Stereophile has turned a critical eye to Light Harmonic’s “Geek “crowd-funding campaigns (the “Geek Out” and the “Geek Pulse”). After a very nice article covering Geek in the January issue, things turned for the worse by the time February rolled around. Rocks started to get thrown. As Stephen Mejias writes on page 43: “Essentially they have sidestepped the burden of establishing a trustworthy dealer network.” Stephen seems clearly uncomfortable, or, at best, he simply has mixed emotions when it comes to the new business model represented by crowd funding.
The editor of Stereophile, John Atkinson, proceeded to write even more bizarre comments on the Stereophile website, with a January 14th posting criticizing the underlying crowd-funding model that Geek used to fund the “Geek Pulse”. He states, “Unlike KickStarter, where the company being funded doesn’t receive a dollar until the goal is reached, with Indiegogo the donors’ credit cards are charged and the money credited to the company when they make the pledge, regardless of the goal. LH Labs will therefore have the use of that $1.1M until they start shipping the Geek Pulse.” It seems John takes up issue with the immediate access to capital and the seemingly (to me, at least) trivial amount of interest income. Doesn’t the access to capital pay for manufacturing the product? What the heck is going on here? Why are rocks being thrown at good people trying something new?
It seemed very clear to me that the successful LH Geek campaigns are causing much consternation in the “old-guard” audiophile world. Curious by nature –I’m a marketing consultant to the Fortune 500 – I decided that I needed to do some further investigation. And what I discovered is both hopeful and frightening for the High-End audio business. I began my investigation by speaking with various manufacturers, including Gavin Fish, who represents Light Harmonic.
Light Harmonic and Crowd Funding
You may already know about the phenomenal success of Light Harmonic’s (“LH”) crowd funding campaigns for its Geek product line, but if you don’t, all you need to know is that the campaign was a triumphant success. Crowd funding is simply a way to bootstrap a product by sharing plans with a universe of potential investors. These potential investors are you and me, the general public. Participants invest money upfront in the product and the sponsor-company uses the money to build a product that is then delivered to the “investors”, often at a reasonable discount. Basically a scaled down version of Venture Capital, but instead of equity in the company, you receive a product at a reduced rate. If the firm doesn’t raise enough money, the campaign ends and the money is returned to the investors.
In the LH Geek campaigns, investors bet that an established firm already responsible for one of the world’s finest performing DACs, the Da Vinci, would make a stellar entry-level item. Perhaps, even “giant-killer”. After all, it’s rewarding to buy wholesale and directly support a new idea, a new product.
Gavin and Larry, the two main principals at LH, figured that they could offer music lovers, not simply audiophiles, a combination headphone amp and DAC that sounds great and at a reasonable (read: low) price. The initial product, the “Geek Out”, is a neat metal device that attaches to the USB output of your computer on one end and a headphone input at the other. They set the initial goal for funding at $28,000. Gavin created a compelling video that clearly spelled out the pleasure one could achieve with this device and Geek Out quickly raised $303,000 in thirty-days, with over 1500 individual orders. Surprisingly, there was a lot of immediate demand for this product.
Based on these campaign results, Geek doubled-down and decided to offer a more refined, desktop-based DAC, the “Geek Pulse”, which would be a step up from the Geek Out device. Gavin mentioned that much of what they learned from their $20,000 Da Vinci DAC has trickled down into the Geek Pulse. I watched the Geek Out campaign from the sidelines, but I was in the market for something like the Pulse – for the desktop system for my home office – and I quickly “invested” $189 as an early participant. The campaign took off like wildfire. By the time the campaign ended, LH had raised a whopping $1.2 million, light years ahead of their $38,000 goal. Along the way, LH offered some really impressive upgrades like a femtosecond clock (that I quickly forked over an additional $140 to own). As I tell my friends, in digital audio, timing is everything!
So the charismatic Gavin Fish and LH team successfully pre-funded two “entry level” products that will bring better sound to more people. Geek Out is shipping now and Geek Pulse will show up sometime this summer. That certainly seems like a “mega-win” for an audio-industry that is otherwise complaining of being on the edge of extinction, not to mention the benefit to the consumers who participated.
Here is a wonderful fact: There were over six thousand participants in the Pulse campaign. Yes, six thousand people willing to “invest” in a DAC to make their music sound better.
It seemed incredibly odd that this would be a “problem” for some in the Hi-Fi business. Something was clearly askew. Indeed, as I investigated, I realized that there were traditional groups, such as dealers, distributors, and reviewers, pitted against a brand new, emerging business model that involves cutting out the distributor, cutting out the dealer, and most likely – limiting the reviewer’s overall influence. No wonder the ol’ boys are getting fidgety!
How did this happen and who will win? Is the distributor/dealer model dying or is it already dead?
The Dealer is King
To get the answer, let’s take a close at the economics of the traditional brick and mortar Hi-Fi dealer business model. When consulting, we often look at the “value chain” of where value is added as a product moves from the manufacturer to the end customer. By examining costs, we find out much about the business model and understand where money is being made relative to the value provided. After interviewing several manufacturers, I created the following chart to highlight how this works. Please note, these numbers are correct as an average example, but specific margins will always vary by company. Nonetheless, I believe this is an accurate representation of high-end audio economics.
Since people tend to look at only the manufacturing costs when discussing value, we based the chart on an average $1.00 cost of goods. In hi-fi, consider this the raw parts, the labor to assemble, and an amount, however small, for overhead (to pay utilities, rent, etc). I then assumed a reasonable and conservative marketing and warranty budget. This totaled to $1.50, and I assumed a typical 100% profit margin for the cost to distributor to be an even $3.00. I then assumed that the distributor would add $2.00 roughly of profit margin and then sell to the dealer for $5.00. The dealer then doubles the cost for a 100% profit margin and sells to the customer for $10.00. So for $1.00 cost of making the item, the customer will pay $10.00. This is quite a spread, but not uncommon for consumer goods of a limited production nature, such as we find in the land of High End Audio. In some instances, there might even be a $20.00 cost to the consumer.
