I joined Leo Laporte, John C. Dvorak and Jason Snell on This Week in Tech. We covered a wide range of topics, including Apple University, OnePlus’ appalling “Ladies First” contest, Facebook’s timeline algorithm, Twitter’s capacity for both good and evil, and a whole lot more. Plus murses!
In this week’s episode we discuss feedback about Ben’s Android criticism, then dive into Andreessen Horowitz’s $50 million investment into BuzzFeed. Is there a real business here? We also discuss native advertising: Ben is quite a bit more optimistic than James.
Links
Ben Thompson: Is BuzzFeed a Technology Company? – Stratechery
We see BuzzFeed as a prime example of what we call a “full stack startup”. BuzzFeed is a media company in the same sense that Tesla is a car company, Uber is a taxi company, or Netflix is a streaming movie company. We believe we’re in the “deployment” phase of the internet. The foundation has been laid. Tech is now spreading through every industry and every part of the world. The most interesting tech companies aren’t trying to sell software to other companies. They are trying to reshape industries from top to bottom.
BuzzFeed has technology at its core. Its 100+ person tech team has created world-class systems for analytics, advertising, and content management. Engineers are 1st class citizens. Everything is built for mobile devices from the outset…BuzzFeed takes the internet and computer science seriously.
The issue is that, generally speaking, media companies don’t make for good venture capital investments. VC firms like Andreessen Horowitz aren’t looking to fund nicely profitable companies; they are searching for home runs, the one or two investments that make a fund profitable despite lots of failures. This means a focus on companies that can scale. Marc Andreessen told Adam Lashinsky in Fortune:
We describe it is we invest in Silicon Valley style companies. So we invest in the kind of companies that Silicon Valley seems uniquely good at producing at scale, you know, large numbers over time.
What makes technology companies – software companies, especially – different from media companies is the distribution of costs. Even before the Internet, for a software company, almost all of the costs were up-front fixed costs: you spent money primarily on salaries to develop a piece of software, and you spent that money well before you knew whether or not said software would sell.
The payoff, though, was that the software itself had minimal marginal costs: it cost basically nothing to produce one more copy (discs and packaging, basically). Thus, the vast majority of revenue for every single copy sold went straight to the bottom line. Moreover, most software is universal: it can be used anywhere (although localization can add to the fixed costs), and it’s useful for a long period of time. That results in the sort of scale that Andreessen was referring to.
Media companies, on the other hand, have traditionally differed from technology companies in three ways:
Created content had a very short shelf life, which leaves a very small amount of time to recoup the fixed costs that went into its creation
Media’s marginal costs (paper, ink, delivery) were higher than the marginal costs for software, at least in relative terms
Media was generally limited in its geographic availability
In this pre-Internet world, media did have an ace-in-the-hole: their significant up-front costs often resulted in geographic monopolies that made them the primary option for advertisers. This made media companies interesting investments for hedge funds, but the limited upside meant they were much less attractive to VCs.
Fast forward to today, and the Internet has seemingly made the differences between technology and media companies even more stark:
Packaging is no longer necessary, reducing the marginal cost of software to zero
Multiple new business models have emerged for software, such as attracting massive user bases for free which can then be monetized through advertising or premium services1
Media, meanwhile, has lost its local monopoly, and advertisers have fled for platforms that have more scale – there’s that word again – and better targeting
So why on earth is Andreessen Horowitz investing in a media company? Or is Dixon right – is BuzzFeed really a technological company that can use software to succeed in everything from listicles to hard news to now, their own movie production company? What has changed since Andreessen wrote in his post introducing Andreessen Horowitz:
We are almost certainly not an appropriate investor for any of the following domains: “clean”, “green”, energy, transportation, life sciences (biotech, drug design, medical devices), nanotech, movie production companies, consumer retail, electric cars, rocket ships, space elevators. We do not have the first clue about any of these fields.
I suspect what Andreessen and company have come to realize in the five years since that post was written is that because of the Internet media is more like technology than it might first appear, and that what Andreessen Horowitz cares about is not the software but the potential scale.
Like software, media has zero marginal cost
Multiple new business models have emerged for media, such as attracting massive user bases for free which can then be monetized through advertising or premium services
The addressable market for media is the connected population of the world, and content is itself self-selecting when it comes to effective targeting
These are all points that are overlooked by those in the media kvetching about the death of journalism: everything that is hurting traditional media companies – zero marginal costs, “free” expectations, unlimited competition because of global distribution – are opportunities for new media companies unencumbered by traditional thinking.
So, for example, as Dixon writes about BuzzFeed:
Internet native formats like lists, tweets, pins, animated GIFs, etc. are treated as equals to older formats like photos, videos, and long form essays.
And why shouldn’t they be? The only reason to treat a tweet differently than a pull-quote, or an animated GIF differently than a photo, is if you are worried how they will appear in print. Remove those shackles and you realize there is no difference at all. What Dixon didn’t say, though, is that this sort of liberation also applies to monetization, and that includes native advertisements. I’m quite bullish on native advertising, and I think the ethical concerns are overstated. Specifically:
“Native” advertisements are how every medium monetizes free content: newspaper ads are stories and pictures, magazine ads are beautiful imagery, radio ads are jingly voice-overs, TV ads are scripted stories, so on and so forth. Still, it took each of these mediums time to figure it out – they all went through their banner advertisement stage, i.e. ineffectually using an advertising format that worked on the old medium.
