Ventures To & Fro
28 Dicembre Dic 2011 0904 28 dicembre 2011

Fire, Razors & CAC for Startups

The Kindle Fire: A Short Discussion of CAC.

(N.B., an Italian translation--via Google Translate--can be found at this link.)

What does the Kindle Fire have to do with startups? They are losing money every time they sell one (and they are selling a lot of them). Each device costs about 8-10% more than the retail sales price (so the loss is even greater when they sell the device through retailers). Call the average loss, then, about 15-20%.

So?

Customer Acquisition Costs. That “loss” is part of the cost Amazon incurs to acquire each of its customers—or CAC. Put that way, the “loss” of between $25 and 40 is a business development “cost” to acquire that customer.

That’s because Amazon is not really in the business of selling devices. True, it sells them—the Fire is the latest in a Kindle model range released over the last three or so years. But its revenue comes from selling books. Increasingly, their book sales have come from the sale of e-books.

And guess what the predominant use is for the Kindle? Reading e-books.

True, again, that the Kindle can browse the web, send and receive emails and utilize apps from the Android apps store. (True also that it is speed in these categories is, well, slightly above glacial but at the retail price, who cares?) But it shines as an e-book reader. And that’s where they make their money.

Razor Blades and Razors. Deja Vu All Over Again.

Amazon’s approach with the Kindle, then, is the latest variant in the “Gillette” model also known as the razor blade model. Gillette practically gives away the razor itself—that is, the hand device into which you insert the razor blades. Then it charges gejillions for the razor blades themselves. (OK, not gejillions, but, hey, it’s over a Euro a blade.)

OK, so what does this have to do with startups? Well, for starters (pun intended), it is a pricing issue. “Losing” money with a device’s pricing at the outset does not necessarily mean you will fall off a revenue cliff. The cliff comes closer if you have no other source of money (that’s where venture capital investing comes in). Your “loss” represents a large part of your CAC.

If your model is a variant on the Gillette or Amazon approach, then this is a reasonable part of your CAC—a “loss” of 25 to 40%.

Take, for example, a device used to enhance the magnification of your iPhone camera. If that device is your market, then you cannot afford much loss. But suppose that you are using that device only to acquire visual information that is then sent somewhere—say, to a database? If your potential revenue is in that transmission or that database, then you want to price the device low enough that many people will adopt it.

So, losing money for Amazon on each Kindle Fire sold is not a bad thing. It’s part of CAC.

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