At What Cost?

I met with a company yesterday that is trying to launch a new consumer product. The product was pretty cool and the software made some sense but most of our conversation revolved around the simple question "does it make sense for a startup to launch a consumer device?"

The number one reason given by the company for pursuing the market themselves, rather than seeking design wins and simply being the underlying technology for a new class of consumer devices, was their ability to extract higher margins by selling the product themselves. But can they really? If you dig into the true costs of selling a product yourself, it turns out that your high margins are often illusory.

Look at the instance of a consumer device -- there's the cost of the retail channel, there's inventory cost, there's marketing, there's breakage, there's returns, there's support, there's obsolete inventory, and the list goes on. When push comes to shove, a whole host of costs eat away at the otherwise appealingly large margins of consumer direct sales. It's just another example of how powerful it is to already have a channel and why startups are often best served by leveraging other people's channels rather than building their own. And it is a good reminder that costs come in all shapes and sizes and it is incredibly important when you're building a business to know precisely what all of those costs are and what knobs can be turned to impact the bottom line.

Comments

[Ven Reddy]

Any startup that wants to launch a consumer device, no matter how innovate it is, needs to study the trials and tribulations of Sonicblue and TiVO. In addition to the "hidden" costs don't forget the lightening-quick copycats.

-Ven

[Matt Kursh]

The notion that companies get to choose where they sit in the value chain based on how much money they'd like to make is the key flaw here, IMO. Market dynamics, brand elasticity, risk profiles, corporate power, and - most importantly - customer preference often limit a company's choices as to what role in plays in a business segment.

Consider outsourced manufacturers like Flextronics, who manufactures Xbox for MSFT. Certainly, Microsoft would _prefer_ to have the margin that Flextronics takes on each unit (particular since MSFT's is negative ;-), and MSFT has the cash to buy any expertise needed to become a hardware manufacturer. But, for a number of reasons, it makes the most sense for Microsoft to outsource.