In the case of the Internet, content consumption is primarily about either the timeline – think Facebook, Twitter, or even blogs – or the irresistible atomic unit that spreads on social media. We should expect – and applaud – advertising adapting itself to these formats.
Newspapers in particular have been the most conscientious about maintaining a “wall” between the business and editorial sides of the businesses. Newspapers, though, as I noted above, were de facto monopolies. So while it certainly benefited journalists that they need not worry about how the newspaper made money, there was absolutely a political benefit to trumpeting the objectivity and impartiality of the editorial side. Newspapers could declare themselves to be above reproach even as they made money hand over fist.
The situation is far different on the Internet. Anyone anywhere has access to everything on the web,2 which means there are no monopolies on either the news or on advertising. Quite the contrary, in fact: the Internet is the closest thing in human history to a true marketplace of ideas, and the currency is user attention. Ultimately, well-functioning markets are a much better police of ethical lapses than self-rightous arbiters.3
Moreover, the truth is that bias lurks in any author, or in any ownership structure, something that is of particular concern when it comes to the consolidation of traditional media. One can absolutely make the case that an organization like BuzzFeed, with clearly labeled native advertising, is a lot more trustworthy than any reporting that may come out of an organization like NBC (which is owned by Comcast). Oh sure, NBC journalists will object to that statement, but how can we every truly know?4
This is what makes BuzzFeed so interesting: absent legacy, media absolutely benefits from Internet economics as long as you can figure out effective monetization, and it’s possible BuzzFeed has done just that, and, just like their product, they have done so by abandoning that which primarily mattered in the old medium.
This begs a deeper question, then: what is a technology company? I actually don’t buy the idea that BuzzFeed has some sort of magic algorithm that makes what they do possible, and if that’s the basis on which Andreessen Horowitz is investing, then I have a bridge they may be interested in as well. However, the entire premise of this blog is that product is only one part of what matters: so does channel, distribution, advertising, business model and the addressable market. And that is what makes BuzzFeed a “tech” company: the world is their addressable market, and they make money by scaling for free.
Obviously data centers and the like cost money, but again, those are fixed costs, not marginal one: each additional user is “free” ↩
Obviously lots of markets are not well-functioning; I’m not an absolutist here. However, when it comes to what is read online, it is much more of a level playing field than almost anything you can compare it to. That this blog is read at all is testament to that; hopefully, the fact I am monetized by my readers is a competitive advantage ↩
To be fair, the same criticism applies to Andreessen Horowitz’s involvement in BuzzFeed, and this aspect makes me just as uncomfortable as Comcast owning NBC. Moreover, it certainly is convenient that Marc Andreessen sits on the board of Facebook, BuzzFeed’s most important channel ↩
This week’s Daily Updates have had a heavy international focus, especially on China but also India. This particular update is from this morning and seeks to understand why Apple fares so differently in these two critical markets. To read all of the Daily Updates for $10/month or $100/year, please visit the membership page.
Bloomberg writes about the iPhone’s appeal in India:
Apple Inc., which has struggled in emerging markets because of the price of its new iPhones, has devised a strategy for India that’s starting to pay off: It’s pushing older models that offer cachet at affordable prices.
The iPhone 4, which was released in the U.S. in June 2010, is still available. So is the iPhone 4s that went on sale in October 2011.
“You flaunt an iPhone, but you don’t flaunt an Android,” said Punit Mathur, a 42-year-old vice president of a digital media company who switched to a new iPhone 4s from a Nexus 4. An iPhone 5s that would cost 53,500 rupees ($874) is too expensive, “but the 4s is still an upgrade,” he said…
Apple’s approach in India has helped it build traction in a country where 225 million smartphones will be sold this year, said Brad Rees, chief executive officer of London-based Mediacells, a marketing company. Apple, the fifth-largest vendor in India, more than doubled sales there in the first quarter to 325,000 iPhones from a year earlier, according to researcher Canalys.
I’m honestly a little hesitant to jump on this article; it fits a little too neatly into the prevailing narrative about iPhones. Moreover, according to the numbers in the article, the iPhone is on pace to have less than one percent of India’s smartphone market, so the iPhone is not exactly dominating.
That said, the union of these two facts – that the iPhone in India has high-end appeal, but sells in infinitesimal numbers – lends credence to a point I made last fall in The $550 iPhone Makes Perfect Sense:
It’s not so much that the iPhone has saturated the American-style and European-style markets, and ought to focus on the Asian-style one; rather, the iPhone has saturated the high end in all three markets – the high end just varies in accessibility ($200 for American-style, $650 for Asian-style). And, if you accept that the iPhone is in roughly the same competitive position in all three markets – that the difference in market share is due to inherent structure of the market – then it’s not at all obvious Apple should focus on the SE Asia-style market. In fact, it’s obvious they shouldn’t.
My use of the word “saturated” was probably a bit strong, but the point I was making was that the iPhone skims the top of every market, and that their market share is simply a function of how rich a country is (as well as how subsidized the handset market is). I fleshed out this idea in a post about Apple’s growth in Japan:
It’s not that the iPhone has fully penetrated developed countries, leaving the rest – we’re not talking about a Pampers or Pepsi here, or some other consumer packaged good. Rather, the iPhone is an affordable luxury item; the percentage of the population to which it is affordable just happens to differ market-by-market.
The iPhone targets the high-end in all markets, not just developed markets.
