The Crowdfunding Pricing Paradox

Marketing for non-marketeers, lesson 6

I’ve haunted the working world for quite a while and have found that more often than not, common business workings are over complicated. I doubt that it’s intentional in most cases; some of the tasks and concepts we business folks deal with just don’t make a lot of sense from the surface viewpoint, even if they do under the hood.

Crowdfunding hasn’t helped much to relieve the lack of clarity. It’s made the inside of the process more accessible, but hasn’t made it any more clear. From what I see, that’s why a fairly large number of seemingly good crowdfunded projects either fail to get funded, or “succeed”, but don’t turn into a viable business.

Not long ago, I decided to take a closer look, and paired up with a friend to run a Kickstarter campaign. We did it twice for the same product. The first time failed, only reaching about 30% of the funding goal. The second succeeded, bringing in nearly twice the funding goal. What I discovered is that a crowdfunded business is not terribly different from any other business. The funding rules, and the order of things, or course differ, but the “business” is still just a business.

Profitability models work different at different volumes

Our first attempt with the Kickstarter garnered more dollars: $4,224, from 78 backers vs. $3,867 from 98 backers in the second attempt. But, the first one was overpriced and over ambitious. We had set a funding goal of $14,000. The second time, we lowered prices and lowered the goal to $2,000.

I’ll use a rounded example to illustrate why the $3,867 wasn’t as much a payout as it might seem. The numbers are from a hypothetical example, but are more than accurate enough for the illustration. We’ll be looking at a small electronic device.

At a targeted sales number of 100 units, the total cost of parts and packaging is $15.00 each. You can hand build the 100 over a few weekends, so you call that a zero manufacturing cost. Shipping costs you $3.00, and you include it in the selling price. Similar products sell for $25.00, so that’s what you set the price at. The crowdfunding goal is $2,500. A successful campaign brings in $2500, less $1500 in parts, less $300 postage, giving you $700.00 profit after all is said and done. Except, the funding website will take 10% of your $2,500, leaving you with $450.00.

If you over fund with 200 backers, receiving $5,000, you’ll still be in decent shape. Jumping from quantity 100 to 200 probably isn’t enough of of an increase in volume to get more than a tiny reduction in parts cost, and shipping will still be $3.00. It may be a stretch, but you can still hand build the 200 units, maybe with the help of a friend or two. $5,000 funding, less 10% fees, less $3,000 in parts, less $600 in shipping equals $900. You took your helper friend out for pizza and beer after, for $50.00. The $850.00 left starts to feel like real money.

In another scenario, your device ends up really popular and sells 1,000, for a funding amount of $25,000; less 10% fees, or $22,500. Parts costs drop in half. Shipping does not. You see that nice “profit” number, $12,000, and get excited. But… You don’t have enough friends (or tolerance among friends) to hand build 1,000 units. It’s simply not practical.

Scaling up doesn’t always make it less expensive

In the US, you can find a manufacturer that will assemble the boards for $10.00 each. To avoid handling $7,500 worth of parts, you have the manufacturer purchase them, for an added 10% markup. Your $12,000 drops by $750 for the parts markup, and $10,000 for the manufacturing cost, leaving $1,250. Your buddy helps to tape boxes, place address labels, and carry boxes to the post office, so you still pay $50.00 for pizza and beer. 1,000 boxes is a lot, so it’s going to cost you $100 for two dinners of pizza and beer.

The $1,150 is nothing to shake a stick at, but really? You sold ten times what you expected, and didn’t quite make two and a half times the cash profit?

Still, it was a successful Kickstarter. It was wildly popular, so you’ve got a viable business. Right? Well, with $1,150, you can’t even buy enough parts to build your original 100 target, let alone enough to get good volume discounts. And without the Kickstarter hype, you’ll have to pay to market the product. If you build 25 at a time, the parts cost goes up to $20.00, shipping still costs $3.00. You don’t have to pay to have it built, or any of those fees off the top, so you earn $2.00 for each one of those 25 that you sell.

That’s not enough money to build a website or do any advertizing. Fortunately, there’s Tindie, a web market place designed for post-crowdfunding products like yours. They have a very reasonable fee structure, only charging 5%. That’s $1.25, leaving you with $0.75 profit per board.

If you look for an offshore manufacturer, you might be able to drop the build cost to $5.00. That immediately adds $5,000 to your bottom line. You will, however need to have the manufacturers build a small pilot run to makes sure it will be built correctly, for around $500.00. You can add nearly a month to the fulfillment time for this.

Provided it all works out, you’ll want to up the quantity by 20 – 30% to make sure you get enough working boards. 80% would not be an unheard of yield at the cheap offshore manufacturers. An extra 25% would run you $3,125. You’ll also need to 100% test the boards, or develop a test program at the manufacturer, taking more time and money. Build, test, and shipping will add another month. Now you’re up to about $2,500, with two extra months to the delivery time. Don’t forget the 30% that will go to taxes. You’re left with $1,700.00. Nice money, but probably not so much when you add up the time involved.

These numbers are not close enough to copy, but are close enough to use as a case study illustrating that it can be pretty easy to build a product with crowdfunding. Turning the product into a business is a different story. It is possible to build a business out of a crowdfunding campaign. It’s just not much easier than it is to build a business without it.

I’ll follow this up another day with some thoughts on getting closer to a viable business after the campaign.