Friday, May 5, 2017

Startup Musings–Pricing your product

I haven’t been writing very much. Life can be busy and while I try and stay up to date with everything in the sports world, it can be a little tough. I’ve debated trying to do some of this stuff via video on youtube to help share the knowledge but it’s not something I have always have the time, the hardware (recently “downsized” to a Core m laptop), or the video equipment for. I may in the future given a camera upgrade.  

So until I find the motivation and the money, it’s text. So thanks for reading.

In the last few months I get pulses of emails. Sometimes I reply right away, and sometimes not.. or never. So I want to discuss (see radio definition) is a recurring theme in these emails. Several people have asked me about the mythical open source or android phone head unit. It’s prompted by the theoretical “if I can buy a 100 dollar android phone that has all the same hardware why is my Garmin / Polar / Sunnto device with less power 300/400/600/etc dollars! It’s a scam”.  Okay, so that isn’t an actual quote. When I first started this blog I didn’t understand anything about products, marketing, sales and pricing. Now I know about 1% and I’m rounding up. Bear with me and this might make sense.

The TLDR of why (because I'm a wordy person) is

1) Different distribution models + hardware turns a $100 phone into a $500+ head unit

2) Devs – You trade one type of development for another type. It’s not easier, just different, and expensive 

3) Durability – Slightly different ideology here

4) Screens – Need a custom one or make trade offs. Period.

5) What’s different? To be a killer device it needs to offer something different, something "better". An Android head unit isn’t blue ocean – it’s a a head unit. What’s unique?

Lets examine the least important on the road to the super cheap android phone head unit but in the reverse order. Then I’ll make a comment on the Hammerhead Karoo (Spoiler: I’m rooting for them)

 

Is it blue ocean – Great if it is but what if it’s not?

I wish I had more experience here. I’ll get it in the coming years. I never suggest anyone to enter into a price war competition unless you have an ace up your sleeve on some other innovation (market, distribution, manufacturing, etc – more later). Having something incrementally different doesn’t win you the war. Starting a price war can get you noticed, but you have to deliver and keep delivering. And for head units you’re going to lose on features – Sorry, it’s your lack of resources as a startup. Time to undercut it. If company X charges 1000 and you want to make a splash it needs to be less. How much? It depends and I don’t have those answers. However there are magic numbers. 499 is one, 299 is another. There is a psychology on pricing. People buy based on emotion and a price can illicit a feeling.

Even if your product isn’t innovative you can cause other disruptions. They can be in manufacturing, sourcing, and distribution models. Canyon bikes is an example of changing the market by the use of a direct sales model to reduce price. However, someone has to assemble that bike, and shops tend to upsell labour when the bike didn't come from their store. In fact I’ve read on forums of bike shops double or tripling service prices specifically on Canyon because of their sales model. Obviously that’ll just hurt the shop but only in the long run.

Canyon is unique but for us slobs the normal distribution model is how most things get sold.  Skip ahead to the last main section if this is all you care about.

Devs are expensive – like really

So you have an ARM platform. Great. One guy can port the reference code to the latest AOSP build and viola you have the latest android. Job done. Nope.

Go and download almost any cycling application and see how well it works. If you have any sensors good luck if it’s not a big company. Why is that? Well, multiple phone OS’s, servers, an “ecosystem”, and more all takes time. It takes Garmin and others tens of engineers to write the firmware for their cycle computers and integrate them with apps. In the Edge 500 days maybe 1 to 2 but now, with expectations of connectivity, BLE, ANT+, Wifi, syncing, alerting, etc you need more.

Seriously though, you’ve got bodies. Switching to android didn’t reduce the workload, it shifted it. You might need to amortize at least 10 x 80k/year salaries for about a year or you need to have the charm and wit of a better CEO than Richard Branson. So you need to amortize at least about 1 million dollars to get that product out the door. 1 Million. At about 50 dollars a unit of theoretical profit (first estimate we’ll see later) you need to sell about 20k in the first year to pay for that… and still being in debt the same amount the next year.  Hardware needs a lot of this money up front. There are slower routes, but this is the do it in a year or two method.