To that end, it is very interesting to compare the underlying fundamentals of the Indian and Chinese markets. Why is it that Apple is doing so well in the latter, while barely penetrating the former?
When it comes to China, I wrote the following when Apple finally agreed to a deal with China Mobile:
The two pertinent facts about China are that:
There is tremendous income disparity
There are a TON of people
So while many Western markets may have a greater percentage of the population that can afford an iPhone, the absolute number of Chinese who are potential customers is very high as well.
The chart is obviously inexact, but we can look at the actual numbers:
The nominal GDP per capita in China is only $6,747 – clearly not enough to afford an iPhone!
However, China has a Gini coefficient of 47.4, which is quite high (the United States is in fact quite close to China with a Gini coefficient of 45.0)
That means a relatively small number of individuals have an outsized share of income, but, because China is so huge, the absolute number of high income individuals is quite large.1
India, on the hand, is just about as large as China, but has a very different economic profile:
India’s nominal GDP per capita is significantly lower than China’s, coming in at only $1,504
India also has much less inequality than China: the Indian Gini coefficient is only 36.8
The average is lower and there are fewer outliers, which mean many fewer people are in iPhone territory:
India has a lower average income and fewer outliers than China, which means a much smaller iPhone market
Ultimately, I think these numbers confirm my hypothesis: Apple is indeed the preferred vendor for people at the top of the market, but because the iPhone is priced (about) the same everywhere in the world, its market share is a function of a country’s average income and the way in which that income is distributed.
To be fair, this is hardly a controversial thesis: the more pertinent takeaway is that as long as Apple has globally available iPhones (which I don’t think will ever change), the chief constraint on Apple going downmarket in countries like India is the risk of forgoing profits in countries like China or in the West, both of which have plenty of people who can afford Apple’s prices. That’s why I continue to doubt we’ll see Apple abandon its lower-cost iPhone = old iPhone strategy in favor of releasing a new-to-the-world low cost device.
The full list of topics covered this week in the Daily Update include:
Why Facebook is About the Explore
NFL to Use Surface Tablets
Mobileye IPOs
Xiaomi Wins on More than Price
Micromax and Local Taste
Local Brands and Scale
Sprint Abandons T-Mobile Bid
Microsoft Hires New Head of Business Development
Understanding China, or Not
Apple’s China Risk
China Cracking Down on Messaging Apps
Apple/China Follow-up
The iPhone in India (versus China)
Buying Smartphones in the U.S.
To read all of these updates and to receive future updates, please visit the membership page and sign up!
I’d like to thank all of Stratechery’s subscribers for their support, and for making this site possible.
In this week’s episode we discuss how the Internet is enabling not only big winners, but also small, focused niche players, and why that’s exciting. We also discuss the impact this transition will have on society, follow up on last week’s integrated/modular discussion, and in a special “After Dark” segment briefly discuss Ben’s recent experience with Android and theorize that the smartphone market is at equilibrium.
Links
Ben Thompson: Daily Update: Micromax Wins on Local Taste – Stratechery (members-only)
Rohin Dharmakumar: Can Micromax Become India’s Leading Smartphone Maker? – Forbes India
Ben Thompson: How Technology is Changing the World (P&G Edition) – Stratechery
Ben Thompson: Christmas Gifts and the Meaning of Design (includes a reference to P&G’s design process in the footnotes) – Stratechery
Ben Thompson: Pleco: Building a Business, not an App – Stratechery
Ben Thompson: Smartphone Truths and Samsung’s Inevitable Decline – Stratechery
I’ve been surprised at the amount of attention my little corner of Twitter has given to the news P&G, the largest CPG company in the world, is making significant cuts to its brand portfolio (a Marc Andreessen tweetstorm certainly helped). From the Wall Street Journal:
Procter & Gamble Co. will shed more than half its brands, a drastic attempt by the world’s largest consumer-products company to become more nimble and speed up its growth.
The move is a major strategy shift for a company that expanded aggressively for years. It reflects concerns among investors and top management that P&G has become too bloated to navigate an increasingly competitive market.
Chief Executive A.G. Lafley, who came out of retirement last year for a second stint at the company’s helm, said P&G will narrow its focus to 70 to 80 of its biggest brands and shed as many as 100 others whose performance has been lagging. The brands the Cincinnati-based company will keep—like Pampers diapers and Tide detergent—generate 90% of its $83 billion in annual sales and over 95% of its profit.
The obvious way to interpret this news is to assume, as the WSJ did, that the reason for this move is to “become more nimble” and that P&G has “become too bloated.” This has certainly been the take of most of the folks in my Twitter feed, who have long been regaled by tales of Apple’s focus in particular:
6/Steve Jobs legendarily used strategy of cutting brands & SKUs for Apple's turnaround. But few CEOs have followed suit in last 15 years.
I think, though, there is something much deeper at play here, and it’s far more of a tech story than a superficial Apple comparison might suggest.
One of the more interesting – and telling – factoids about the consumer packaged goods (CPG) market is that there are no product managers; rather, there is a very similar position called a “brand manager.” The nomenclature is no accident: while tech products have traditionally differentiated themselves by their product attributes, the distinguishing feature of your typical consumer product is its branding and positioning.
