Loss Leader

My colleague Joel Harrison is good at encapsulating learnings from his experience. In 2006, while I was visiting him at his startup company, Abrevity, he said, “You can’t justify a new product based on a cost analysis of the first-generation product. You have to have a vision.”

Joel and I had experienced the frustration of trying to create new products at a company that was in a high-volume, low-margin business — hard disk drives. On the one hand, Joel had prototyped a product that could have been the first available Ethernet-interfaced free-standing disk storage unit. I had been involved with defining a disk drive that stores and plays back video streams without a computer attached. While our company had funded the early prototyping of these products, it did not make the investment needed to launch them as consumer or end-user products.

Joel’s explanation, as I understand it, is that the company did an analysis of the cost of the first products in each case and concluded that the product cost too much to be priced reasonably in the marketplace. Now here’s where “vision” comes in. When you’re introducing a radical new product, you have to price it not based on the initial product’s cost, but based on a combination of the needs of the market and the expected cost curve as volume increases.

Companies selling services, such as cell phone service
, do this all the time. To make the service workable, they have to invest a large amount of capital in infrastructure, such as cell phone towers, switching equipment, and so on. But pricing of the phone service must chosen both to make it attractive to the consumer and, when the number of subscribers reaches a reasonable target, to make a reasonable return on the investment.

The same thing is true with new products. The barrier to radical innovation and new product introduction in companies that have been operating in a low-margin high-volume environment for years is primarily a failure of imagination. They need the vision to see that (a) there is a market to be created or captured, (b) the product they have conceived is viable, and (c) initial pricing will lead to losses during the early stages of market development. Venture capital is based on selecting and funding this sort of innovation. But old companies have trouble thinking outside the low-margin, pay-for-itself-or-die product box.

That’s what Joel was telling me. If we could have planned the new businesses beyond the first product, and had got a commitment to fund the initial losses, we could have made history in disk drive marketing.

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About John Levy

John Levy, Ph.D. is an expert in computers, software and storage who is available for consulting in patent litigation.

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