How is this still a business?

wineMarketPlace radio show tried to answer a reader question on wine pricing. A reader asked them to investigate,

How do wineries set the price of a bottle of wine?

The reporter answered this by calling on many different wineries. The answer from all of those interviewed is exactly the same – based on costs. And worse, with fixed cost allocation for each bottle of wine.

Adding up Costs -“… the price depends on three big costs. It would be vineyard, then production, then sales,”

Marketing Costs allocated to each bottle of wine – “80 percent of the cost of a $30 bottle of wine, distributed nationally, can be advertising”

Expecting customers to pay more for operations  – “And we’re pulling out any bugs, any leaves, any stems”   (To this the reporter replies, “I am willing to pay for wine without bugs”.)

Don’t forget to add packaging costs – “The grapes are going to be about 15 percent. The package might be 10 percent. The production is the vast majority of the cost for me.”

2012 NYTimes article on winery business points to dismal state of profitability in wine business. It is the only business where success is measured by ability to break even rather than ability to turn a profit. Once again we can see this cost driven thinking,

He said the costs of making a high-quality but small-production wine make it difficult to turn a profit. There are the salaries of the vineyard manager and the winemaker and also the costs of the bottles, labels and corks, which, he said, are $2 each.

The old saying in the wine business, “How to make $1 million in wine business? Start with $10 millions”,  seems to be explained by this pricing philosophy. If you look at this closely winery is one of the least customer driven of all businesses. There is no understanding of customer segment, why they buy wine to what wine to make. If they understand there is lot of factors affect the final product that are not under the maker’s control.

So you wonder how is this still a business? Only explanation is what one of the winemakers said,

“This wine business, we don’t make any money,” Mr. Ross said. “I do it for love. I sell shower doors for money.”

What is ahead for Fitbit

Screenshot 2014-12-18 at 10.09.15 AMOne of the features of Fitbit’s bands is the step counter is reset everyday. You are assigned an arbitrary default goal of 10,000 steps a day and you are measured on how you do on this goal. You cannot bank the excess steps from one day to another, nor is there a moving average (no pun). Fitbit investors seem to me treating its performance in exactly the same way – what can you deliver next quarter, no matter you crushed the current quarter. Despite beating consensus estimates on units and revenue its stock dropped 16% in off-hours trading due to its bad outlook for next quarter. It is getting a taste of its own medicine – does not matter you walked 60,000 steps today, can you walk 10,000 tomorrow?

The problem is actually lot more than this simple explanation of what is ahead in the next quarter. It is the realization of its market dynamics, product strategy, gross margin concerns and cost of growth.

Market Dynamics: It is tempting to define the market as fitness and personal training. If we look through that lens there is not a significant customer spend for fitness alone and definitely not enough to spend $150 to $250 for a band. Just like fitness products and behavior changes the sales are seasonal and habits are fleeting. When it comes to fitness we jump from one fad to another quickly. If it is a disposable product with fleeting usage there are far cheaper options available. In fact there is virtually no barriers to entry for any new player to enter this category. The components are standard and mass produced and the software is not insurmountable.

If we expand the market as smartwatch with fitness features added, that space is warped by the biggest black-hole Apple that pretty much sucks every customer dollar in the disposable income bucket. Fitbit lacks the wherewithal to enter this market or the investment dollars to compete against Apple’s ecosystem.

fitbit-7Product Strategy: Fitbit’s product strategy seems to be hit driven with single product delivered as multiple versions. It is trying to add accessories revenue by appealing to style sense with multiple fashionable bands for the devices. You can see the futility of that model when customers abandon the bands just after few months of usage. It is launching a stylistic band called Fitbit Alta priced at $149 and a smartwatch priced at $200. Alta does not have Heart Rate Monitoring (HRM) like its other $149 model Fitbit HR and hopes to appeal to style sense over health monitoring. That strategy has been called into question.  And its Blaze faired very badly in product reviews. In essence a very shaky or non-existent product strategy and pipeline.