Take something like health and grooming products: on a product level there are not massive differences between, say, Axe and Dove. But their branding could not be more different. Dove has had massive success with their “Real Beauty” campaign that fights against highly sexualized stereotypes that only serve to make most women feel worse about themselves:
An ad from Dove’s ‘Real Women’ campaign
Axe, on the hand, in an attempt to appeal to young men, heavily emphasizes exactly the sort of stereotypes Dove is objecting to:
Not exactly a ‘real’ woman
Here’s the kicker, though: Axe and Dove are both owned by Unilever, the Anglo-Dutch CPG conglomerate.
When we in tech talk about identity, we’re usually talking about the ability to manage individuals, whether that be for connecting to corporate networks or for effectively running ad networks. In social science, however, the concept of identity is about a person’s own personal conception of who one is and one’s place in the world.1 It is this definition of identity that is at the root of effective branding. What both Dove and Axe are doing in the above ads is appealing to identity: to use Dove products is to reject society’s expectations and to embrace your identity as a woman; to use Axe is to drown insecurity and affirm your manliness, whatever that means.
In fact, if you squint, you can see that both Dove and Axe are trying to accomplish basically the same thing but for two totally different audiences; while the ends may be similar, the means are necessarily different. Moreover, identity is not just about demographics: it is also about psychographics – things like personality, opinions, lifestyles, etc. This means that, by definition, one brand can not fit all. That is why Unilever sells both Dove and Axe, and it’s the primary reason why P&G has nearly 200 brands of its own: when you can’t differ hugely on product2, you find growth through winning niche by ever-more-specialized niche.
There is one more factor that explains P&G’s brand proliferation: shelf space. The most effective way to beat out competition is to have your product in front of the customer – and to ensure your competitors’ are no where to be found. Buying decisions for low cost/relatively undifferentiated items are not made through extensive research and online price comparisons; rather, you need body wash, so you go to the body wash aisle, and pick from what is available. P&G leveraged its size and ownership of dominant must-stock brands like Tide, Pampers and Gillette to finagle the maximum amount of shelf space possible, and then filled that shelf space with a cornucopia of specialized brands that not only appealed to specific niches, but also kept competitors away from P&Gs real breadwinners.
So how, then, have changes in technology forced P&G into a different direction?
The first change has been the massive increase in noise. It is so much more difficult today for a brand to break through, especially as compared to the halcyon days of one local newspaper and three broadcast channels. Today there are not only TV channels galore, but display advertising, search advertising, Facebook, Twitter, and more. While it is true that uber-specialized brands can now more easily hone in one specific niches, that takes real money and is much more difficult to pull off across 200 brands. P&G has likely realized that many of its brands were simply getting drowned out, rendering the money spent marketing them effectively worthless. Thus P&G has decided it needs to “go big or go home” – either spend a lot of money to make sure a brand stands out, or simply get rid of the brand.
This is a phenomenon that is playing out across multiple industries. For example, it is significantly easier today to get a startup off the ground; however, that actually means startups need more venture capital, not less, because the real challenge is marketing and/or sales (and thus, by extension, venture capital is bifurcating between very large and very small). The same thing is playing out in the app store. Similarly, there are a few big winners when it comes to journalism and attention, with many medium-sized players fighting for survival. In music stars like Beyoncé are richer and more powerful than ever before, while many smaller acts are struggling to survive. The ease with which information flows means we all get a whole lot more of it, which actually makes it more likely we glom onto whatever it is that stands out, which makes it stand out even more.
The other big technological change that is affecting P&G’s strategy is e-commerce. As I’ve previously noted in the context of Amazon:
Jeff Bezos’ critical insight when he founded Amazon was that the Internet allowed a retailer to have both (effectively) infinite selection AND lower prices (because you didn’t need to maintain a limited-in-size-yet-expensive-due-to-location retail space).
That’s great for Amazon, but not so great for P&G: remember, dominating shelf space was a core part of their strategy, and while I’m no mathematician, I’m pretty sure dominating an infinite resource is a losing proposition. What matters now is dominating search. That is the primary way people arrive at product pages like this:
Most customers arrive at this page via search, not browsing
There are two big challenges when it comes to winning search:
Because search is initiated by the customer, you want that customer to not just recognize your brand (which is all that is necessary in a physical store), but to recall your brand (and enter it in the search box). This is a much stiffer challenge and makes the amount of time and money you need to spend on a brand that much greater
If prospective customers do not search for your brand name but instead search for a generic term like “laundry detergent” then you need to be at the top of the search results. And, the best way to be at the top is to be the best-seller. In other words, having lots of products in the same space can work against you because you are diluting your own sales and thus hurting your search results
The way to deal with both challenges is the same way you break through the noise: you put more focus on fewer brands.
There is a lot that tech companies can learn from companies like P&G. Probably the biggest one is that brand matters. It is the key to breaking through the noise and a major part of sustainable differentiation. However, it’s also worth noting that even after this cull P&G is still going to have nearly 100 brands: that’s because identifying and serving specific groups matters as well. P&G is trying to figure out the balance between specialization and reach that makes sense for them as a Fortune 50 company, and right now that balance is leaning towards less specialization and more reach.
However, I think that means the opposite is the case for smaller players: the Internet may be noisy, but it also makes it possible to identify and reach niches that were previously too hard to segment or reach at a scale great enough to support a business. As I wrote last week, independent app developers ought to pursue a niche strategy, but so should writers, musicians, and even CPG startups.
