If Your Business Model Is Based On Hoping Your Customers Never Do Math, You're In Trouble

from the ny-times,-we're-looking-at-you dept

As we get closer to the NY Times finally putting in place its long-promised, often-mocked paywall concept, it's worth pointing to a story from a couple months ago, which I didn't have time to write about when it came out. It involved some comments on a panel from Gerald Marzorati, the Times' assistant managing editor for new media and strategic initiatives, in which he more or less mocked the subscribers of the print publication for being too ignorant to do basic math and realize just how much they were paying:

"We have north of 800,000 subscribers paying north of $700 a year for home delivery," Marzorati said. "Of course, they don't seem to know that."

As evidence that Times subscribers don't realize how much a subscription costs, he pointed to what happened when the paper raised its home-delivery price by 5 percent during the recession: Only 0.01 percent of subscribers canceled. "I think a lot of it has to do with the fact that they're literally not understanding what they're paying," he said. "That's the beauty of the credit card."

Of course, another explanation (which is much more favorable to the NY Times) is just one of general price inelasticity to a newspaper like the NY Times. If that's the case, where the price rises and most people keep subscribing, it suggests that most of those people continue to value the subscription more than the price, and the newspaper might even be able to get away with raising the price further. What's odd, however, is this assumption by Marzorati, that it's the general ignorance of their subscribers that keeps them in business. We're in an age when assuming ignorance on your customer base is a very dangerous position to be in.

If the company's guy in charge of new media and strategic initiatives seems gleeful over ignorant readers, rather than focusing on ways to make sure they continue to get more value out of their subscription than they pay for it, it makes you wonder how long this sort of setup can really last. There are all sorts of ways that a publication with the reputation of the NY Times can make lots and lots of money. But betting on the ignorance of subscribers does not seem to be like the best overall strategy.

Filed Under: business models, customers, ignorance, journalism, paywalls
Companies: ny times

Second Humble Indie Bundle Does Even Better Than The First

from the but-it'll-never-work-twice dept

Earlier this year, we wrote about the "Humble Indie Bundle," which was a group of indie video games available in a bundle on a pay-what-you-want basis (and with a nice charitable component). The bundle got a lot of attention, and they were able to bring in $1,273,588 in just two weeks. After it was all over, one complaint I heard was that such things were clearly a "one-off" that could never be repeated. Well, recently, the Humble Indie Bundle 2 came out, and with plenty of time to spare, it's already made more money than the original. Also notable, just like last time, it was Linux users who are still paying a significantly higher amount on average -- contrary to the typical claims that Linux folks just want stuff for free....

Filed Under: humble indie bundle, pay what you want, video games

The Myth Of Razors And Razor Blades

from the debunking-the-conventional-wisdom dept

The story of Gillette and the famous "razors and razor blades" business model is legendary at this point. The story goes that King Gillette revolutionized business by coming up with the strategy of selling razors cheaply, but then locking people in to expensive disposable blades, where the margin existed. This strategy has become so well-known that it's mentioned all the time and seen in lots of other industries as well, especially the technology industry. It's seen as the basis for console video games (consoles cheap, games expensive), printers (printers cheap, ink expensive), mobile phone service (phones cheap, service expensive), etc.

Of course, various business strategists who discuss the razor-razor blade business model suggest that there are some key rules to making this work: for example, many feel that there needs to be some level of lock-in, that prevents competitors from entering the high margin part of the market. That is, if someone else can just sell the high margin razorblades, then why would Gillette make the low margin (or negative margin) razors, since customers might just go elsewhere for the blades?

Well, it turns out that an awful lot of both the history and the theory turn out to be totally wrong when it comes to Gillette and the razor/razor blade market. Felix Salmon points us to Randy Picker's latest paper, which explores the myths of the razors-and-blades story as it applies to Gillette -- and the counterintuitive reality of what actually happened. I don't think the real story is quite as surprising or confusing as Picker makes it out to be -- other than the surprising fact that the common "story" we've all heard turns out to be wrong.

