the company runs out of capital. Which on the surface, using simple math models, makes a lot of sense. When you consider that a MoviePass subscriber with enough time and love for going to the theater can see a movie every day of the month for the small monthly subscription fee of $9.95. If a customer took full advantage of that 1 movie per day offering they could rack up COG’s to MoviePass of $300 or more. Too many heavy using subscribers on Moviepass could make the company go bust in a hurry. Bears have covered they story well and the stock price of HMNY has suffered as a result.
On the other side, there is the Bull case who believe in a more nuanced view of how Moviepass can turn a profit and save the movie industry from itself. Movie theater attendance has been in decline for years as theaters have steadily raised prices in the face of those declining attendance numbers. Theater owners have defied basic and traditional economic supply and demand models, leading them venerable to a disruptor with a clever new pricing scheme and business model. The nuanced view is a little harder to understand than the simple math model, but if understood and validated it offers investors of HMNY a misunderstood buying opportunity. If the model ends up being proven successful, MoviePass could end up on the fast track of being the next major $billion dollar tech unicorn.
I believe that the Moviepass business model works, but the nuance in the model is that it takes advantage of behavioral economics over classical economics. Only simple math that would say it is doomed. With key behavioral economics concepts fully considered, investors might find it easier to take that leap of faith needed in order to believe the business model for Moviepass can and will work.
Behavioral Economics is a “relatively” new field that seeks to combine behavioral and cognitive psychological theory with conventional economics and finance to provide explanations for why people make irrational financial decisions.
According to conventional financial theory, the world and its participants are, for the most part, rational “wealth maximizers”. However, there are many instances where emotion and psychology influence our decisions, causing us to behave in unpredictable or irrational ways.
Moviepass is a poignant example of behavioral economics and demonstrates several of its key theories in practice. Let’s consider a few of the well researched concepts of Behavioral Economics and how these might apply to Moviepass consumers.
Mental Accounting. is the tendency for people to separate their money into separate accounts based on a variety of subjective criteria, like the source of the money and intent for each account. According to the theory, individuals assign different functions to each asset group, which has an often irrational and detrimental effect on their consumption decisions and other behaviors. There are many examples of how people use mental accounting. People tend to spend more of their bonuses or tax returns on frivolous items because they treat it as “found money”. We can all relate to our friend who wins big at the casino and becomes suddenly generous in buying everyone drinks and dinners until the buzz of that found money wears off. Logically of course, money should be interchangeable, regardless of its origin. Treating money differently because it comes from a different source violates that logical premise. Where the money came from should not be a factor in how much of it you spend – regardless of the money’s source, spending it will represent a drop in your overall wealth.
How does this relate to Moviepass? Moviepass customers fully admit that they spend more on concessions than they normally did in the past without Moviepass. The reason for that can be attributed to mental accounting. A Moviepass customer likely has a mental account or budget for how much they are willing to spend going out on any given night. Maybe that amount is $40 or $50 for a couple. If the couple goes to the theater and pays for the ticket price that night, they have already expended somewhere between $18 and $25 dollars – just to get into the show. Leaving them with only $20 to $30 dollars left for the entire evening. Other expenses could include a babysitter, uber, dinner out beforehand etc. When using Moviepass, the mental accounting for the evening does not include the cost of going to the theater, so Moviepass subscribers will “feel” as though they have spent less so far for the evening and can much more easily convince themselves that they have the necessary budget to spent $5 on a soda, or $7 to $10 on a popcorn. Mental accounting helps theater owners sell significantly more high margin concessions. It is a win for theaters, and for Moviepass, and for the consumer who feels like they are getting a high value night. Of course the consumer is paying for the Moviepass subscription. But that Moviepass subscription is in a different mental account, and it also connects into another important behavioral economic concept – Sunk Cost Fallacy explored below. It is clear that Mental Accounting concept is a winner for Moviepass.