Gross Margin Concerns: The Average Selling Price (ASP) has been hovering around $86-$87 range. That implies its current $250 product is not finding any takers and its $149 retail priced bands are sold to retailers at much lower price. For the coming quarter Fitbit will not have many days to sell its new $200 Blaze or the stylistic $149 Alta. With considerable inventory built up for older models, retail channels filled with those,  and customers waiting on sideline for the newer models Fitbit has to run price promotions this quarter. BestBuy has already slashed price by up to $30. All these factors explain the low 46.5% gross margin that Fitbit is forecasting for this quarter. Investors can see this is a repeatable pattern due to its week product strategy. With ASP stuck at $87 and no traction for its smartwatch there is no visible path for higher gross margin in the future.

Cost of Growth:  Fitbit made its story all about growth and posted triple digit units and revenue growth past few quarters. While that makes sense in early stages of the market it does not carry over in fitness or fashion category. If 50% of users abandon after few months and only a smaller share of who is left upgrade every two or three years, Fitbit can post growth only by continuously acquiring new customers. Investors are growing tired of growth at any cost companies and in this case there is no magic switch Fitbit can turn on to suddenly make more profit from all its growth.

It should not surprise that finally its valuation is catching up to this reality after the initial euphoria.

When is a $0 Price Valid?

Vita Banner

This is Tax season and I see ubiquitous Ads for free basic tax filing. All players from H&R Block, TaxAct to TurboTax offer free App for basic tax filing. Is that a good decision?

When is it good to give your product away for free?

If you believe any of the proponents of freemium, their generalization is, “if your marginal cost is zero, you should give it away”. If you were to look closer at this claim you will see why this fails miserably.

  1. Free is not free marketing because marketing is segmentation, targeting and positioning
  2. Cost has nothing to do with pricing
  3. Your marginal cost and $0 price does nothing to customer demand

It all boils done to pricing 101 – Pricing is share of value created not a markup over cost. And your share of value is affected by reference price in the minds of customers. If the reference price, that is that is the price they are used to paying for alternatives, is $0 then there is signifiant value compression that prevents you from charging for your product.

Returning to the Tax filing question, if we were to use just the marginal cost argument it would appear the answer is yes to offer them the standard tax filing as free. But by extension you could argue all advanced editions must be free as well because the marginal cost is still $0. You cannot have a breakdown in the chain of logic where it applied to basic version but not to advanced versions of your product.

A $0 price is recommended only if the following conditions are met

  1. The reference price is $0 and there is no way to move it –  filling out 1040EZ manually is the easiest thing even with paper and you have free  option from IRS.
  2. The $0 price does not diminish the value of your portfolio through adverse self selection – people who have more complex tax scenarios are not going to choose free version despite it being free.
  3. A business does not incur additional investment or marginal just to serve the free users –  the tax software is built for more complex scenarios and serving the simple filings does not incur incremental cost.
  4.  Free users serve as a pipeline for premium versions (through customer delight or stickiness)- as economic mobility happen, free tax software users will find the need to use paid versions for their new scenarios.
  5. There is no other opportunity cost of taking on free users.
  6. Your brand will suffer no erosion if the free option were to go away.

$0 price is not based on your cost. It is driven by customer reference price and the decision to whether or not offer it is based on your business dynamics.

 

 

When there is no value in beating customer expectation by a mile

The concept of “Good enough” draws mixed reactions from people. While some say  good enough isn’t good enough and we need to exceed customer expectations. Others argue for it more from the point of view of launching a good enough product on time vs. waiting for perfection. When it comes to product management and product design do we go with far superior features than what is available in the market or just checking the box will do? Does either one guarantee defending or expanding market share?