What Picker found, first of all, is that Gillette really didn't use the cheap razors and expensive blades strategy at all in the early years. In fact, it went the opposite direction, and charged an extremely high price for the razors. While other razors went for closer to $1, Gillette charged $5 for its razor (with a set of 12 blades). As Picker notes, this represented about 1/3 of a week's wages at the time, and made it a luxury item. While there were some convenience factors, other safety razors entered the market soon and charged a lot less than Gillette for both razors and blades... and Gillette kept its prices high.

And here's where patents enter the story.

Gillette received patents in 1904 on both the razor and the blade. As Picker notes, conventional wisdom would suggest that this is the perfect point for Gillette to have used the famed razors-and-razor blades strategy, since it could use the patents to exclude competitors from offering compatible blades. But, it did not. The same "conventional wisdom" would then argue that once the patents expired, and others could offer compatible razors, the razors-and-blades strategy would not work. And yet, it was after the patents expired and when there were compatible blades on the market that Gillette finally went to this form of strategy.... and its sales and profits shot up.

Picker suggests that none of this makes sense. He says without exclusion via things like patents, a razors-and-blades strategy shouldn't work, because there would be no lock-in on the platform (razors), and there would be competitors who would just offer the blades, undercutting Gillette, which would have to eat the costs on the cheap razors. Meanwhile, without the lock-in, users could just jump ship to a competitor at will, since the platform was so cheap.

I'd argue, however, that it actually makes perfect sense, the more you think about it. With patents, Gillette priced the razors (and, potentially, the blades) artificially high, creating a smaller, artificially limited market. This has long been our complaint with patents in general. Once the patents expired, and actual direct competition became more of an issue, then Gillette finally had to price to the market, capturing a much larger segment of the market, driving up revenue and profits because of it. As for why once the patents were no longer a serious issue, this strategy still worked, I think Picker underestimates both the value of brand loyalty and convenience, as well as mental transaction costs.

That is, even if others offer compatible blades for Gillette products, people are generally loyal to the overall platform brand if it hasn't done them wrong. Not everyone will be, of course. There will always be some pure price shoppers who look for the best deal. But many people will remain generally loyal to Gillette, and with more customers coming in due to market pricing, the net benefit could be much greater. On top of that, people don't want to have to worry about whether or not the blades will really fit or really work as well. They're likely to feel more comfortable going with the brand name that is the same as the razor maker, knowing that it will work, and that there's a level of quality involved. Choosing a different brand of blade involves risk and mental transaction costs that many users just won't want to bother with.

The whole thing is quite fascinating in thinking about these kinds of business models. Printer companies, especially, might learn a thing or two, as they've now become quite aggressive in using patents to block competitors from offering compatible ink cartridges or ink refills. But, the example of Gillette suggests they could be better off not fighting it, but focusing on providing better quality that doesn't annoy users quite so much.

Separately, I should also note that this is why I think that the classic (now, apparently mythological) Gillette razors-and-blades business model is not quite the same as the business models I suggest when it comes to infinite and scarce goods. That's because the classic Gillette story (as opposed to what really happened, apparently) would require lock-in. But the give away the infinite and sell the scarce setup is to not worry about lock-in, since that tends to piss people off, but rather focus on providing value so that people are comfortable buying from you -- which seems to be a bit closer to what actually happened with Gillette.

Filed Under: business models, patents, razorblades, razors
Companies: gillette

Freakonomics Does 'Pay What You Want' Screening

from the reasons-to-buy? dept

Last month, we talked about how the new Freakonomics movie was going to flip the traditional windowing methodology, and get released online before it was in theaters. At the time, Stephen Dubner warned that there was also going to be another "wrinkle" in how they released the movie. I'm not sure if this is it, but it's been announced that there is going to be a special "pay what you want" screening in select cities (Los Angeles, San Francisco, Washington D.C., Chicago, Boston, Dallas, Philadelphia, Denver, and Seattle). Free isn't an option, however. The prices range from $0.01 to $100, and you also have to answer some survey questions. I'm always a little hesitant to buy into straight "pay what you want" deals, because I don't think they represent much -- and I worry that people read too much into the results of any particular experiment, especially when little is done to give people a real reason to buy on top of the content. So, to some extent, I worry how Levitt and Dubner might interpret any results from this experiment.

