"Are we in the meth business...or the money business?" - Jesse Pinkman, Breaking Bad
Like basically every other American male, I recently watched the Breaking Bad series on Netflix. I won't waste much time summarizing the plot, but, suffice to say, a former chemistry teacher, Walter White, decides to start cooking and selling crystal meth, which gets him wrapped up in a whole world of crime. What makes his business so successful is the fact that he is something of a chemical prodigy and is able to manufacture crystal meth at a purity level that is unsurpassed by any other producers. His focus on purity borders on obsession, even causing him to destroy entire batches due to small anomalies. At the end of the day, however, isn't the purpose of the business to make money by selling meth? Isn't the crystal meth market in Albuquerque such that 95% purity, at lower cost, would be more economical than 99.1% purity? Also, does this behavior sound like any other prominent (non-fictional) business men or women?
In fact, there are numerous CEOs that seem to view profitability as a secondary concern to making great products. Marissa Mayer, CEO at Yahoo, is renown for her meticulous attention to detail when it comes to design, even drawing the ire of some of her former reports: "I had a recent debate over whether a border should be 3, 4 or 5 pixels
wide, and was asked to prove my case. I can’t operate in an environment
like that." (from Digital Trends) Jeff Bezos, CEO at Amazon, runs a business that has very high revenues and very thin margins. He is almost notorious for making very long-term decisions seeking to further gain revenue and customer trust at the expense of short-term profitability: "Percentage margins are not one of the things we are seeking to optimize." (from Business Week). Of course, any modern discussion of product would be incomplete without mentioning Steve Jobs. The PC market was highly competitive and with very low margins. Essentially, computers had become commodities sold 100% based on specs such as storage, processor, RAM, etc. Steve Jobs realized that the only way for Apple to succeed was to differentiate based on design. The design of both the hardware and software products became paramount at Apple, though this required significantly more capital investment than churning out bland-looking computers (remember that only 14 years elapsed between the first Macintosh, in 1984, and the original iMac, which was released in 1998).
So what is the purpose of business? Is it to make great products or is it to make money off of products? Clearly, in a business such as crystal meth distribution, there are very few people in the business for the innate love of providing customers with a valuable service. But in businesses like organic grocery stores, fitness centers, or musical instrument lessons, the pendulum may swing more towards offering great products to customers rather than profit maximization. In the long-term, these two goals are not in conflict and are actually complimentary, but this is certainly not the case in the short term. As Walter White finds out, his obsession with perfect quality in his meth generates a great deal of attention in his business. Fortunately, in legal businesses, this will not lead to the continual attempted murders that Walt must face from his competitors and business partners.
So, at the end of the day, are you in business to make perfect products or to make money? Determining the balance might be the most important decision a company makes.
Monday, December 9, 2013
Sunday, November 3, 2013
AmazonSmile and the State of Corporate Charitable Donations
Amazon recently announced the launch of AmazonSmile. The gist of it is that Amazon will now donate 0.5% of the purchase price of goods on Amazon to the charitable organization of your choice. Lots of companies donate a certain amount of revenue or profits to charity, but generally the company selects which charity. So why is Amazon doing this?
First off, Amazon is claiming that the prices of goods will not increase. Fantastic, but let's assume that the price of goods did increase by 0.5% and Amazon simply donated the extra portion to charity. In this case, there would be only one difference between Amazon making the donation and the customer personally donating the money outside of Amazon: in this case, Amazon would get the tax deduction and the customer would get nothing. Basically, Amazon would have tricked customers into handing them millions of dollars in tax benefits for the reward of less freedom in being able to determine the amount of money they wish to donate to charity. In fact, Amazon is crystal clear on their page about the tax consequences of these donations:
From the AmazonSmile Program Details:
First off, Amazon is claiming that the prices of goods will not increase. Fantastic, but let's assume that the price of goods did increase by 0.5% and Amazon simply donated the extra portion to charity. In this case, there would be only one difference between Amazon making the donation and the customer personally donating the money outside of Amazon: in this case, Amazon would get the tax deduction and the customer would get nothing. Basically, Amazon would have tricked customers into handing them millions of dollars in tax benefits for the reward of less freedom in being able to determine the amount of money they wish to donate to charity. In fact, Amazon is crystal clear on their page about the tax consequences of these donations:
From the AmazonSmile Program Details:
Can I receive a tax deduction for amounts donated from my purchases on AmazonSmile?
Donations are made by the AmazonSmile Foundation and are not tax deductible by you.
Donations are made by the AmazonSmile Foundation and are not tax deductible by you.
So it's good news that the price of goods will not increase. In that case, however, where does the money come from? I think that a lot of people assume the money comes straight from the bottom line; in other words, Amazon just donates some of their profit. There's a problem with this interpretation though: Amazon doesn't make profit! In the most recent quarter, Amazon lost 9 cents per share. Also, Amazon doesn't actually sell many of the products listed on its site. Through their affiliate model, other companies can complete transactions through Amazon. So what is Amazon thinking?
Here is my take. First, Amazon received a great deal of positive publicity for this, which is good for Amazon. These days, people seem to want to only do businesses with companies that care about people. Donating to charity is a great way to do that, especially if it makes the company less of a target to boycotts. Presumably, this increases Amazon sales in the long term. But what about the cost?
Notice that, for the charitable donation to be valid, the user must start their shopping at smile.amazon.com. How many people will actually do this? Probably very few. Even of those who do, not all of the products are eligible for the donation. Amazon states that only products that state “Eligible for AmazonSmile donation” will be valid. When the benefit of this program is supposed to be effortless charitable donation, Amazon sure seems to be requiring a lot of effort on the part of customers.
So in effect, Amazon is generating a lot of positive publicity at very little cost. This may increase overall charitable donations, and that is commendable. However, there is little question that this move will be beneficial to Amazon's business. But what do you think? Am I being cynical and is Amazon making a genuine, selfless attempt to making donations to society? Or is this a calculated move that Amazon's finance department has projected as improving long-term shareholder value?
