May 30, 2011

Winning through simplification

Filed under: pricing, strategy — Rakesh Agrawal @ 7:16 pm

Temporary housing site Airbnb is raising a $100 million round at a valuation exceeding $1 billion, according to TechCrunch. Airbnb is a great example of creating new markets through simplification.

People have been selling rooms and temporary space through sites like cragislist. But it has been a fragmented market with difficulty in information discovery, reputation risk and transaction risk. Airbnb addresses these issues.

Here are some other examples of companies and products that are succeeding through simplification:

StubHub. StubHub is the most similar in dynamics to Airbnb. It simplified two big elements of the ticket purchase experience. One is information discovery. Unlike craigslist, where you have to decipher hundreds of listings (many with incomplete information) and then pull up stadium maps, StubHub lets you pick your game and see available seats right on a map of the stadium.

You can also complete the transaction through the site. This eliminates two problems: flaking and bad tickets. Because you have a completed transaction, you don’t have to worry about whether the buyer or seller will participate. I once arranged for a last minute craigslist transaction for a Coldplay concert at Shoreline Amphitheatre. We had agreed on a price, but up until the moment we met, we didn’t know if the transaction would complete. He could easily have sold them to someone at a higher price or I could have purchased from someone else at a lower price before we met.

StubHub also guarantees that the tickets are good. That’s a risk that people tend to overestimate; in more than a decade of regularly buying tickets from scalpers, I haven’t once purchased a bad ticket. But the guarantee is something that people are willing to pay for. I once did a test of craigslist, eBay and StubHub for the same set of tickets. If the buyer had found me on craigslist, he would have paid a lot less.

AT&T Digital OneRate. A long time ago in a telecom galaxy far, far away, you had to worry about roaming charges. If you were traveling, you didn’t use your phone out of fear of getting a bill for hundreds or thousands of dollars. Networks were spotty enough that you often didn’t know when you were roaming. Phones came with roam guards that essentially disabled your phone if you were out of your home area. As a result, people didn’t use their phones very often. Then AT&T came out with Digital OneRate. You didn’t have to worry about who you called and where you called from. Every call was the same price regardless of whether you were in your home area, regardless of whether you were calling local or long distance.

Even today, there is a lot of complexity in underlying telecom pricing. Calls to Iowa cost your carrier a lot more than calls to New York City. But the carriers have abstracted that complexity away. As a result, people don’t worry about whether to make a call — they just make it. The simplicity has two other benefits: Wall Street likes predictable revenue streams. And Sprint has reported lower customer supports costs because people aren’t calling in about bill shock.

Square readerSquare. Credit card pricing has historically been incredibly complex. Rates vary based on the type of business you run, the average value of each transaction, your overall transaction volume, the brand of credit card (VISA/MasterCard/AMEX), whether the card is a rewards card and other factors. There are upfront fees, monthly minimums, statement fees, etc. It’s all enough to make someone’s head spin. Small merchants often don’t bother, simply because it’s too hard to even begin to figure it out. Square has simplified all of this into two rates that are predictable: one if you swipe a card, a higher rate if you don’t. Although many have focused on the physical device, the real innovation is Square’s model for selling payment services. This simplification has caught the attention of more than 300,000 businesses and Square is on a run rate of $1 billion in annual transactions.

Costco. Costco makes shopping simpler. You know that if you buy something from Costco, you will get a very good price. It may not be the best price in the market, but it will be a very good price. Unlike other retailers, Costco doesn’t do high/low pricing, where some items are deeply discounted while others are priced high. Costco’s generous return policy virtually eliminates buyer’s remorse. Decide you don’t like it? Bring it back. For items other than electronics and cigarettes, the return policy is virtually unlimited. I know I’ve purchased a lot more as a result.

USPS flat rate shipping boxes. Mailing a package has historically been a pain. You have to find a box, then wait in line at the post office to have it weighed and stamped. (If your post office experience is anything like mine, that alone is a reason not to do it.) The post office has made this a lot simpler — if you use their standard boxes, whatever you can fit into it ships for a set price. Adding to the simplification, you can get prepaid boxes delivered to you and the postage is good forever, even if rates go up. And your package can be picked up by your postal carrier. Not only does this simplicity expand the market, it reduces operational costs for the post office.

In designing a simpler product, here are some things to think about:

Figure out the obstacles
Faced with a lot of choices, people will often do nothing. Faced with a lot of work to find a reasonable solution, people will look for (and be willing to pay for) a simpler way. You don’t have to find the perfect solution for someone — just one that allows them to reach an acceptable solution in a reasonable amount of time.

Win most, lose some
In designing simplified offerings, it’s important to focus on the big picture, not individual transactions or customers. The point of simplification is to expand the market and encourage adoption. It’s possible that you will lose money on an individual transaction or customer.

If someone calls free Iowa conference call numbers on weekends and talks for hours, AT&T will likely lose money on him. Egregious exceptions can be dealt with in fine print. (Most unlimited roaming plans have fine print that says if a certain percentage of your calls are roaming for consecutive months, they can terminate your service.)

Price based on averages, not worst case scenarios
Square could price their service based on a worst case scenario, like the average transaction being $3 using an American Express Platinum card. This would reduce the likelihood that you’d lose money on an expensive transaction. But it would also significantly reduce the likelihood that anyone would adopt the product.

Take the risk
The ridiculous amounts of money spent on things like loophole-laden travel insurance and extended warranties are a clear indication of the  degree to which people overestimate risk. To the extent that you can take on or mitigate  that risk, you will increase adoption. You’ll also be able to capture a premium (either explicit or implicit) for taking on that risk.

See also:

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1 Comment »

  1. Prepossessing blog post you have here. I hadn’t thought-through this.

    Comment by Tyler Steininger — June 29, 2011 @ 11:44 pm

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