Filed Under: economics, freakonomics, movie, pay what you want

Software Startups Realizing That Cookie-Cutter Freemium Doesn't Always Work Well

from the but-don't-miss-the-point dept

A few weeks ago, we ran a webinar about "using free as a part of your business." One of the speakers was Phil Libin, from Evernote, who gave a very detailed presentation (you can view the whole thing here) about how Evernote has turned "freemium" into a success story. I found his points fascinating, in part because I've actually never been a huge fan of the "freemium" model for software -- where you get some basic features for free and then to use more, you have to pay. I don't talk about "freemium" very often, because I'm not convinced it's a strategy that works in most cases. It can obviously work in some specific cases, as Evernote has discovered, but it can be tricky to apply elsewhere.

There are a few reasons for this. First of all, the basic concept of "freemium," involves some rather arbitrary choices. You provide "x amount" of storage/users/projects/features/etc. for free, and you hope that people will pay for increased storage/users/projects/features/etc. But where do you make the cut off? That's quite tricky to figure out, because there's no fundamental reason for the cutoff points. When we talk about using free in a business model, we generally focus on freeing infinite goods and selling the scarce goods, but "freemium" offerings for web services don't tend to make any such distinction. The "free" versions are basically given away as marketing in the hopes that people will upgrade.

But in many cases, that doesn't work for a few key reasons: first, you now have incentives to make the "free" offering worse. That's never a good thing. In the effort to get people to sign up for the premium version, you have bad incentives. You don't want to make the free version "too good" as then people won't feel the need to upgrade. I find that to be a bad incentive structure in many cases. On top of that, there's a part of this that's a "give it away and pray," type strategy. Yes, you're offering more features, but figuring out that right mix of what's free and what's paid is really incredibly tricky, and you simply have to learn to accept, as Libin has done, that the vast majority of people using your app are just there for the free version. For Evernote, one of the keys to making it work is that the app itself becomes more and more useful, the more you use it. That leads to greater conversions over time. That's honestly rare for most apps which have a more or less steady-state usefulness.

The problem is that while the "free" version is supposed to act as "marketing" for the paid version, it's often wildly mis-targeted. Many people use the free version solely because it's free, and have no interest in signing up for the paid version at all. So that's not the right target market. If you're going to charge for something, you need to give people a real reason to buy, which often is offering something entirely different that is enhanced by something free, rather than limiting something free.

Unfortunately, however, the whole concept of "freemium" (including the catchy term) has received so much attention that many startups now jump right in with a cookie-cutter "freemium" offering -- and now they're learning why that's a mistake. Ross Pruden alerts us to a really interesting article from an entrepreneur who went the cookie-cutter freemium route, and eventually backed away from it and saw his revenue shoot upwards. He then explores a few other companies that have gone through similar evolutions, and saw the exact same thing happen.

This isn't surprising, given the problems described above about "freemium." Unfortunately, however, the author of that blog post, Ruben Gamez, jumps to the wrong conclusion that "free plans don't work." That's taking it a bit far. Freemium type plans can work in some cases, and "free" by itself can work wonders, if done right. But that tends to involve using free to enhance the value of something else, rather than using it as a sampling.

Filed Under: business models, freemium, startups

Why Waiting Until A New Business Model Is Proven Doesn't Work

from the it's-why-you-need-to-start-early dept

One of the criticisms of our business model discussions here is something along the lines of "but how will this replace the $x billion already made." Or, alternatively "well, how can you expect anyone to switch until you show that it will replace what they already are doing?" The answer, of course, is that by the time you know that a new business model will work well enough, it's too late. It means one of two things have happened: either a competitor has figured it out and taken over the market or your existing business model is too decimated to have enough left to make the switch. This is the nature of so-called "Creative Destruction."