Sunday, September 8, 2013
Big Data and the Future of Analytics
"Big Data" has all of the characteristics of your typical business buzz word: fairly new, widely used, and almost universally misunderstood. So what is big data and how is it useful? In order to investigate, I read the book that seems to be the definitive guide for business people, Big Data: A Revolution That Will Transform How We Live, Work, and Think by Viktor Mayer-Schonberger and Kenneth Cukier.
Unfortunately, even this book admits that there is no formal definition of big data. There are, however, some guidelines. The idea is that data collection has become so ubiquitous that the volume is great enough that traditional database management systems cannot handle it. From a technical standpoint, new technologies are needed just to extract basic information from this data.
The main focus of the book is the three shifts of mindset that must occur in this new world of data. First, is the ability is there for vast amounts of data to be analyzed about topics, rather than small subsets, prior to making decisions (seems intuitive enough, right?). The second is a willingness to settle for less precision in data collection with big data, as these small mistakes presumably will not matter as much as in the past. And the third is an understanding that correlations, rather than causality, might be the best conclusions we can draw.
Overall, the book is a fairly short read with plenty of examples. It does not purport to be evangelizing big data. The simple fact is that big data is available and smart companies are already using it, so being familiar with it is imperative for data-driven decision making. As a former database administrator, I found the sections describing "noSQL" very interesting. Essentially, this requires no preset structure in order to work (easy to see why they titled it "No structured query language"). There are also some serious privacy concerns that are raised. Keep in mind, this was written prior to information of NSA e-mail reading was made public. Though the focus of big data is drawing overarching conclusions about groups of people rather than individuals, the point is taken that almost everything we do is now being recorded and stored. The book even hinted at a future similar to Minority Report, where big data is used to predict crimes before they happen. Somewhat scary to think about; at least, I'm assuming that was the thrust of Minority Report. I saw it in theaters a decade ago and can barely remember.
I definitely recommend the book for anyone working in business analytics. In some ways, big data does make me very excited (even though it may render my SQL skills useless). I love doing things more efficiently and intelligently and big data provides that ability for marketers and business people. However, the risks are great and the privacy concerns associated with data collection and potential for use by governments is of great concern. Let's hope it's more of the former than the latter.
Unfortunately, even this book admits that there is no formal definition of big data. There are, however, some guidelines. The idea is that data collection has become so ubiquitous that the volume is great enough that traditional database management systems cannot handle it. From a technical standpoint, new technologies are needed just to extract basic information from this data.
The main focus of the book is the three shifts of mindset that must occur in this new world of data. First, is the ability is there for vast amounts of data to be analyzed about topics, rather than small subsets, prior to making decisions (seems intuitive enough, right?). The second is a willingness to settle for less precision in data collection with big data, as these small mistakes presumably will not matter as much as in the past. And the third is an understanding that correlations, rather than causality, might be the best conclusions we can draw.
Overall, the book is a fairly short read with plenty of examples. It does not purport to be evangelizing big data. The simple fact is that big data is available and smart companies are already using it, so being familiar with it is imperative for data-driven decision making. As a former database administrator, I found the sections describing "noSQL" very interesting. Essentially, this requires no preset structure in order to work (easy to see why they titled it "No structured query language"). There are also some serious privacy concerns that are raised. Keep in mind, this was written prior to information of NSA e-mail reading was made public. Though the focus of big data is drawing overarching conclusions about groups of people rather than individuals, the point is taken that almost everything we do is now being recorded and stored. The book even hinted at a future similar to Minority Report, where big data is used to predict crimes before they happen. Somewhat scary to think about; at least, I'm assuming that was the thrust of Minority Report. I saw it in theaters a decade ago and can barely remember.
I definitely recommend the book for anyone working in business analytics. In some ways, big data does make me very excited (even though it may render my SQL skills useless). I love doing things more efficiently and intelligently and big data provides that ability for marketers and business people. However, the risks are great and the privacy concerns associated with data collection and potential for use by governments is of great concern. Let's hope it's more of the former than the latter.
Friday, August 9, 2013
5 Rules for Undercover Viral Marketing
With the internet and social networks being what they are, companies have begun to pour more and more money and effort into making content go viral. The idea behind this is that, assuming the company can generate appropriate content, distribution of it is essentially free. Companies are absolutely salivating for customers to like, tweet, and favorite their content. But when this content is deliberately deceptive, where is the line?
For me, one of the best examples of this was from baseball's Double-A New Britain Rock Cats. If you haven't seen the video, the company paid two employees to stage a fake marriage proposal; one that goes horribly wrong when the woman rejects the man posing as her boyfriend.
Was this successful? Definitely. The video received over 600,000 views on YouTube and the only cost was the wages for probably an hour of two employees' time. So is this something that all companies should be doing?
Marketing in this way is similar to negative political ads; everybody claims to hate them, but they wouldn't be produced if they didn't get results. Nobody wants to be deceived by a Minor League team. However, how many of the 600,000 people that watched the video had even heard of the Rock Cats prior to the video? And, of those who hadn't, how many of those will remember the name after the video?
For companies considering going undercover and trying to get content to go viral under deceptive pretenses, here are some rules to ensure the desired result is achieved:
For me, one of the best examples of this was from baseball's Double-A New Britain Rock Cats. If you haven't seen the video, the company paid two employees to stage a fake marriage proposal; one that goes horribly wrong when the woman rejects the man posing as her boyfriend.
Was this successful? Definitely. The video received over 600,000 views on YouTube and the only cost was the wages for probably an hour of two employees' time. So is this something that all companies should be doing?