More broadly, I strongly believe P&G’s changes are yet another example of how technology is touching – and massively changing – every single industry. To be sure, P&G has been at the forefront of using technology in its business practices, but now technology is changing the very foundation of how they approach business itself. And, in a way, it speaks to how impressive P&G is as a company that they are among the first to significantly alter their business in the face of these changes; they won’t be the last.
It really is fascinating how “identity” as used in tech is the total inverse of “identity” as used in social science. The former effectively reduces people to a row in a database; the latter is about expressing uniqueness ↩
Although, to be clear, P&G spends a lot of money and effort on R&D ↩
This past week has not been the first outbreak of independent developer angst over the app store, but it feels like it has been one of the more intense. The pump was primed by the news that Kim Kardashian: Hollywood is on pace to make $200 million this year, news that was in stark contrast to Brent Simmons’ observation that there didn’t seem to be many indie iOS developers (I think his is the post that kicked the discussion off; Simmons’ blog contains a good roundup of all the posts that ensued).
The high point though — or low point, I suppose — was when Jared Sinclair revealed the sales numbers for his excellent iOS RSS reader Unread:
Unread for iPhone has earned a total of $32K in App Store sales. Unread for iPad has earned $10K. After subtracting 40 percent in self-employment taxes and $350/month for health care premiums (times 12 months), the actual take-home pay from the combined sales of both apps is $21,000, or $1,750/month.
Considering the enormous amount of effort I have put into these apps over the past year, that’s a depressing figure. I try not to think about the salary I could earn if I worked for another company, with my skills and qualifications. It’s also a solid piece of evidence that shows that paid-up-front app sales are not a sustainable way to make money on the App Store.
First off, Unread is a great app that I myself use, and Sinclair is a very interesting and provocative blogger who has written some reallystrongpieces about design and iOS 7 in particular. I’ve also had the pleasure of meeting him in person and consider him a friend, and admire his willingness to share his financials even if they aren’t as great as he might have hoped.
That said.
Sinclair’s results are not a “solid piece of evidence” of anything. They are an anecdote. And as long as we’re drawing grand conclusions from single data points, I thought it might be useful to look at someone on the other side of the spectrum. So I called up another friend of mine, Mike Love.
Love makes Pleco, the preeminent Chinese dictionary on the app store (iOS, Android). Pleco is not by any means a new app; in fact, it was first developed for the Palm (I actually bought a Palm in 2003 for the express purpose of using Pleco). Here’s Love on its genesis:
I was an exchange student in China and launched the app on Palm in 2001. The signature feature was handwriting recognition (licensed from Motorola) which nobody else had at that point. The problem [for other Chinese dictionaries] was that Palm didn’t have a Chinese font built-in, it did not in fact have Unicode support [or other Chinese text encodings]…you could only get Chinese working on it all through a hack. So having it all in one place, no extra setup needed, no buying licenses to three different $30 apps to get it working, that was kind of the key part of it.
The one other thing we had besides the handwriting and Chinese support was that we exclusively licensed the Pocket Oxford Chinese dictionary…[everyone else used] CEDICT which had been less exhaustively edited and had no parts of speech or example sentence.
What stands out to me about Love’s approach was that from day one his differentiation was not based on design, ease-of-use, or some other attribute we usually glorify in developers. Rather, he focused on decidedly less sexy things like licensing. Sure, licensing is particularly pertinent to a dictionary app, but the broader point is that Love’s sustainable differentiation was not about his own code. Sustainable differentiation never is.
I decided to do the iOS app pretty much as soon as Apple announced the app store…but I was in the middle of a pretty ambitious update for Palm and Windows Mobile, so we were pretty late and there were a bunch of other dictionaries on iOS [by December 2009, when Pleco for iOS launched].
Love noted that although Pleco was quite late – there were multiple Chinese dictionary apps in the store – they were fortunate that Apple had just started allowing free apps to offer in-app purchases. So, even though Pleco had always been a paid download on Palm, Love immediately took advantage of the new business model:
Our initial plan in iOS had been to have some sort of free lite app, some sort of slightly nicer paid app with a minimum set of features, and then you could buy other stuff as add-ons. Then in October 2009 Apple announced they were lifting the ban on free apps having in-app purchase so immediately we retooled the whole thing to be free with in-app purchases.
Love thinks the fact he started from day one with the new business model in mind gave him a competitive advantage to the dictionaries already in the store, but I think he sells himself short; after all, it’s been five years and only now are most independent developers starting to realize that free with in-app purchase is the only viable monetization model. To put it another way, Love differentiated himself again by being a student not just of APIs and frameworks, but of business models as well. More from Love:
Unlike others, our free app had not only CC-CEDICT (the evolution of the aforementioned CEDICT), we actually licensed another Chinese-English dictionary which we called the PLC dictionary and offered that in our free app and we thought it would be a nice differentiator compared to all of the CC-CEDICT apps because it had sample sentences and other nice things that they didn’t have.
This point blew me away. Love invested real money into differentiating his free app (Love still had the great handwriting engine, but iOS’s built-in handwriting – while hugely inferior – had lessened that advantage). Love was confident that after he won in free, he could make up the difference with his plethora of paid add-ons, which at this point included not only additional dictionaries – several of them exclusives – but also modules like stroke order diagrams, different fonts, a document reader, and a year later, optical character recognition (OCR).
At this point I asked him about price. One thing to note about developing on Palm was that significantly higher prices were the norm. Pleco on Palm was available in three different bundles, depending on your choice of dictionary, for prices ranging from $60 to $120. Surely that wasn’t possible on iOS, or was it?
