Recently I was watching the scene in the final episode of The Queen's Gambit where a collection of Beth Harmon's buddies, boyfriends, and boosters gather around the phone in New York City to talk to her in Russia about strategies for the big chess game the next morning. The conversation continues for some time and then Benny Watts, who's hosting the gathering, says to the other guys that they have to wrap things up because the international call was "costing him a bundle."
It's a great scene, but it left me wondering--when, exactly, did the concept of costly long-distance calls, along with so many other things we all grew up with and took for granted, disappear from our lives? It was just a given-- our parents beat it into our heads--that the further away the person you called lived from you and the longer you spent on a call, the more it was going to cost. Just like driving a car: more miles, more gas, more time. Simple math. Distance and duration meant you paid more money.
And then one day, they didn't. Was it some magic of physics or advances in technology that overnight shrunk the world and enabled us to use our cellphones to call anywhere - near or far, at no incremental cost? Was it due to deregulation or increased competition? Nope. It was mainly math. Or to be more precise, accounting.
The change occurred when phone companies realized they were spending so much money each month to track and bill individual customers for their long-distance calls that it was more cost-effective to convert the entire pricing structure to a flat monthly fee, especially because that change actually meant that every customer was paying a little more, whether they took advantage of the opportunity to make distant calls or not. Not only did the new structure cut the telcos' operating expenses, but it also permitted them to grow their aggregate revenues. And the customers, by and large, thought they were getting a bargain. The dirtiest little secret, of course, was that distance never did matter in the phone business because you were merely connecting circuits, whether the calls were next door or halfway across the country.
There's an important lesson here for new businesses as well. While it's generally thought of as a bad joke these days to say that your pricing strategy is to make up any early operating losses by growing your volume, there are times when simple pricing strategies like "one fee fits all" or "all you can eat" do make a lot of sense and don't hurt the bottom line. It all depends ... as most things do. The trick is to understand your customers and to understand the underlying economics of your business.
In terms of customers, many years ago when I was first selling various services to car dealers, they would almost universally balk at paying fees on a per-vehicle basis. We had our own theories about why they were so hesitant, but it was clear that they didn't want to be surprised with a bill at the end of each month that might be higher than they had expected, or budgeted for, based on the number of cars sold or serviced. They were very good at doing the quick math and they would explain to us that if they sold 300 cars a month, their aggregate monthly fee would be some huge number, which they certainly couldn't afford.
But we also knew that the vast majority of our dealers and prospects would be lucky to sell more than 150 cars in their best months. They wouldn't necessarily admit that to us, but it was undoubtedly true. So, we basically used their own math (and hubris) against them, did a little reverse jiujitsu pricing, and proposed a flat monthly fee, which divided by 300 meant that their per-vehicle service charge would be a fraction (less than half) of what we had initially proposed. And they ate it up and thought it was a steal. And not one of them ever sold more than 200 cars a month for the next 5 years. We made out like bandits.
In the case of Cameo, its CEO, Steven Galanis, had a similar problem. He was trying to attract athletes and celebrities who made millions in their day jobs (or used to) to work with his startup and create short, personalized videos for his customers. They could set whatever price for their videos they wished, but, of course, if the prices were crazy, no one would use the service. So, he took a different approach. He analyzed those multi-million-dollar salaries and figured out how much each of the players made per minute during the season, since it only took a few minutes for any of them to make a Cameo video. And it turned out, they could make more money per minute doing the videos for his company than they were being paid by the NFL or the NBA. Once again, some clever math to the rescue. And, of course, the pitch worked, and the business exploded. By the middle of last year, in the midst of the pandemic, more than 40,000 celebrities had joined Cameo's platform and more than 1.2 million videos have been purchased by consumers.
On the other hand, when Groupon first launched its two-fer coupon program for restaurants, it was one of the worst things a restaurant could sign up for. Basically, the restaurant was agreeing to sell two meals for the price of one. The theory was that the customers would come back and maybe bring their friends. The reality was that the deals attracted not foodies, but cheapies who never came back. Long story short: It was the restaurants whose lunch got eaten, but not in the way they anticipated. They had all of the costs and virtually no comebacks. It made no economic sense because it didn't match their business model.
But there's an equally important lesson here if you're in the right kind of business. It's all about the incremental/marginal cost of serving additional customers. If you're filling seats in a class that has space, if you're streaming an online performance on the web, if your product is digital and replicable at almost no cost, or if you've got people and resources just sitting around or excess capacity, then these are the kind of economics that make sense.
And those are the criteria you need to use to evaluate any "two-fer" or "all you can eat" deal.
- The deal needs to drive new users and incremental revenue. It can't replace or cannibalize existing full-margin revenues.
- Your business can't be subject to capacity or size constraints.
- The deal can't require you to spend or invest a great deal of money upfront.
- The deal can't give you cash flow or other float problems.
If these few tests are met, it makes a lot of sense to take a look at the opportunity. If not, it makes more sense to walk away.