Marketing in this way is similar to negative political ads; everybody claims to hate them, but they wouldn't be produced if they didn't get results. Nobody wants to be deceived by a Minor League team. However, how many of the 600,000 people that watched the video had even heard of the Rock Cats prior to the video? And, of those who hadn't, how many of those will remember the name after the video?
For companies considering going undercover and trying to get content to go viral under deceptive pretenses, here are some rules to ensure the desired result is achieved:
- Ensure the concept of undercover viral marketing is consistent with your brand identity. Customers may be more willing to forgive being deceived by a brand known for a playful culture than one that is more straight-laced. In other words, customers might expect something like this from Virgin Atlantic or Boston Brewing Company, but probably not from Lexus or Charles Schwab.
- The content should be humorous, but not offensive. Giving people a light-hearted chuckle based on something that turned out to be staged is very different from emotional exploitation. So the content should be harmless and humorous.
- The content needs to be very believable. Your sales force is essentially the entire networks of Twitter, Facebook, etc. who are spreading links. When it is revealed that the content was fake, these people will feel foolish for having not been able to see this beforehand. Therefore, they need the plausible denial of content that seemed real in every possible respect. Otherwise, you will have left a sour taste in their mouth about your brand (and these are the last people you want to offend).
- Be timely with admitting the ruse. Of course, content that is obviously fabricated will not go viral as easily, so companies shouldn't admit their plans immediately. But the longer you wait, the more you risk insulting your customers. Fess up early and people will be more forgiving.
- Do it infrequently. If you cry wolf all the time, even legitimate content will go unnoticed. By making this a small, infrequent part of your marketing strategy, companies can generate an enormous amount of brand recognition for very low cost. But the risks are high if it is not done carefully.
Tuesday, July 9, 2013
Voluntourism and the Macrobiotic Yogurt Generation
While reading the Wall Street Journal today, I came across the following opinion piece:
Summer Jobs for the Guilty Generation
Now let me start with a few things. I feel very qualified to comment on this article. I have been a member of three Habitat for Humanity Global Village trips (including one to Guatemala, the subject of this article) and was the leader of one of these. And since I don't even know what "macrobiotic yogurt" is, clearly I am not a member of the generation he is denigrating! My initial gut reaction after seeing the headline was that the author has no idea what he's talking about, but I must admit that he does make some very valid points. Overall, however, attacking voluntourism as an inefficient economic activity is misguided, short-sighted, and, well...wrong.
First, let's state the obvious: there are a wide range of charities with varying levels of effectiveness. This is exactly what is great about private charity: free choice. In a free market, the more effective charities that spend money efficiently, have a clear message, and focus on the problems important to the individuals donating will thrive, while ineffective, poorly-run charities will eventually cease to exist. Some charities are certainly complete wastes of time and money (often, a good way to identify these is if they are named after a professional athlete); ideally, these charities will not be around long.
The real issue seems to be the efficacy of voluntourism as a whole. So what is voluntourism?
Voluntourism really is the perfect word to describe international service trips, because it is a combination of both volunteering and tourism. Volunteering is a selfless act of providing for others, while tourism is a "selfish" (though I don't believe there should be a negative connotation to this) act of providing yourself with an experience. In reality, these trips involve plenty of both. What people do not understand is that they are volunteering their money more than their time. Indeed, it seems to be tremendously inefficient for organizations to fly individuals from wealthier countries to third-world countries to do a job that could be done better and cheaper by a local worker. So why do they do it?
In a way, it is a value-based bundling of services. If an organization asked you to donate $500 to have a house built in Guatemala, you probably wouldn't be scrambling for your check book. But if the same organization said that it wanted $3,000 and that it would provide you with flights to a foreign land, room and board, local guides, security, and a unique experience of helping those less fortunate, many would sign on immediately. The fact that $500 of this money is going directly to a donation does not enter your mind, as it is the cost of admission for a bundle that you desire.
Furthermore, these trips are fantastic marketing opportunities for the organizations, particularly for those at a young age. The kid mentioned in the article probably does not have money to donate right now; however, there is a high probability he will in the future as he comes from a wealthy family. What is the first organization that he is going to think of when determining his donation strategy? You guessed it. By letting him be involved at a young age, the organization may have just guaranteed itself a million dollars or more in his will.
When the author implies that going on an international service trip is a less efficient use of money than providing venture capital for a start-up, he is probably correct; however, he is also misguided. He is viewing the total money spent as all charity, while actually only a portion of it is. The rest, used to cover the costs of the trip, stimulates the economy as much as any other economic activity. The fact is that most people are not making the choice strictly between voluntourism and an activity that more directly stimulates the economy. The author implies that his kid working at Jamba Juice is providing a service more useful for the economy. Wrong! The child going to Guatemala for the summer has a job: his employer is his parents. The money they are spending to send him to Guatemala for this program is not, as the author says, tax deductible (save the actual donation portion). This is money they would not have spent if he were working at Jamba Juice and likely came from savings. They are directly contributing to the economy by spending this money.
This also ignores the fact that the majority of these trips are not filled with participants choosing between the trip and a job. Each time I went on Habitat for Humanity trips, it was during my vacation and was used as an alternative to a more typical vacation; for instance, drinking margaritas in Cancun. I don't think Ayn Rand herself would say the drinking in Cancun is more beneficial than voluntourism to society as a whole (well, maybe she would).
A lot of the article sounds like sour grapes about a spoiled generation of children. Honestly, I'm inclined to agree that the current generation seems to have an amazing amount of luxury without having contributed much. Wouldn't this be true of most generations though? I'm sure my parents couldn't believe that I had a video game system (the original Nintendo, for those keeping score) in my home when I was 5 years old, when they were born before color television even existed.
The fact is that economic growth is the greatest way to contribute to society and voluntourism can be an amazing driver for this. Blaming voluntourism for the fact that it occasionally attracts privileged, self-righteous volunteers is ridiculous. I'd invite the author to learn a little more about voluntourism and some of its real-world benefits. If he promises to do that, I'll promise to read Eat People: And Other Unapologetic Rules for Game-Changing Entrepreneurs.