Sunk Cost Fallacy Consumers commit the sunk cost fallacy when they continue a behavior or endeavor as a result of previously invested resources (time, money or effort) (Concept was demonstrated by Arkes & Blumer in 1985). This fallacy, which is related to status quo bias, can also be viewed as bias resulting from an ongoing commitment. For example, individuals sometimes order too much food and then over-eat ‘just to get their money’s worth’. Similarly, a person may have a $50 ticket to a concert and then drive for hours through a blizzard, just because she feels that she has to attend due to having made the initial investment. If the costs outweigh the benefits, the extra costs incurred (inconvenience, time or even money) are held in a different mental account than the one associated with the ticket transaction (Thaler, 1999).
How does this relate to Moviepass? Sunk Cost Fallacy relates to Moviepass in two important ways. One which is immediately and obviously positive and mentioned above in the Mental Accounting concept. When a Moviepass consumer goes to the theater, they view the price of the ticket as a sunk cost. They have already paid for their Moviepass, and in many cases they paid upfront for the year and it may well have been several months ago that they spent that money. Because of mental accounting, the price paid for Moviepass now has no bearing on what that consumer is willing to spend for their evening out at the movies today. This is why a Moviepass customer is so much more likely to spend money on high margine concessions, their mental accounting is free from the sunk costs of the Moviepass subscription long previously paid for. $5 Sodas thus don’t feel like such a bummer, nor does overpriced Popcorn or Candy.
The second implication of Sunk Cost Fallacy could be good or bad for Moviepass depending on the customer segment you are looking at. Here is where Sunk Cost Fallacy intersects with the all important utilization factor of Moviepass. A quick primer on utilization factor is necessary here to fully explain these implications. Moviepass CEO (Mitch Lowe) has explained that 88% of existing subscribers are profitable, and only 12% are heavy users.
Heavy users are unprofitable – because their utilization factor – AKA how often the user goes to the movies and uses Moviepass surpasses the amount that the subscriber pays each month for their moviepass subscription. (This is a bad thing for Moviepass Cost of Goods- potentially very bad to the point where Moviepass economics don’t work).
Here is where things get tricky, and where Mitch Lowe and Ted Farnsworth need to be pretty close to the mark with their data and utilization predictions. For the remaining 88% of Moviepass customers who exhibit low utilization rates, the best outcome is that these customers go the movies more often than they did prior to having Moviepass, but not so often that they tip the scale to being a high user who is unprofitable. The stats that Mitch and Ted use are from the MPAA, they state that the average moviegoer sees a movie 4 times a year. When the average moviegoer buys moviepass that number of outings doubles to 8 times a year. That is pretty much the PERFECT scenario for Moviepass. This is perfect because Moviepass needs to demonstrate to theaters that they can both increase attendance and increase consumption of concessions. If they can prove this out, they can legitimately claim they are making a big increase not only in attendance, but they are also driving up the real profit making machine for theaters – concessions! If they can prove this out, it could lead to one or more of the big chains doing a deal with Moviepass where Moviepass gets both a reduced rate on ticket prices for Moviepass customers, and they would also get a cut of the juiced up concession sales. Moviepass reports positive progress with independent theaters who are more progressive and buy into these economics already.
So back to Sunk Cost Fallacy – how does that concept help make Moviepass customers who were previously only seeing 4 movies now step up to seeing 8 movies a year. Take the example of the person who buys the concert ticket for $50 who will risk driving through a blizzard and a traffic jam because he bought the damn ticket already. The ticket is a sunk cost, the money was already spent, it should have no logical connection in the consumers mind if the costs outweigh the benefit. But that is not how the human mind works. The concert goer will risk life and limb not to lose the $50 bucks they already spent! Similarly with Moviepass, if a consumer is already paying for a subscription, they will feel more compelled to go see a movie, even if there are few attractive movie options available. The consumer will figure that they have already purchased the Moviepass, so they might as well go ahead and use it so they can derive value from that sunk cost. Think about people who have a seasons ski pass, they are more willing to ski in less than ideal conditions for the same reason, it is a sunk cost, they might as well use it and get whatever enjoyment they can out of that sunk cost on the seasons pass.