 

Screens – Your sample size is small and you should feel ashamed of yourself

I’m going to have to shoehorn an explanation of why I used that quote, but stick with me. If you want an LCD to be viewable you have three options

  • Reflective – think B/W watches normally
  • Transflective – old iphone, Garmin’s (all), anything that says “daylight viewable”
  • Transmissive – your phone, computer, tv. So outdoors you need power to overcome direct sunlight.

iPhone’s up to version 4 were Transflective. They had a hole in every pixel that light goes down through and scatters and reflects back up. However, the first Retina display tried it and so little light made it’s way back up that they scraped it and went to Transmissive only on the next version – they did this by jacking up it’s backlight and setting a new standard for brightness in displays. 600 nits = “okay” for outdoor use. Okay, not great. Daylight viewable became daylight “usable” with a caveat of “sorry battery, you must die my friend, and soon”.

I get lots of people saying “it’s easier to see the Wahoo Elemnt” to which I respond “yes, it is Black and White”. That’s important. Yes it’s viewable, but without colour it can’t easily differentiate features, types of roads, etc. However, with colour, the technology is trash and we resort to running the backlight during the day to get it a helping hand (thus killing our batteries). Readability is directly traded for mainly mapping features here. Some companies have accepted this and made the trade because of the custom screen problem. It’s not really useful to navigate if you can’t understand if it’s a trail, a road, a bike path, or a small river.

While I haven’t torn down an Elemnt, a Stages Dash, or an SRM PC8 they have one thing in common. I mean literally the exact same thing. The screen is a Sharp Memory LCD and the exact same one. I could literally pull the screen out of one and plug it into another. I can order this from Digikey and because of their magical shipping Wizards I have the replacement tomorrow (pending ordering before about 5pm).

While breaking a Garmin screen is rare, it’s possible, but try and find a replacement. You can’t. Not China, usually not ebay (unless pulled from another unit), nada. Why? It’s 100% Grade A fully custom with 100k + setup cost.

I’ve looked and got quotes, and getting a transflective colour screen falls into a few categories

  • 70 – 120 dollars USD for the screen… in medium volume (5000 units) for off the shelve.
    • Can be less, but requires accepting lower quality I found or other weird things. Like uncertainty in the supply chain
  • Chinese that says in one document it’s transflective, and in another it’s transmissive
  • Custom = 100k USD setup fees and about 30 – 40 per unit with MOQ of usually 10k, 140k for 10k screen or an additional $14 a screen. Yes, a $54 dollar screen with 540k outlay. (yes this is half a million dollars).
  • Old iPhone screens but limited volume supplies (messed up MPL interface too, needing encoder chips)
  • Sharp Memory LCD if you don’t mind limited sizes and B/W
    • Actually they have an 8 colour one but not in a good shape or resolution for cycle computers
    • They can do custom but see above

And, yes, colour transflective screens suck. It bears saying again They suck a bunch. Low contrast, bad brightness, etc. All symptoms of how they work. Tiny 15% hole has to let in light for the other 85% that runs through 3 filters sequentially. Not much light getting through. The Edge 500 was transflective B/W LCD. High contrast, low res, B/W.

However, you know what else sucks… power… and a lot of it. High brightness backlights. Talking about 200 – 300 mw for the backlight. So that 1300 mah battery, common in cheap phones can only do 16 hours… with the backlight on and the phone off. And also, run a phone playing a video with the screen on full brightness and measure how many minutes you get? 180? 250 minutes? not 15 hours.

Some promising tech has also died, like Qualcomm Mirasol demo’d in the Toq Watch. Nothing else is really available. Sharp is the best potential for the future I’ve seen but it’s still expensive with 30 – 40 dollar screens in volume.

Durability – My phones totally durable – you know, with an otterbox

Okay, this isn’t huge, but you need to design for different abuse. Not necessarily more or less, but different. That means the design is different, so stock engineered bodies aren’t the solution so OEM rebranding of an Alcatel (Blackberry?) won’t cut it. You’ll also want some custom hardware in there and designed for those pesky IPx7/x8 tests that phones are only starting to do – and you pay a premium for it! NRE = non-refundable engineering. The Non-Refundable is the important bit. You don’t get it back. And in some cases, depending on the contract, if they fail to deliver you still don’t get it back. Most startups will do this in house but getting waterproofing right is hard. Most don’t get it on a first try.