We launched with a basic bundle for $50, a professional bundle for $100, and a complete bundle for $150. So pretty close to the Palm prices actually.
But surely prices have fallen, right?
We actually charge mainly the same prices. Our lowest bundle is $40, but it doesn’t include an additional dictionary now, just features. Some people didn’t like the dictionary we were offering in the basic bundle so we felt it would be more flexible to have a cheaper bundle that didn’t have any dictionaries with the assumption that people could buy whatever dictionary they wanted to go with it. The pricing change helped though – we’re actually netting more off of the basic bundle now than we were when it was $50. The cost reduction actually did us some good.
Pleco’s bundles. Individual features and dictionaries are also sold separately.
Love’s high prices have not hurt sales:
Pleco has about 100 times the number of customers as Pleco on Palm/Windows Mobile (thanks to being free)
Those free customers convert at about a 5% clip, meaning Love has about 5x more paying customers than he did previously (Palm/Windows Mobile did not have a free edition)
Net revenue per customer has been cut by a third, primarily due to significantly higher royalty rates charged by publishers who realized Pleco was cutting into their book sales
Pleco also has an Android version that makes about a third as much revenue as the iOS version, although Love noted it takes up a lot more than a third of his time. I asked him if it was worth it:
As a brand expansion, yes. The number of sales we get from the fact that when a typical student starts their Chinese class or exchange program and you get a little sheet, and the sheet says “Here’s some useful Chinese things you should get” and Pleco is one of them, that’s very valuable, and making sure that Pleco is the only app on there and you don’t need to recommend some other app for Android, that’s valuable.
I think this is a crucial point: Love owns his niche, and he is willing to do whatever is necessary to ensure that remains the case.
In a follow-up post to the one quoted above Sinclair wrote:
Arguments that I naively built and marketed an RSS reader in 2014 aren’t relevant to the heart of my article. Any polished app — in any category, with any amount of marketing or promotion — is a lottery. Increasing the marketing budget is just as likely to increase the potential losses as it is to increase potential sales. Each niche is an apple or an orange. It’s all a gamble.1
Love is testament this is absolutely not true. He has identified a niche – Chinese language learning – and over many years he has worked diligently to be the app for that category. Much of that time has not been spent on development or design. Rather, it’s been spent understanding and listening to customers (which led to the aforementioned bundle change), making business deals with slow-moving publishers, careful consideration around pricing and app store presentation, investments in both free and paid differentiators, and a whole bunch of time spent on an Android app that doesn’t make that much direct money but that marks him as a leader in his space.
Make no mistake, Love has had his breaks, particularly his having started with favorable licensing terms, but I would ask every indie developer who is bemoaning his or her fate in the app store:
Are you serving a niche that has a clear need, an audience that is willing to pay, and that is large enough to sustain your app?
Have you developed sustainable differentiation that is more tangible than just look-and-feel?
Do you have a fully thought-out monetization model that lets you make a meaningful amount from every customer you serve? If your app is truly differentiated then you need to charge customers accordingly
Have you invested just as much if not more effort in non-development functions like making partnerships, licensing, promotion, etc.?
Have you made an Android app?
All of this is table stakes for any developer, indie or not, and as much as I like Sinclair personally, the lessons I draw from his experience is not that the app store is broken, but rather that he built a bad business (particularly in his choice of market). If doing everything I listed doesn’t sound attractive, or realistic, if all you want to do is develop and make something beautiful, then you need to get a job that will pay you to do that. To be an indie is to first and foremost be a businessperson, and what I admire about Love is that he is exactly that. His development skills are a mean, not an end.
To be clear, Apple could do much more to make things easier for developers of all sizes. Two in particularly would make a big difference:
Trials: One of the big advantages Love has in his space is that it is possible for him to offer a highly useful (and differentiated) free app along with a whole slew of paid add-ons. There are other categories, though, where to remove features would render the app useless. These sorts of apps need app-store supported time-limited trials along the lines of the Windows Store:
The Windows Store lets developers set up time-limited trials of up to 30 days with the click of a button.
This would quickly make clear which apps in a given niche were the best, because customers could try them all, and that developer could charge accordingly. Over the long run, different niches would end up with different apps at different prices, with price as a signifier of quality (which, of course, the customer could verify through a trial)
Paid Upgrades: The key to any sustainable business, whether it be a restaurant, airline, or app developer, is to make money off of your best customers over time. Apps with a service component, like Evernote, or ones with an ever-increasing array of in-app purchases, like Pleco, do this successfully. Again, though, there are other types of apps that are complete experiences unto themselves. Right now there is little motivation for a developer to invest time in improving their app, because the people who are mostly likely to appreciate those improvements – the current customers – can’t pay. It is true you can release a separate app entirely, but then you lose access to the original app’s data, plus you have no means of communicating with your current customers to let them know why they should update.
Apple really should care: the iOS ecosystem is one of the iPhone’s biggest differentiators, and absolutely one of the reasons Apple maintains its impressive margins. But independent developers also need to appreciate that the iOS app store, with its minimal barriers to entry and massive consumer audience, requires that they first and foremost be businesspeople.
Love reminisces:
I do miss the Palm days. The thing about that is it was much more about writing apps for people like me. I think a lot of people complaining about the state of the app store now are realizing it doesn’t work that way anymore – but in the early days of the iOS app store it did. People on Palm just wanted you to add cool stuff. They wanted more features, they were excited by the same things I was excited by.
