Thursday, March 25, 2010

One Million Screwdrivers: Lessons Learned (Part 4 of 5)

This is an article in a series called One Million Screwdrivers. You may read all the articles in this series by clicking here.

Is this story far-fetched? Perhaps. The hypothetical is conveniently divorced from actual economic concerns, like cost of production as determining market price. If a good costs more to produce than it can be sold for, it's pointless to keep producing that item... unless that item is a loss leader to sell another product or service, e.g., access to your expertise.

The Ebay thing might be a bit much, yet stranger things have happened. Even so, I hope it drives the point home that none of this would have happened if the screwdrivers not been given away for free. Before putting things out into the world, you never know what's going to come of them—the only way to know is to do it. In the above scenario, the story happened to capture the public's imagination and go viral. Not planned, of course, but still possible.

Of course, the math is simplified and exagerated to illustrate the basic principles in play, i.e., reducing unit price by a factor of ten does not mean buyers will also increase by a factor of ten to net the same revenue, at least not indefinitely. However, in the real world, evidence suggests that does happen for narrow windows: Valve co-founder Gabe Newell revealed that dropping the zombie game Left 4 Dead to half-price resulted in a 3,000% increase in sales which outsold the game's launch sales. Valve's weekend deep discount sales—reducing prices as much as 75%—resulted in a 1470% increase in sales. That is, if you were to sell a $10 game to 1,000 customers for $10,000 revenue, and temporarily drop the game's price to only $2.50, you'd gain an extra 14,700 customers—15,700 in all. At $2.50/game, that equals a revenue of $39,250 instead of only $10,000. Almost four times the revenue from dropping your price three quarters below what the market typically expects.

The actual numbers might be closer to this:

$49 retail price @ 10,000 customers = $490,000 revenue
$12.5 (75% retail) x 147,000 customers = $1.9 million revenue

Not only do you make more money this way, but you explode your fan base in one fell swoop. Of course, only a fraction of your new customers will be the kind of "true fan" that will buy anything you produce, but more consumers means more chances to sell them accessories and other similar products. More attention means more opportunities to convert neophytes into casual fans, and casual fans into true fans.

The most important question you should be asking is: If you can get more attention to convert more fans and make more money by drastically reducing the price of your product, why aren't you doing it? Is it because you still believe your product's true value is inextricably tied to its price? If so, then you quite literally pay a high price for that belief—you make less money and you get fewer fans.

The crucial difference between the above real-life software/game example and my hypothetical sucess story of one million screwdrivers is that one story is about an infinite good (a software game, which can be copied infinitely), and the other is a scarce good (the screwdriver, a physical object, which cannot be copied infinitely). Valve can make money from selling infinite goods (which can be easily pirated) because they're actually selling the convenience of their Steam platform, rather than the content by itself. For screwdrivers, there is true scarcity: over time, every screwdrivers will have been obtained and only the holders of those screwdrivers will have possession of the good. By contrast, a software game can be copied over and over and over again. The intrinsic nature of digital data is infinite abundance, and when supply is infinite, like water or air, its price is forced down to zero. This has nothing to do with the object's value, only its price. That's why Valve is selling the content's intangibles (i.e., convenience and time, which are scarce, and thus costly) bundled with the content (i.e., the software game, which can be abundantly found, and thus free).

Authors in particular worry about the devaluing their content if they let their content go for free. But take a work like the Bible: it is freely available online, in every hotel room, in any library... it is the very definition of abundant. It is, in effect, free. Yet, strangely, people keep buying it. So if people can get the Bible for free anywhere, why do they keep paying for it? Because they aren't buying the content, they're buying the stuff around the content. In the case of the Bible, they're buying the embodiment (a really nice leather bound edition with snazzy typesetting), personalization (a name emblazoned on the front), interpretation (historical context explanations), patronage (buying it from a specific organization as a form of donation), etc.

This is an article in a series called One Million Screwdrivers. You may read all the articles in this series by clicking here, or the other articles here:
  1. Introduction
  2. The Experiment
  3. Ripple Effects
  4. Lessons Learned
  5. The Bassinet Story (Friday 3/26 9:00 AM PST)

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