Summer Jobs for the Guilty Generation
Now let me start with a few things. I feel very qualified to comment on this article. I have been a member of three Habitat for Humanity Global Village trips (including one to Guatemala, the subject of this article) and was the leader of one of these. And since I don't even know what "macrobiotic yogurt" is, clearly I am not a member of the generation he is denigrating! My initial gut reaction after seeing the headline was that the author has no idea what he's talking about, but I must admit that he does make some very valid points. Overall, however, attacking voluntourism as an inefficient economic activity is misguided, short-sighted, and, well...wrong.
First, let's state the obvious: there are a wide range of charities with varying levels of effectiveness. This is exactly what is great about private charity: free choice. In a free market, the more effective charities that spend money efficiently, have a clear message, and focus on the problems important to the individuals donating will thrive, while ineffective, poorly-run charities will eventually cease to exist. Some charities are certainly complete wastes of time and money (often, a good way to identify these is if they are named after a professional athlete); ideally, these charities will not be around long.
The real issue seems to be the efficacy of voluntourism as a whole. So what is voluntourism?
Voluntourism really is the perfect word to describe international service trips, because it is a combination of both volunteering and tourism. Volunteering is a selfless act of providing for others, while tourism is a "selfish" (though I don't believe there should be a negative connotation to this) act of providing yourself with an experience. In reality, these trips involve plenty of both. What people do not understand is that they are volunteering their money more than their time. Indeed, it seems to be tremendously inefficient for organizations to fly individuals from wealthier countries to third-world countries to do a job that could be done better and cheaper by a local worker. So why do they do it?
In a way, it is a value-based bundling of services. If an organization asked you to donate $500 to have a house built in Guatemala, you probably wouldn't be scrambling for your check book. But if the same organization said that it wanted $3,000 and that it would provide you with flights to a foreign land, room and board, local guides, security, and a unique experience of helping those less fortunate, many would sign on immediately. The fact that $500 of this money is going directly to a donation does not enter your mind, as it is the cost of admission for a bundle that you desire.
Furthermore, these trips are fantastic marketing opportunities for the organizations, particularly for those at a young age. The kid mentioned in the article probably does not have money to donate right now; however, there is a high probability he will in the future as he comes from a wealthy family. What is the first organization that he is going to think of when determining his donation strategy? You guessed it. By letting him be involved at a young age, the organization may have just guaranteed itself a million dollars or more in his will.
When the author implies that going on an international service trip is a less efficient use of money than providing venture capital for a start-up, he is probably correct; however, he is also misguided. He is viewing the total money spent as all charity, while actually only a portion of it is. The rest, used to cover the costs of the trip, stimulates the economy as much as any other economic activity. The fact is that most people are not making the choice strictly between voluntourism and an activity that more directly stimulates the economy. The author implies that his kid working at Jamba Juice is providing a service more useful for the economy. Wrong! The child going to Guatemala for the summer has a job: his employer is his parents. The money they are spending to send him to Guatemala for this program is not, as the author says, tax deductible (save the actual donation portion). This is money they would not have spent if he were working at Jamba Juice and likely came from savings. They are directly contributing to the economy by spending this money.
This also ignores the fact that the majority of these trips are not filled with participants choosing between the trip and a job. Each time I went on Habitat for Humanity trips, it was during my vacation and was used as an alternative to a more typical vacation; for instance, drinking margaritas in Cancun. I don't think Ayn Rand herself would say the drinking in Cancun is more beneficial than voluntourism to society as a whole (well, maybe she would).
A lot of the article sounds like sour grapes about a spoiled generation of children. Honestly, I'm inclined to agree that the current generation seems to have an amazing amount of luxury without having contributed much. Wouldn't this be true of most generations though? I'm sure my parents couldn't believe that I had a video game system (the original Nintendo, for those keeping score) in my home when I was 5 years old, when they were born before color television even existed.
The fact is that economic growth is the greatest way to contribute to society and voluntourism can be an amazing driver for this. Blaming voluntourism for the fact that it occasionally attracts privileged, self-righteous volunteers is ridiculous. I'd invite the author to learn a little more about voluntourism and some of its real-world benefits. If he promises to do that, I'll promise to read Eat People: And Other Unapologetic Rules for Game-Changing Entrepreneurs.
Sunday, June 23, 2013
The Economics of CrossFit
For anyone interested in fitness, the rise of CrossFit has not gone unnoticed. Founded in 2000, the company and philosophy of exercise has only really gained international traction in the past several years. What is CrossFit and why has this business model shaken up the fitness industry?
First, let's discuss the economics of the typical gym or fitness center. These establishments tend to have a large area for weight-lifting, numerous treadmills and stationary bicycles, and often a studio area for small classes. Members join the gym, often with a hefty sign-up fee, and pay a consistent fee every month.
Initially, this sounds like a fantastic idea for a business: provide customers with access to a room with equipment and then count the money as it comes in. In reality, it is not so simple.
These gyms have fairly low barriers-to-entry. To lease or buy weight lifting equipment, though expensive, requires no special expertise and the facilities can go in most buildings. The fact that there are numerous alternative establishments, combined with the fact that many people can simply buy their own gym equipment, has driven down prices. Many of these gyms charge fees as low as $30 per month. While it's true that variable costs are relatively low, the up front purchase of equipment must be covered. These facilities also have costs of SG&A, skilled staff, liability insurance, franchise fees (if the gym is part of a franchise), and lease on the property. Since fitness-enthusiasts demand a large variety of equipment with low waits even at peak hours, the costs for the equipment increases and the facility must be large enough to accommodate sizable groups. With the high fixed costs, these gyms must make up the cost with volume, locating in a centrally-located area where membership will be high.