This is the critical point: developers all want to write an app for themselves, which means everyone has. That’s why there is no money to be made in something like an RSS reader. But there are whole swathes of people out there who have really interesting and specific needs – like Chinese language learning – just waiting for someone who can not only develop, but can also do market research, build a business model, and do all the messy stuff upon which true differentiation – and sustainable businesses – are built.2
In a follow-up conversation, Sinclair expounded on this, saying, “The scale of the App Store might lead a newcomer to believe that even a small niche is capable of generating satisfying revenues for a solo developer.” To me this seems to be saying the same thing, but judge for yourself ↩
Note: For this article I also interviewed Elia Freedman, another former Palm developer who has built the best financial calculator on the app store (no, really – look at the reviews). My thanks to him for this time, and definitely check out both his apps (he has a whole suite of calculators), as well as his very thoughtful blog (where he disagrees with me about trials) ↩
The growth curve is impressive enough, even before you notice that the scale is logarithmic. And to be sure, Amazon has had doubters from the beginning: few gave the company a chance when it started, and even fewer thought it would survive the bursting of the bubble. And yet, today Amazon is the king of e-commerce, at least in the United States, and the clear leader in cloud services, and now they are making a big push into digital content and devices.
I too was once a skeptic. I remember several years ago, after being invited for final interviews with Amazon, I decided that I wouldn’t take the job even if offered.1 Beyond the fact the retail-focused role wasn’t a great fit, I was also concerned that total compensation at Amazon, at least relative to other established tech companies, is heavily stock-based. At that time the stock was trading at a price-to-earnings ratio of nearly 90, which on the surface seemed unsustainable, and it didn’t seem worth the risk.
As of today, the stock price has doubled.
Since that time I’ve come to appreciate what an incredible business Amazon has built, as well as the size of the opportunity. Just about a year ago, when every one was freaking out about Amazon’s earnings (this week’s angst is nothing new), I wrote about Amazon’s Dominant Strategy:
Jeff Bezos’ critical insight when he founded Amazon was that the Internet allowed a retailer to have both (effectively) infinite selection AND lower prices (because you didn’t need to maintain a limited-in-size-yet-expensive-due-to-location retail space). In other words, Amazon was founded on the premise of there being a dominant strategy: better selection AND better prices – the exact same as Sears.
And, just like Sears, Amazon has added convenience. No, they haven’t opened retail stores; instead they created the amazing Amazon Prime.
In a happy coincidence, the same day I posted my piece the aforementioned Benedict Evans posted his own defense of Amazon:
Amazon is constantly creating new business lines. When they start, like any new business, they’re loss making. But they don’t ‘flip a switch’ to get to profitability – they just grow and execute, like any other business…
To put this another way, Amazon is LOTS of different startup ecommerce businesses on one platform. All the profits from the ones that work are spent on new, loss-making ones.
This approach makes sense of the compensation scheme I was nervous about: small autonomous teams have a lot of agency over their own results, even as they all work for a mutually shared outcome, and each team has a part to play. Older groups like books and media are the cash cows, funneling profits to growth engines like clothing or shoes or auto or any of the myriad of businesses under Amazon’s roof, all of them focused on the massive e-commerce opportunity (e-commerce is still only 6% of United States’ retail), and each doing their part to deepen the moat that is Amazon’s scale, logistics network, and multi-sided marketplace of customers, suppliers, and third-party merchants.
My confidence had been further bolstered by the approach Amazon had taken with Kindle: while their own devices had created the market, Amazon was quick to have a Kindle app immediately available on all platforms. Clearly they understood that e-commerce – and its digital equivalents – was a service business that needed to be in front of as many people as possible; to be overly focused on their own devices would be a mistake.
I could even see the point of the Kindle Fire tablet; at that point the cheapest iPad was $500, and Android-based tablets were even more expensive. Here came an alternative for half the price, and even in version one the seamless integration of media you owned, were subscribed to, or could purchase was brilliant. Amazon’s investments into digital media were understandable: their e-commerce business was originally built on books, CDs, and DVDs, but all of those were going away in favor of digital alternatives. Worryingly, Amazon was barred from selling said alternatives on iOS devices, so it made sense to offer an iOS alternative with their media stores fully integrated.
It’s on this point, though, that the Amazon narrative starts to break down, at least for me. See, while Amazon’s revenues keep going upwards, their costs do as well – as, indeed, they always have. Those costs, though, are increasingly not about e-commerce, but rather two areas in particular: devices and video.
Amazon’s financials are famously opaque, and the investments the company is making in streaming video rights, original programming, and their devices are spread around between Cost of Sales, Fulfillment, and Technology and Content. Complicating matters is that spending for Amazon Web Services falls in the latter bucket as well. Still, in 2013 BTIG estimated that Amazon would spend $500 million that year on video, and FierceOnlineVideo has put this year’s expenditures at nearly $1 billion. Last quarter’s 10-Q noted (emphasis mine):
The increase in cost of sales in absolute dollars in Q2 2014 and for the six months ended June 30, 2014, compared to the comparable prior year periods, is primarily due to increased product, digital media content, and shipping costs resulting from increased sales, as well as from expansion of digital offerings.