This point is highlighted in a recent NY Times article about how Netflix tries to avoid creative destruction by experimenting with new models well before they need to, and well before the old model has lost steam. The article compares Netflix to Blockbuster, which highlights this perfectly. Even though Blockbuster did see the success of Netflix and how the market was changing, it was very slow in embracing it, and never did so whole-heartedly. And even though it has a service quite similar to Netflix's, it has a lot fewer users and is struggling financially.

The article highlights this with Kodak as well:

Kodak saw digital photography coming. It even invented some of the earliest such technology, in 1975. Kodak just misjudged how fast consumers would give up on film and start snapping up digital cameras. And it misjudged its ability to outrun both trends.

Indeed. In 1997, I did work with a professor who was consulting for Kodak, and we did a detailed report on why Kodak needed to embrace digital now. The response? Kodak told us "yes, yes, digital is important, and we'll be ready to switch, but right now, chemical processing of photos is so much cheaper, there's no reason to change yet." And, they were right that it was a lot cheaper, but they were wrong about the time to start switching.

There are a few reasons for this:

1. Companies always misjudge the speed of trends, especially the rate of change. Things like digital revolutions start out slowly, and the quality seems bad. So companies in legacy businesses figure they have a long time to make the change. But the rate of change increases rapidly, especially once it "tips" and reaches a critical threshold. At that point, if you're not fully invested in the new business, you're, way, way, way behind.
2. It's difficult to really understand the new technology/market unless you're playing deeply in the space. This is the same thing we noted with people who claim that patents are necessary because once a good idea comes along others will just copy it. In many cases, that's not possible. That's because the truly innovative ideas require some real hands-on experience. Watching others do it is not the same thing.
3. It's very difficult, culturally, to build up businesses that cannibalize your existing cash cows. The skill sets may be different, and people begin to recognize that these "new" people may be working on projects that replace the "old" people. That leads to a lot of resentment and makes it really difficult to actually hire the good new people -- since they recognize they're going to face those kinds of institutional restrictions. For them, it's just easier to go to a "native" company that has bet entirely on the new offering.

All of this impacted Kodak:

Even when Kodak wanted to change, it couldn't, said Mr. Lucas, who has studied the company. "It was so large and had been so successful for so long that it was difficult to bring in people with a digital background."

Kodak has had to take draconian steps to survive. It closed labs and factories and laid off 60 percent of its staff of 60,000.

Indeed, Kodak is impressive in that it actually has been able to shift... even if it took a lot longer than necessary, and even now it's considered to remain behind other players in the space.

This is, of course, the typical Innovator's Dilemma, but it helps explain why so few companies are able to survive the innovator's dilemma. Even if they know about it, they think they can wait. They think that they shouldn't invest heavily in those new technologies and new markets until there's a clear path to profitability, or a clear plan for how it "replaces" what's already there. The problem is that by the time they have the answers to those questions, it's too late.

Filed Under: business models, creative destruction, markets, waiting
Companies: blockbuster, kodak, netflix

Yes, People Can Comment On Content Business Models Without Having Produced Hit Content

from the appeal-to-false-authority dept

We've seen it over and over again in the comments on Techdirt. We'll talk about the impact of copyright or patents, and a lawyer will claim that unless we're an IP lawyer, we should not comment. Or we'll talk about content business models for the music or movie industry, and someone will claim that until we've had a hit song or movie, we should not comment. The argument always struck me as a curious one. After all, just because you don't have a law degree, doesn't mean you can't understand copyright law. In fact, since we're usually talking about the economic impact of copyright law, it seemed like the easy retort is that if those lawyers didn't have an economics degree, perhaps they shouldn't be talking about the impact of copyright law either. Of course, that's silly. The fact is, anyone who understands the basic issues has a right to give their opinion, and back it up with facts and discuss their positions. But saying that someone who doesn't have "x degree" or "y experience" is usually a response from someone who doesn't want to argue the actual details.