It is fairly obvious that there is not much these gyms can do to improve margins, other than lower costs or cross-sell into other services. With a fixed gym size, there are only so many customers they can accommodate, but cross-selling may not require much extra space. Hence the increasing trend of smoothie bars selling protein smoothies at high markups and trainers always anxious to sell you on personal training sessions, at a very hefty price per hour.
CrossFit, on the other hand, initially sounds like a horrible proposition. CrossFit membership fees are often extremely high; seeing fees over $100 or even $200 is very common. Equipment in a CrossFit gym is minimal and classes are the only option, decreasing the flexibility for the member. On the surface, it is quite shocking that CrossFit gyms are able to break even.
The difference is that CrossFit gyms do not need such a vast membership to survive. In fact, they have turned both the revenue and cost models around. Instead of a high volume of customers at small average revenue per user (ARPU), CrossFit focuses on a smaller number of customers at high ARPU. Fixed costs are fairly low and variable costs are slightly higher, due to the need for additional trainers for an increasing member base.
CrossFit gyms have some equipment, but a small fraction of what is available at a big-box gym. Some of the most expensive gym equipment such as treadmills, elliptical machines, and stationary bicycles are not used in any CrossFit gyms. CrossFit gyms tend to be located in inexpensive, unused warehouse space; in fact, the members often take pride in the austerity of the design. Since the gyms do not require such vast memberships, these facilities can be located almost anywhere and do not need to be in densely populated areas. The only increased cost is that of certified trainers, which are required to be present for every class that is offered.
So the one final key to the equation. It is clear that CrossFit gyms have reduced costs significantly, but how have they been able to charge members the exorbitant fees that they charge? Why are people willing to pay that much for what, on its surface, amounts to much less?
For many people, normal gyms have become a commodity: a treadmill at one gym is the same as a treadmill at the next, so consumers tend to choose purely based on hours, price, and location. The philosophy of CrossFit, Inc. is to provide brand-building and trainer certification, but allow individual gyms the freedom to customize almost everything else. In this way, each gym is unique and has its own culture. The idea behind this brand licensing model, as opposed to the franchise model, is that individual gyms will be pushed to innovate and the best ideas will rise to the top quickly. These gyms also provide a much more interactive experience, enabling community-building that is absent from a normal gym. In a way, CrossFit has attracted a middle segment of the market: those who did not receive enough value from a simple gym membership, but also did not have a high enough willingness to pay for consistent, expensive personal training. These consumers get a personalized experience and are willing to pay a significant premium over normal gym membership. In this way, CrossFit offers real, sustainable value to the fitness community.
Will CrossFit survive the test of time? Or will it soon be forgotten, like so many other fitness trends? Only time will tell, but the business model and approach to fitness are certainly providing rapid growth that has the owners of traditional gyms on notice.
Full disclosure, I am currently a member of a CrossFit gym. I had been a member of a more traditional gym for the seven years prior to joining CrossFit.
First, let's discuss the economics of the typical gym or fitness center. These establishments tend to have a large area for weight-lifting, numerous treadmills and stationary bicycles, and often a studio area for small classes. Members join the gym, often with a hefty sign-up fee, and pay a consistent fee every month.
Initially, this sounds like a fantastic idea for a business: provide customers with access to a room with equipment and then count the money as it comes in. In reality, it is not so simple.
These gyms have fairly low barriers-to-entry. To lease or buy weight lifting equipment, though expensive, requires no special expertise and the facilities can go in most buildings. The fact that there are numerous alternative establishments, combined with the fact that many people can simply buy their own gym equipment, has driven down prices. Many of these gyms charge fees as low as $30 per month. While it's true that variable costs are relatively low, the up front purchase of equipment must be covered. These facilities also have costs of SG&A, skilled staff, liability insurance, franchise fees (if the gym is part of a franchise), and lease on the property. Since fitness-enthusiasts demand a large variety of equipment with low waits even at peak hours, the costs for the equipment increases and the facility must be large enough to accommodate sizable groups. With the high fixed costs, these gyms must make up the cost with volume, locating in a centrally-located area where membership will be high.
It is fairly obvious that there is not much these gyms can do to improve margins, other than lower costs or cross-sell into other services. With a fixed gym size, there are only so many customers they can accommodate, but cross-selling may not require much extra space. Hence the increasing trend of smoothie bars selling protein smoothies at high markups and trainers always anxious to sell you on personal training sessions, at a very hefty price per hour.
CrossFit, on the other hand, initially sounds like a horrible proposition. CrossFit membership fees are often extremely high; seeing fees over $100 or even $200 is very common. Equipment in a CrossFit gym is minimal and classes are the only option, decreasing the flexibility for the member. On the surface, it is quite shocking that CrossFit gyms are able to break even.
The difference is that CrossFit gyms do not need such a vast membership to survive. In fact, they have turned both the revenue and cost models around. Instead of a high volume of customers at small average revenue per user (ARPU), CrossFit focuses on a smaller number of customers at high ARPU. Fixed costs are fairly low and variable costs are slightly higher, due to the need for additional trainers for an increasing member base.
CrossFit gyms have some equipment, but a small fraction of what is available at a big-box gym. Some of the most expensive gym equipment such as treadmills, elliptical machines, and stationary bicycles are not used in any CrossFit gyms. CrossFit gyms tend to be located in inexpensive, unused warehouse space; in fact, the members often take pride in the austerity of the design. Since the gyms do not require such vast memberships, these facilities can be located almost anywhere and do not need to be in densely populated areas. The only increased cost is that of certified trainers, which are required to be present for every class that is offered.
So the one final key to the equation. It is clear that CrossFit gyms have reduced costs significantly, but how have they been able to charge members the exorbitant fees that they charge? Why are people willing to pay that much for what, on its surface, amounts to much less?