Of course this same Sunk Cost Fallacy can work against Moviepass for high consumption users. There will be people who were already going to the movies 8-10 times a month, who will now go twice that amount, and those people will be unprofitable for Moviepass. Even if they buy a lot of concessions and Moviepass gets a cut of them, they will be money losers. They may be good evangelists for the service, but over time, they will be a problem that needs to be dealt with.
Loss Aversion Finally, there is one last concept to consider. Loss aversion is an important concept encapsulated in the expression “losses loom larger than gains” (Kahneman & Tversky, 1979). It is thought that the pain of losing is psychologically about twice as powerful as the pleasure of gaining. As people are more willing to take risks to avoid a loss, loss aversion can explain differences in risk-seeking versus aversion. Loss aversion has been used to explain the endowment effect and sunk cost fallacy, and it may also play a role in the status quo bias.
How does this relate to Moviepass? This concept has its roots in something investors are very familiar with, the pain of losing hurts more than the pleasure offered from gains from an investment. A concept all to familiar to longs on HMNY. In this case the concept is stretched to the fear of going to a bad movie, and losing money from taking that action, as well as the loss of your free time that you spent viewing that movie. We have all been there… We got the babysitter, we took the trip to the theater, we bought the ticket to the show, and you sit down and the movie is a dud! You hate it, yet because of sunk cost fallacy concept, you sit through the movie anyway. But in the back of your mind you are angry. Angry that you wasted the money and your precious free time, angry that the theater is so expensive, and now resentful that you spent that $5 bucks for a soda. It feels like a loss when you see a bad movie, and after you experience it, you seek to avoid that loss and pain in the future. As Mitch Lowe has pointed out, Moviepass helps you to avoid that risk. With Moviepass, you can take a chance on a film, and if you don’t like it, you can simply walk out! This is possible because you are protected by sunk cost fallacy – you feel like you didn’t really “pay for that movie”. And of course if you leave quickly, you get your time back to do something more fun.
Similar to Sunk Cost Fallacy, Loss Aversion can rub both ways for Moviepass investors. On the positive side, the concept can get people going back to the movies again, driving up movie attendance from those who only attend the average 4 times a year, to a higher number. The obvious downside for MoviePass is that it could drive utilization too high with over consumers which can negatively drive up Cost of Goods sold. It seems however more likely that Loss Aversion works more in favor for MoviePass than against it. Heavy MoviePass users are likely already going to as many movies as they can, and don’t view it as a possible negative experience. Disenfranchised moviegoers are much more likely to have experienced a bad movie going experience, and have decided to avoid theaters for other less “risky” entertainment options. Many Moviepass customers on social media have reported that Moviepass has brought them back to the movies again, and I believe the elimination of Loss Aversion is a big part of that new found enthusiasm for going back to the movies.
A long position on HMNY & Moviepass requires a basic understanding of behavioral economics concepts to validate its proposed business model. Key Behavioral Economic concepts appear to favor Moviepasse’s presribed business model. While traditional simple business and economics models would point to an obvious failure for Moviepass based on simple traditional models. The less traditional, and even “illogical” view offered by Behavioral Economic concepts point to a successful model that takes advantage of consumer behavior not easily predicted by simple explanations. Mental Accounting has the potential to drive significant high gross margin concession sales, Sunk Cost Fallacy and Loss Aversion concepts can drive up movie attendance from infrequent moviegoers making more money for the entire Movie ecosystem. In doing so Moviepass stands to help save the movie industry and profit handsomely by providing that value.
Final Note: This is a post I wrote a about 10 days ago. Since writing this post MoviePass has at least temporarily ended the unlimited subscription offering. I wrote in an earlier post why I believe this is a significant development for the company. Later I will make an update on the potential implications of the change and how the new capped offering could impact the behavioral concepts discussed in this post.