You also don’t have the volume of a phone carrier so every piece of custom hardware you want is more expensive. That fiber reinforced injection mold must be EDM cut taking weeks, or adjusted to fit. That’s tens of thousands of dollars. The ultrasonic welding horn, that’s several thousand dollars, assembly is based on volume and estimates so you have to buy units up front with cash and stockpile functional units. It’s a lot of money because you need custom parts to be durable. And as previously talked about – You will likely need a custom screen.

You’re likely going to have to amortize 200 – 300k of tooling here over how many units? potentially 100k units but that could be 2 – 4 years out. What if, like above, it was only 10k units? Your per unit cost just went up 20 – 30 dollars on average.

 

Distribution Model – Who’s eating your lunch?

I have some friends who’ve been working on a medical startup for a few years now. It’s hard, but one thing they said that I’ve heard echo’d in many books: “don’t let someone eat your lunch”. The idea with blue ocean startups being that make sure you’re working hard to not let a competitor steal your idea, clients, and sales. However, your lunch can get eaten in other ways. The distribution model is one of them.

Most people I talk with have zero idea about how product A gets to consumer B and without this understanding you have no idea how to set your MSRP (manufacturer suggested retail price, or SRP). And honestly, I’m like 1% better than the person I described.

The distribution models of cell phone and head units are very different.  Most mobile phone companies use a are direct sales models.  The manufacturer sells it to the retailer directly and the retailer tends to subsidize it (AT&T, Virgin, Vodafone, Bell, etc)  and then people don't see the true cost. The “retailer” is actually a service provider and they aren't profiting from phones but cell phone plans. We all know this but we don’t internalize it. It’s important to understand that when you sell a head unit the customer is the user and the distribution model is the problem that is in the way. With cell phones the service provider is the customer, NOT the user. Now this is changing a bit with more and more people buying cell phones outright but generally I believe this is still true.

Recently I read an article on Xiaomi’s profit margin per phone being razor thin (another one here). In the single digit percentages. They play a volume game. That makes sense considering what I described above. They aren’t ordering 10 units (a small LBS volume for a month or two) or 1000 units (large cycle shop disti) but they are ordering 100000+ units.

A Garmin device, or any other sports electronics, on the other hand goes to a distributor then a retailer.  There is a 20 to 40 percent markup at each time.  They aren't dealing with the same volume nor subscription models.  So rule of thumb is that your MSRP needs to be 3 times your COGs (cost of goods).

Lets take a 100 dollar android phone. Since the phone might be < 10% profit to the manufacturer and maybe only a few points for the retailer we’ll call it 80 dollars and lets say this is the COGS (cost of goods) + amortized tooling.

Your product costs 80 dollars to build and you need profit from that to pay people. So you probably want the largest chunk of the pie (you should, why is a retailer or distributor making more money than you? No seriously!).

Some distribution wants 40% and a bike shop or retailer wants 40 percent on accessories. These numbers can vary from 20 – 40% each. It depends a lot on many factors.

Assuming you want a higher but reasonable 60% (on your COGs) what’s the math

80 * 1.60 * 1.402 = 250

So the minimum you can sell in a high volume product is about 3 times your COGs. However, lets go a little further. Most of the phones I know are still subsidized a bit and usually shady characters unlock the phones.

I have a moto e (LTE, snapdragon 410), I got it “new” but unlocked in a Telus box (I got a code handwritten a torn off piece of loose leaf, the phone was sealed, and a wink of “it’ll work, I promise”). 80 dollars. However, it’s real retail price that is profitable was between 150 – 180. At about 120 COGs estimate lets see what happens to a modern phone. $380 MSRP. Ouch.

Lets pull this phone apart and add in a few things.

  • Larger battery, quick charging capable ($3 – $5)
  • Improved Inertial, GPS, and Baro ($5)
  • ANT+ capability (if it doesn’t already have it, $3)
  • Transflective screen (Most low end screens for mobiles are about < $20 in volume, we have a calc, so this is +$34)

Lets run this math again (one more time, I swear, that’s it)

(120 + 5 + 5 + 3 + 34) *1.6 *1.42 = $523.7

Guys, I think we hit the magic number of reality. Ouch. A few modifications to the pricing gave me over a 500 dollar retail price for a 100 dollar android phone.