For many people, normal gyms have become a commodity: a treadmill at one gym is the same as a treadmill at the next, so consumers tend to choose purely based on hours, price, and location. The philosophy of CrossFit, Inc. is to provide brand-building and trainer certification, but allow individual gyms the freedom to customize almost everything else. In this way, each gym is unique and has its own culture. The idea behind this brand licensing model, as opposed to the franchise model, is that individual gyms will be pushed to innovate and the best ideas will rise to the top quickly. These gyms also provide a much more interactive experience, enabling community-building that is absent from a normal gym. In a way, CrossFit has attracted a middle segment of the market: those who did not receive enough value from a simple gym membership, but also did not have a high enough willingness to pay for consistent, expensive personal training. These consumers get a personalized experience and are willing to pay a significant premium over normal gym membership. In this way, CrossFit offers real, sustainable value to the fitness community.
Will CrossFit survive the test of time? Or will it soon be forgotten, like so many other fitness trends? Only time will tell, but the business model and approach to fitness are certainly providing rapid growth that has the owners of traditional gyms on notice.
Full disclosure, I am currently a member of a CrossFit gym. I had been a member of a more traditional gym for the seven years prior to joining CrossFit.
Sunday, June 9, 2013
Business Lessons from my Honeymoon
When you marry an MBA, conversations can take some weird turns. As my wife and I met in the MBA program at UNC Kenan-Flagler, it is not uncommon for a light conversation to turn into a Wall Street Journal op-ed. During our recent honeymoon in Costa Rica, at one point we were discussing whether the all-inclusive resort was watering down my drinks, and the next moment we were discussing whether you can truly grow an economy primarily based on tourism (we later found out that the largest industry in Costa Rica is actually microchip manufacturing, but I digress).
This honeymoon was actually my first experience at an all-inclusive resort. It was also my first experience as a high-value customer (HVC) as we spent more money on our room than we would have if it were not our honeymoon. This experience highlighted several relevant business concepts that I thought were interesting.
The Pareto Principle. This states that, in many situations, 80% of the outcomes come from 20% of the causes. This has numerous applications, but the one where I’ve heard it used most is that, in many businesses, 80% of the profits come from 20% of the customers. How is this applicable? On this vacation, we were members of that 20%. We reserved the best room in the hotel, got massages, bought expensive excursions, and left with numerous souvenirs. While spending like that was probably a one-time event for us, the hotel definitely wanted us to recommend it to other couples for their honeymoons. As such, we were treated very well when we were there: there was a basket of fruit in our room upon arrival (along with a note congratulating us on our wedding) and we were often able to get priority seats at restaurants during the week. Clearly, this hotel knew that targeting honeymooners can provide a significant boost to margin.
Value-based pricing. Nearly everyone realizes that most pricing is value-based rather than cost-plus. This means that sellers price based on an estimation of how valuable the product is to you, rather than simply adding a percentage to the cost of producing the product. All-inclusive resorts have this down to an art. The most obvious example was sunscreen. At the hotel store, there were cigars, souvenirs, snacks, and numerous other items, all at fairly reasonable prices. The one product that was priced at probably 6x what it would cost in the U.S. was sunscreen. The reason is fairly obvious: if a cigar is very expensive, I may just decide to not smoke one. But the cost to me is very high (sunburn or possibly skin cancer) if I forget sunscreen and decide not to buy it. Therefore, in this scenario I would value sunscreen very highly. All-inclusive resorts are masters of this, since most people do not rent cars as they plan to stay at the resort the entire time and therefore cannot go to another store where sunscreen is less expensive.
Spoilage. In hotels as in airlines, there is very little additional cost to an additional customer, assuming an empty room or seat is available. Therefore, hotels and airlines are incentivized to price in a manner that fills all of the capacity, while segmenting in a way that still extracts the maximum value from the customers with a high willingness to pay. We went to Costa Rica during rainy season, when these hotels tend to be less full. Our hotel partially solved this problem by offering local deals to Costa Ricans for the weekends. By offering these discounts only locally, they do not cannibalize the Americans who want to go on vacation. But a Costa Rican who may not be thinking about a vacation could be motivated to take one for the weekend and fill an empty room, preventing that room from “spoiling.” This does not work perfectly with all-inclusive resorts, as there are more substantial variable costs (due to drinks and meals), but the concept is still valid.
Outsourcing. At our resort, there was a table in the lobby with people selling guided tours throughout Costa Rica and Nicaragua. When we told them to bill our room for a trip to Granada, they said that they are not associated with the hotel. At first, this made no sense to me. But the company running the resort does not necessarily know anything about running excursions. By selecting the best company it can find, allow this company to solicit for excursions in its lobby, and then charging a hefty fee (potentially even a percentage of tour fees paid), the company can guarantee a significant revenue stream without straying from their core competency of running a resort. In fact, many companies should question why they would do something in-house when it can be outsourced to experts.
Check back in some time and I’m sure I’ll have business lessons that I learned from being married.
This honeymoon was actually my first experience at an all-inclusive resort. It was also my first experience as a high-value customer (HVC) as we spent more money on our room than we would have if it were not our honeymoon. This experience highlighted several relevant business concepts that I thought were interesting.
The Pareto Principle. This states that, in many situations, 80% of the outcomes come from 20% of the causes. This has numerous applications, but the one where I’ve heard it used most is that, in many businesses, 80% of the profits come from 20% of the customers. How is this applicable? On this vacation, we were members of that 20%. We reserved the best room in the hotel, got massages, bought expensive excursions, and left with numerous souvenirs. While spending like that was probably a one-time event for us, the hotel definitely wanted us to recommend it to other couples for their honeymoons. As such, we were treated very well when we were there: there was a basket of fruit in our room upon arrival (along with a note congratulating us on our wedding) and we were often able to get priority seats at restaurants during the week. Clearly, this hotel knew that targeting honeymooners can provide a significant boost to margin.