Filmmaker Ross Pruden just wrote a blog post discussing this, where he pointed out that you don't need first-hand experience to understand details and make a proper judgment call about how to run a business. When we talk about music or movie business models, I'm not suggesting I know how to make a hit song or movie. But I can look at the economics and suggest what makes sense from a business perspective given the market today. Just as Ross can look at the market and realize that how things are done today don't make as much sense, even if he hasn't (yet) made a "commercially successful film."

This whole appeal to a false authority is a bit annoying, because it's an easy way to dismiss the messenger without addressing the message. I doubt it will change, but it was nice of Ross to call out this point. Having created a hit song doesn't mean you know how to navigate a changing market. Knowing how to produce a blockbuster movie doesn't mean you know how to use the internet to your advantage. Knowing how to get a patent doesn't mean you know how patents impact innovation. Unfortunately, some people think that if they know one aspect of these things, only they are allowed to comment on the business models or economic implications. That's simply not true -- and those who go there tend to be in denial about the market challenges they face.

Filed Under: business models, commentary

Pay What You Want Works Much Better With A Charity Component

from the empirical-research dept

We've talked a lot about different types of business models with "pay what you want" being a popular one that comes up often. I still think there are some problems with it, but there's growing evidence that it can work very well. When Radiohead got a ton of attention for using it, the band made more from the digital "donations" than any of its previous albums' digital releases -- even though plenty of people still chose to pay nothing, and the average price was a lot lower than standard. But average price is kind of meaningless when judging the success of such a program. It's really the net that matters, and on that front, Radiohead did quite well.

We've seen the general model work elsewhere as well. A taxi driver had some success with it, as have many musicians who have used it with merchandise at shows. Even Panera Bread is testing it out. Earlier this year, there was a lot of attention paid to the really, really successful story of the Humble Indie Bundle that did pay what you want for a group of video games. That had an added component as well. Some portion of what you paid could be designated to go to specific charities (EFF and Child's Play).

It seems that the folks behind the Humble Indie Bundle are on to something.

A fascinating new study has shown that "pay what you want" offerings seem to maximize the net take for those using it if they include charitable giving. The study was done at an amusement park, where people could buy a photo of themselves on a roller coaster, and four different situations were tested: (1) the standard "pay a fixed price" (2) a straight "pay what you want" (3) fixed price with part of the money going to charity and (4) pay what you want with part of it going to charity.

What's amazing is that the fourth one was the best one in terms of the net amount to the seller (yes, after giving the portion to charity). Sales were much higher and the net dollar amount to the seller was much higher than the straight "pay what you want."

Specifically, when people were asked to pay the flat price of $12.95, only 0.5% did. The $12.95 price, where half went to charity, barely increased the number of buyers. Then only 0.57% of people bought, and (obviously) after the charities cut was taken out, the net was way down. If it was pure "pay what you want," a lot more people bought: 8.4%, but the amount was much, much lower (average: $0.92). In terms of overall revenue, the gross is up, but the net definitely depends on the cost of the photos. If there's no marginal cost, then net revenue would go up as well (what Radiohead found). But in the final scenario, where it was pay what you want, but half went to charity, the overall reaction was the highest. 4.5% bought, and the average price was $5.33. Even when you take out the half going to charity, the revenue is much, much higher.

Now, there are a few caveats I can think of here. The $12.95 price appears to be pretty high. It's entirely possible that there could be another, lower, price that would do a better job maximizing profits. Perhaps at $5, the results would be somewhat different. So I'd definitely like to see more research done with different pricing points. Separate from that, I also find it... odd, that the yield rate when charity is added to pay what you want seems to be almost half of the pure pay what you want. Perhaps I'm missing something, but I can't see how that makes much sense. The "cost" to the user is the same, effectively, and clearly a lot of people value it a lot more. But nearly half don't value it at all? That seems... odd. Perhaps there are some more details that are missing from the summary of the study.

Overall, though, a fascinating experiment that shows how helping a charity can not just be good for the charity, but can also maximize your own efforts. Just don't tell that to the financial columnist who thinks charitable lemonade stands are destroying America.

Filed Under: charity, pay what you want, studies