And, in the earnings call, Amazon’s CFO said spending on original content in particular would keep going up:
So video content, for example, we’re ramping up the spend from Q2 to Q3 significantly. And so it’ll be also a significant growth year-over-year. Keep in mind we have two types of content. We have licensed content. We also have original content. A lot of you have probably seen a lot of the announcements that we’ve green-lighted a number of pilots. We’re going to be in heavy production in those series that have been green-lit during Q3. We’ve also announced a number of pilots that will be in production on. And so that original content, it’s a portion of our total content, will be over $100 million in Q3.
It’s this focus on original and exclusive content – and devices that deliver it – that concerns me, and not because it’s expensive. Rather, what exactly does this have to do with e-commerce?
Best I can tell, Amazon’s story goes something like this:
Amazon gets or creates exclusive content at considerable cost
Customers are attracted to said exclusive content and thus sign up for Amazon Prime
Because customers are members of Amazon Prime, they start spending significantly more on e-commerce
Oh, and since mean ol’ Apple won’t allow Amazon’s digital content to be sold on iOS, Amazon will make devices to better sell said digital content. Which will ultimately accrue to e-commerce. And, profit!
I suppose this makes a certain kind of sense, but it reeks of what a former manager of mine calls a “double bank shot.” Amazon seems to be arguing that through this rather convoluted chain of events, all of which carry significant challenges and risks that are outside Amazon’s expertise (content creation, ecosystem development, etc.), they will be better placed to increase e-commerce’s share of retail.
Here’s my question: why not spend all that money – and time and executive attention – on simply growing e-commerce? Instead of pushing for the Prime Rube Goldberg machine, how about simply advertising Prime? And instead of pursuing a separate ecosystem, with all of the challenges and incentive risk that implies, why not focus on both building better apps and on creating partnerships with Apple in particular (who certainly has no intention of competing in e-commerce; Google is obviously much more of a competitor)?2
Moreover, I’m concerned about the internal incentives that Amazon is creating for itself. Amazon is increasingly competing with its suppliers, particularly in the digital space, and I just noted that potential partners like Apple are instead rivals. More concerning is the effect of devices on the company’s overall strategy. In the Fire phone introduction, Bezos was very clear that any device needed differentiation. His answer was Dynamic Perspective, but when that doesn’t work – spoiler: it doesn’t – the easy fallback is to differentiate on services. This will be particularly tempting given that Amazon is clearly looking to make a profit on each device sale. I can’t overstate what a terrible idea this is; I hate the Fire phone not because it seems to be a terrible product, but rather because I see its very existence, at least in the current incarnation, as actively harmful to Amazon’s core business, which needs to be great on all devices.
So what exactly is going on? Why is Amazon building vertical devices that don’t fit a horizontal company? Why are they pursuing convoluted double-bank-shot strategies that are extremely expensive and high risk? All of these are much more pressing questions than why Amazon is or isn’t making a paper profit.
The first possible explanation is that Amazon’s core e-commerce business is in fact very threatened by the shift to mobile, and they feel they have no choice but to build their own platform with its own lock-in.
The biggest problem with mobile is that, according to Michael Mace, while PC shoppers convert at about a 3% rate, mobile shoppers are a mere 1%. That’s a massive drop-off. Moreover, the rise of apps as a primary channel makes vertical and brand-specific retailers just as accessible and visible as Amazon (in contrast, few people go directly to specific web sites).
In addition, the sort of shopping experience that Amazon is particularly strong in – extensive research, reviews, etc. – simply doesn’t work as well on mobile. What does work well are things like flash sales or direct marketing pitches. These new marketing and conversion channels threaten to break into Amazon’s share of wallet: you may not necessarily have bought an item purchased in a flash sale from Amazon, but you do have that much less to spend for the rest of the month.
At the other extreme, it’s possible that Bezos simply wants to rule the world, at least when it comes to buying and selling anything that can be bought or sold. It’s certainly hard to doubt the guy!
Still, the Fire phone in particular gives me pause. Beyond the incentive issues I noted above, rumor has it that Bezos was very involved in the Fire phone’s development process, and that he fashions himself as a product guy. The way-too-long introductory keynote certainly hinted at a certain grandiosity about the phone and its development process.
The problem, though, is that the phone is simply not good. Bezos is clearly an operational and organizational genius, but there is nothing in Amazon’s history to suggest he is a product person.3
These are two rather unappealing possibilities from an investor perspective: a rational response to a mortal threat, or an irrational belief Amazon can seize a seemingly non-existent opportunity. And still the question remains: what’s wrong with simply focusing on the massive e-commerce opportunity? Again, I don’t mind that Amazon doesn’t make profits; I love the way they are constantly building new businesses from scratch. But why can’t those new businesses leverage Amazon’s strengths instead of accentuating its weaknesses?
Or, perhaps there remains truths I still do not fully understand. I was wrong about Amazon in 2010, but my error was one of depth; once I took the time to understand the company, I became a believer. This time though, feels different: I want to give the benefit of the doubt, but I don’t believe in double bank shots or blind faith.
(Check back in 2018 when I write about how I was wrong).
Update May 2015: I was wrong, and it only took me a year: see The AWS IPO
To be clear, this ship has long since sailed; I’m referring to what Amazon could have done instead ↩
An earlier version suggested that no one at the company was a product person; that is obviously not true and was unfair. What I meant to say is that Amazon’s specialty is not finished physical products; rather, they are a services company that improves iteratively. There is nothing wrong with this (it’s something that Apple, for example, is terrible at) ↩