Value-based pricing. Nearly everyone realizes that most pricing is value-based rather than cost-plus. This means that sellers price based on an estimation of how valuable the product is to you, rather than simply adding a percentage to the cost of producing the product. All-inclusive resorts have this down to an art. The most obvious example was sunscreen. At the hotel store, there were cigars, souvenirs, snacks, and numerous other items, all at fairly reasonable prices. The one product that was priced at probably 6x what it would cost in the U.S. was sunscreen. The reason is fairly obvious: if a cigar is very expensive, I may just decide to not smoke one. But the cost to me is very high (sunburn or possibly skin cancer) if I forget sunscreen and decide not to buy it. Therefore, in this scenario I would value sunscreen very highly. All-inclusive resorts are masters of this, since most people do not rent cars as they plan to stay at the resort the entire time and therefore cannot go to another store where sunscreen is less expensive.
Spoilage. In hotels as in airlines, there is very little additional cost to an additional customer, assuming an empty room or seat is available. Therefore, hotels and airlines are incentivized to price in a manner that fills all of the capacity, while segmenting in a way that still extracts the maximum value from the customers with a high willingness to pay. We went to Costa Rica during rainy season, when these hotels tend to be less full. Our hotel partially solved this problem by offering local deals to Costa Ricans for the weekends. By offering these discounts only locally, they do not cannibalize the Americans who want to go on vacation. But a Costa Rican who may not be thinking about a vacation could be motivated to take one for the weekend and fill an empty room, preventing that room from “spoiling.” This does not work perfectly with all-inclusive resorts, as there are more substantial variable costs (due to drinks and meals), but the concept is still valid.
Outsourcing. At our resort, there was a table in the lobby with people selling guided tours throughout Costa Rica and Nicaragua. When we told them to bill our room for a trip to Granada, they said that they are not associated with the hotel. At first, this made no sense to me. But the company running the resort does not necessarily know anything about running excursions. By selecting the best company it can find, allow this company to solicit for excursions in its lobby, and then charging a hefty fee (potentially even a percentage of tour fees paid), the company can guarantee a significant revenue stream without straying from their core competency of running a resort. In fact, many companies should question why they would do something in-house when it can be outsourced to experts.
Check back in some time and I’m sure I’ll have business lessons that I learned from being married.
Tuesday, May 21, 2013
Corporate Tax Planning and Public Perception
Information has recently come out that Apple, despite at least $74 billion in profit over the past four years, has not paid any corporate tax. Tim Cook is being grilled by the Senate on this topic and it seems to be reopening the issue of the morality of corporate tax planning.
First, what is corporate tax? In the U.S. there is no value-added tax as there is in many other countries. There is, however, a corporate tax that is consistently one of the highest in the entire world. Corporate tax is simply a tax that corporations pay on profits made in the United States (the situation is more complicated when profits are made in other countries). When these earnings are returned to shareholders as dividends, they are taxed again at the dividend rate. This double-taxation is confusing and is why prominent wealthy citizens that generate the majority of their income through the stock market are often seen as paying extremely low tax rates, since the corporate taxation and dividend taxation occur separately.
So what is the "fair" amount of corporate tax for a corporation to pay? If a corporation wants to maximize profits returned to its shareholders or reinvested into the company, shouldn't all companies strive to pay as little corporate tax as legally allowable? This question is extremely tricky and raises a number of issues:
As with most complicated questions, there are a valid arguments on both sides. In general, I personally believe companies are right to try and minimize their tax bill within reason, particularly publicly-traded companies that have to release this information in earnings reports. I believe that a simplified tax code that lowers rates and eliminates loopholes generates a more level playing field between small and large companies. Of course, what is "within reason" for one person may not be for the next, and virtually everyone (except accountants and tax attorneys) is, at least ostensibly, in favor of a more simplified tax code. One thing is for sure: if Apple is trying to make the argument that it reduces its tax liability in order to have more money available for growth, it is certainly not helping its case by sitting on $145 billion.
First, what is corporate tax? In the U.S. there is no value-added tax as there is in many other countries. There is, however, a corporate tax that is consistently one of the highest in the entire world. Corporate tax is simply a tax that corporations pay on profits made in the United States (the situation is more complicated when profits are made in other countries). When these earnings are returned to shareholders as dividends, they are taxed again at the dividend rate. This double-taxation is confusing and is why prominent wealthy citizens that generate the majority of their income through the stock market are often seen as paying extremely low tax rates, since the corporate taxation and dividend taxation occur separately.
So what is the "fair" amount of corporate tax for a corporation to pay? If a corporation wants to maximize profits returned to its shareholders or reinvested into the company, shouldn't all companies strive to pay as little corporate tax as legally allowable? This question is extremely tricky and raises a number of issues:
- The morality of paying taxes to the government. There is a definite split, at least in the U.S., on whether government tax revenue is beneficial to society as a whole. Let's take the extreme views of each side. One side believes that companies that use accounting trickery to avoid paying taxes are devious opportunists that are extracting all value from society without giving anything back, to the detriment of the working men and women. The other side believes that, when these corporations obey the law, they are simply generating the maximum after-tax profits that they can and then using these profits in a more efficient way to produce growth than a wasteful government could anyway.
- The use of net operating losses (NOLs). When a company incurs a net loss in a given year, it is often able to use these losses to offset profits in subsequent years. In this way, a company could make an exorbitant profit one year and pay no tax. Not only is this prudent for companies to do, it is the intentional result of NOL carryover policy.
- The public image of taxation. It is no secret that paying very low taxes on very high profits can result in negative media coverage, even when these effective tax rates are the result of NOLs. In fact, Starbucks recently paid a voluntary tax in the UK, presumably entirely to improve a brand that had been hurt in media coverage of their low tax bill. In this way, paying taxes could be seen as an expense for the marketing department. Reconciling this with shareholders exerting pressure for higher profits is a fine line that companies engaging in this practice must walk.