The simpler way to approach this conundrum is to understand the value step function. Value perceived by customers is not a linear function of product features. Value is a step function – an initial package of features causes a step increase in value perceived but  after that point it can level off for a very long time or until another shift occurs at which point it makes another step jump.

value-step-function

Take for instance the new Galaxy S7 that was launched in Mobile World Congress in Barcelona yesterday. Here is a reaction from the Journal on the device

We have seen the similar product strategy from Galaxy before. Improved camera, longer battery life, better screen etc. are all good, but do these matter on the plateau portion of the value step function? As customers see no incremental value in this part of value curve, none of these improvements will help with market share.

If a marketer want to gain share and drive adoption they need to focus on those value dimensions where the current products are stuck in the valley floor of the value step function. That is what happened when iPhone entered. The next innovation that will dominate the market comes only from focusing on new value dimensions.  In this part of value curve, good enough is good enough.

May I suggest innovating on a smart phone that is priced at $50? If the 7″ Amazon Kindle Fire can be priced at $49, a phone like that will most likely be a step function in gaining share.

When 50% of Your Customers Abandon Your Product

Customer churn is unavoidable. I have written before the futility of chasing 100% loyalty from customers.  Simple reason is – change.  Customers change, their needs change, norms change, technologies change, and competitors change. When such changes happen some fraction of customers stop buying all together, switch to competition or your product becomes irrelevant.  Every business needs to build in a certain level of churn in its future growth and plan to continue to grow installed base of customers despite losing some.

But what do you do when,

50% of your customers stop using your product, close to 30% in the first 3 months?

Your whole valuation is based on growth,  showing triple digit user and revenue growth year over year for next several years?

When you have really just one product?

That is the case for Fitbit. First it is a product that customers should want to buy and not a necessity. Second customers lose interest so quickly. Third even among  those who want to buy the band it is facing competition from low and high ends.

Just a few weeks ago Fitbit’s stock hit highs of $50, 250% over its IPO price, and now trading 30% below IPO. Today Fitbit will announce its fiscal Q4 2015 earnings. It may very well post its best quarter yet in terms of number of bands sold and revenue. Its stock will see movement in the near term to levels above its IPO price. But is there long term value in this? Take a look at this chart below on what it means to its growth when 50% of customers drop out

fitbit-growth

If it has to show even a modest 40% growth over next five years it has to get that all from acquiring new customers. Think of the effect of this on its marketing dollars.

How many more campaigns it needs to run?

How many new markets it needs to break into and the cost of market entry?

How many promotions it needs to run? (Costco is running a promotion on bundle and today BestBuy is running a $30 off promotion)

What is the ROI on all these marketing dollars when only 50% return and spend less and less over lifetime.

This is not to repeat the fact the product itself does nothing really to fitness despite the name.  It will be interesting to see heart rate data of its shareholders over the next few months.

Why Wearable Fitness May Be Bad For You

BN-MR546_Wearab_G_2016021910593910 Reasons why wearing one of those fitness bands that count steps may be bad for you.

  1. They make you believe walking 10,000 steps is an effective activity and make you forgo or skip regular exercise that elevate your heart rate.
  2. It takes time to obsessively track the number of steps you take making you miss the day to day moments or simply enjoying the walk.
  3. They mislead you in calories burned and make you eat more than you would have otherwise – well I walked 15,000 steps today, I earned this cupcake (which happens to take 42 minutes of intense cycling to burn off)
  4. They make you believe you are making progress on your health and fitness goals while there is no improvement in either.
  5. They measure the wrong thing – not all 10,000 steps are the same.
  6. They do not take into account the fact that the effect of your activities are cumulative and instead treat every day as a new start.
  7. They make you do wasted effort just so you can hit the mystical 10,000 step goal.
  8. They make you do wasted effort just so you can hit the mystical 10,000 step goal.
  9. They make you do wasted effort just so you can hit the mystical 10,000 step goal.
  10. They make you do wasted effort just so you can hit the mystical 10,000 step goal.