This is where I say the dream of a 100 dollar android phone as head unit is dead. Not quite. However, you just have to look at the Acer Xplova and see that these estimates are not far off. It’s hardware would be barely in a 100 dollar phone but it’s much much more than that. The distribution models are so different. It would take doing something very different to change this price model. Maybe you’d get it into a LBS for 20% disti and 20% retail margin but that shaves $100 off the price, not $400. Unless your name is Apple don’t expect disti’s and retail to accept 5 – 10% margins. It doesn’t happen (unless it’s food? an edible android head unit!)

Hope. Hope is not lost. It comes at the expense of something else though. Selling through direct channels like website sales is a start, but many small companies can’t handle the logistics. This is one of the potential deaths of a Kickstarter – logistics. A lot of times this is outsourced to a fulfilment house which operates on a similar model of profits as…. a disti. However, you usually lose control.

I have a friend who works at a company that makes a car accessory. It’s unique in what it can do but on a glance people think it’s the same as a Chinese product that doesn’t offer the functionality. However, there have been a number of times someone stuffs a Chinese item back into the box (looks kind of similar) to get their money back. The problem is the fulfilment house doesn’t inspect returns very well. They take a major lose when this happens as well as a chunk of profit going to the fulfilment house. They lose a product + they lose shipping costs + they may lose money to the fulfilment as a service (in some cases, not all). So one bad customer can cost them a real money. That has to be amortized over actual sales.

 

Clawing Back – Startup style

So could something competitive with the Garmin 520, Wahoo Bolt, or whatever is Polar’s thing (I’m an avoider until BLE pulls it’s pants up). Sure… but how? (using the $523.7 dollar version)

  1. Direct sales model ala Canyon. I think this could anger fewer people than a bike, but you seriously limit your ability logistically. Shipping into different countries is hard and a good distribution system will sort that out. That’s one of the things you’re paying for. So, if you can focus on one large and easy market then it’s okay, but keep in mind that if you accept orders to other countries be ready for “why did I just pay 150 euros / pounds / Australian dollars to get my device!” emails. A lot. I mean, about every single one.
    1. Savings = $256.5, new price =  267.2 but profit being eaten into logistics, so raise marketup to 80 – 100%. Gives 299 at the low end. Magic number
  2. Partner / HW reuse – So the Dragonboard 410c is the same hardware as my Moto E and using the Qualcomm radio it has ANT+ (but Motorola didn’t include it). If you literally negotiated the reuse of a board with an existing manufacturer.
    1. Savings = < 10 dollars on COGs. Suggest increase profit to 90%
  3. Surplus screen or screen from other product. This is going to mean going to Shenzhen in person to pull this off or amazing Google-fu. But maybe a savings of $20 here.
    1. Savings = 20. Suggest maintain the 299 price point for future sales. Profit increases to 120%. Now you have a chance of retaining some devs because they might even get paid. New risks though
  4. B/W Transflective screen
    1. Similar to above, just, you know… 1930’s but great contrast
  5. Invent some aspect that is unique and commands that higher price point. Blue Ocean it!

Hammerhead Karoo – Bu-ga-looooooooo (It rhymes I think)

Hammerhead_Karoo_3QuartersView_RoutesAppI would be lying (At least withholding information) if I didn’t say that Ray’s post on the Karoo didn’t influence me to get me off my butt and post this. I own a Hammerhead H1 – I pre-ordered it long before they reached their goal on Dragon. Unfortunately it died (wouldn’t charge after being left after winter) but they delivered, it worked, and I saw the software improve over a few months. I reached out to them a while back to give some nerd feedback. Nice guys. To me it was left field about the Karoo. I remember saying “don’t let someone eat your lunch” in my last email to them. So this is a Wow moment for me to me. I think they are leveraging the navigation stuff so that’s awesome.

Honestly, it looks a little big, but I don’t mind the large head units. If they can pull off a sub $400 dollar unit I’ll pre-order. Honestly, if they pulled off 299 maybe two (girlfriend still on an aging Edge 500). If 499 or more, nope. Sorry. However, based on my estimates I don’t know how they could pull off a price point where I’d hand over my money. It’s hard considering all the things that have been added to the edge series since they launched.

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