As with most complicated questions, there are a valid arguments on both sides. In general, I personally believe companies are right to try and minimize their tax bill within reason, particularly publicly-traded companies that have to release this information in earnings reports. I believe that a simplified tax code that lowers rates and eliminates loopholes generates a more level playing field between small and large companies. Of course, what is "within reason" for one person may not be for the next, and virtually everyone (except accountants and tax attorneys) is, at least ostensibly, in favor of a more simplified tax code. One thing is for sure: if Apple is trying to make the argument that it reduces its tax liability in order to have more money available for growth, it is certainly not helping its case by sitting on $145 billion.
Sunday, May 19, 2013
The Anachronism of the Compassionless Executive
There has been a lot of discussion lately about the CEO of Abercrombie & Fitch, Mike Jeffries. For those unfamiliar, he is under fire recently for the company's refusal to stock larger sizes of clothing, the idea being that he does not want the brand diluted by overweight people in the clothes. This led to some old quotes of his going viral, including this gem: "Candidly, we go after the cool kids. We go after the attractive all-American kid with a great attitude and a lot of friends. A lot of people don’t belong [in our clothes], and they can’t belong. Are we exclusionary? Absolutely."
Now, what's wrong with this? Abercrombie & Fitch is well-known as designing clothing that is expensive and seen as a status symbol among kids; not just of wealth, but of popularity. It is undoubtedly marketed this way intentionally, and almost everyone already knew that. What Jeffries is doing here is stating the truth about his strategy, however indelicate his phrasing and self-serving his motives for pursuing it.
But this raises a larger issue. Mike Jeffries is not the only executive today that seems to have very little compassion for customers or people in general. This is certainly not a new phenomenon; in fact, executives being primarily profit-driven capitalists with little concern for the common man was such a prevalent phenomenon in the 80s that it was almost seen as heroic. This mentality was caricatured as Gordon Gekko in Wall Street (1987). The ultimate opportunist, Gordon was all business; a profit-seeking machine that viewed life as a zero-sum game and was perfectly comfortable with that.
What other executives have run companies that appear to show a flagrant disregard for compassion?
Now, what's wrong with this? Abercrombie & Fitch is well-known as designing clothing that is expensive and seen as a status symbol among kids; not just of wealth, but of popularity. It is undoubtedly marketed this way intentionally, and almost everyone already knew that. What Jeffries is doing here is stating the truth about his strategy, however indelicate his phrasing and self-serving his motives for pursuing it.
But this raises a larger issue. Mike Jeffries is not the only executive today that seems to have very little compassion for customers or people in general. This is certainly not a new phenomenon; in fact, executives being primarily profit-driven capitalists with little concern for the common man was such a prevalent phenomenon in the 80s that it was almost seen as heroic. This mentality was caricatured as Gordon Gekko in Wall Street (1987). The ultimate opportunist, Gordon was all business; a profit-seeking machine that viewed life as a zero-sum game and was perfectly comfortable with that.
What other executives have run companies that appear to show a flagrant disregard for compassion?
- In 2010, BP was responsible for the Deepwater Horizon oil spill, which claimed 11 lives and resulted in oil flowing into the ocean for 87 days. During proceedings on the matter, Tony Hayward (BP CEO) described the environmental impact as "very, very modest" and said "There's no one who wants this over more than I do. I would like my life back."
- About a year ago, Spirit Airlines refused a refund on a flight for a military veteran who was terminally ill. After the CEO went on record supporting the decision, the airline received enough bad publicity to fill a 747. Hastily, the CEO reversed the decision and donated to the man's favorite charity, Wounded Warriors.
- During violent protests against the government in Egypt, Kenneth Cole tweeted: "Millions are in uproar in #Cairo. Rumor is they heard our new spring collection is now available online at http://bit.ly/KCairo -KC" A hasty apology was issued, also on Twitter.
So what changed? Why do we expect our executives to be more compassionate today than we did in the past? I think there are several reasons:
- The Financial Crisis of 2008. While it is debatable what the causes of the Financial Crisis were, I think the average citizen believes that unbridled greed was one of the primary drivers. This was a major departure from previously accepted wisdom that greed is good: in the new world, a company's greed can not only hurt their customers but extend to society as a whole. When a lack of compassion is perceived as being capable of bringing the country to the brink of financial chaos, we need to be more careful about the motives of our executives. We no longer have the luxury of finding out motivations after the fact.
- The rise of social media. There has been much written on the increased scrutiny on individuals due to social media, and executives are not immune. With this increased scrutiny, there are bound to be mistakes; moments of indiscretion being broadcast for the whole world or simple deafness to tone causing public relations nightmares. These incidents have eroded our confidence in both elected officials and individuals in corporate America. With the potential for any mistake to go viral within minutes, the public (and investors) expect executives to build a reputation of genuine concern for employees, customers, and other stakeholders.
- Demographic and cultural shifts. In general, the Millennial generation is much less tolerant of any behavior that stigmatizes certain groups or is not compassionate to those in need. Offending various groups, whether it is a specific race or even the plus-size high school student, is not accepted. Beyond being compassionate, we now almost expect corporations to have in-house charitable arms, giving back to the communities in which they reside.
The fact is that showing a lack of compassion is simply not good business. With the heightened scrutiny, this lack of compassion, if evident in the individual, will manifest in a public forum eventually. Businesses certainly need to spend time focused on ensuring there are appropriate checks and preparing for damage control of mistakes, but this is only half of the equation. Boards of Directors need to take a much deeper look at character when forming succession plans. Long term profitability will be better achieved through executives with a genuine customer focus and a greater sense of purpose. Those that view customers as a necessary evil to the business of making money will ultimately fail.
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