So, at each step along the way, participants add value. The distributor often has local market knowledge. They know the dealers and how to navigate a particular market’s idiosyncrasies. The dealer, in turn, has cultivated an established clientele who are interested in the products that a Stereophile or TAS reviewer might recommend. The reviewer gets the gear in his hands early, tests the product, and then offers a judgment as to the quality of the item. Assuming the gear becomes a recommended product: said turntable becomes placed “on the short list” of the reader, who also happens to be the consumer. A consumer will hopefully visit their local dealer for that exact turntable and eventually take the item home.
In this model, the dealer acts as a “reducer of risks” for the customer, because they may be trusted, over time, to carry reliable brands and offer in-house service, and perhaps, work with the manufacturer to resolve repair work or any problems that may arise. They have invested significant money to populate their showroom with product for demonstration, and in order to maintain that showroom they have a fair amount of overhead to maintain, month over month. In the case of speakers, the dealer may also deliver, uncrate, and properly setup the system for optimal performance. Thus, in addition to being the source for the product, the dealer acts as an educator and a guide.
In this world, the dealer and the reviewer are Kings. The customers, the so-called “life blood” of the industry, are at their mercy (and judgment), in terms of products offered and products recommended. Over time, audiophiles build up trust, or lack thereof, in the quality of an individual reviewer’s writing and the advice and wisdom of their local audio dealership. This is the traditional model for audio sales in the USA, and elsewhere in the world – and High End AUdio has operated this way for decades upon decades.
To a large extent, this model has worked very well. High-end audio manufacturers were established and funded successfully through sales. Dealer networks were built and several long-term audio publications flourished, such as The Absolute Sound and Stereophile. The customer paid the $10.00 for $1.00 of product cost, but they seem to have received value along the way (commensurate with the $10.00 cost).
Or did they? To answer that question, we have to look at a different business model.
The Customer is King
If you look at successful marketing strategy in the corporate world, around the year 2000 it became clear that a sea-change was occurring with regard for how people purchased goods and services. (Thank you Internet.) Amazon and Ebay quickly demonstrated that online purchases could be reliable and a bargain. There are limitless choices and never-ending inventory supply. It was, and still is, a boon for consumers across many products and services. As the Internet became more established, we saw the emergence of the ability to share opinions with online review sites, turning the consumers into the critics. Recently, mobile and social networks have entered the scene, creating yet more ways to promote, talk about, and sell product.
In recent years, thanks to the increase in online spending, we have seen customer-data proliferate. This explosion of data led to a full employment act for marketing-analytics nerds like me to advise on how to use such data to precisely target customers and increase revenue. The advent of smartphones and their ilk made it much easier to buy things at all hours, regardless of location. At the same time, but over a larger span of time, the ability for Madison Avenue to influence sales with traditional branding-eforts has diminished because of growing distrust in corporate marketing. This is being replaced with the “opinions” of trusted friends or community. In audio, that may refer to a group of “experts” on a familiar audio forum or a member in a local club. In the High-End Audio press, the seemingly unrealistic number of purely positive reviews produced counteracts the perception of the “genuine objectivity.” Consumer trust in the press seems to have eroded as a result. The perception persists that there is an established connection between reviews and advertising pages sold in these publications. Check out who advertises, then check out who makes the recommended components list or editor’s choice compilation. Despite their protests to the contrary, it seems that editorial and advertising are very much sleeping in the same bed.
Today we have a world where the Customer is King. We are in the driver’s seat. Businesses need to drive engagement directly with the customer, because they can, and because it will yield positive financial results. Companies like Apple know how to do this and they are reaping huge rewards (in terms of profit, sales, and image). This new economic ecosystem not only involves a fair price for the consumer, but it allows for a more satisfying customer experience. As the Fortune 500 is finding out, this new “customer-centric” view of the marketplace produces optimal results in terms of revenue growth. This has deep and wide implications for the audio business.
The old “Dealer is King” model is perhaps a bit antiquated and unstable. The “Customer is King” model is creating opportunity for more innovation at the entry-level, thus providing manufacturers greater access to more customers.
It has became obvious that a “direct-to-consumer” business model makes a lot of sense for newer and smaller manufacturers. This model revolves entirely around the customer, yet with great benefit to the manufacturer. Let’s look at the economics based on the same parameters we set before around the $1.00 of cost to produce an item.
Here we have eliminated two “middle-men” in the value chain, the distributor and dealer. Because the manufacturer sells directly to the consumer, the distributor and dealer profits are eliminated and it only costs the consumer $4.00 for the product, two-and-a-half-times less than the $10.00 they would pay for the same item in the “Dealer is King” system. There is at least $1.00 per item of additional cost to the manufacturer because they are responsible for acquiring new customers (and building trust) for themselves.
Cultivating a customer-base has become inexpensive these days because it doesn’t cost much to spread the word with digital campaigns. And new marketing analytics techniques – not to mention the highly detailed data our social media engines are collecting on us – are incredible at finding likely buyers or persons of interest. Digital campaigns are generally effective, which brings us to crowd-funding. With the advent of Kickstarter and Indiegogo, you don’t even need to borrow money from a bank to pay for manufacturing – you simply start a campaign, tell your story, and offer a good deal to your customer. If enough people are excited by your idea, you’re off to the races.
Let’s think about crowd-funding from the manufacturer’s viewpoint. With each campaign the manufacturer receives a precise demand forecast for their product. By the end of the campaign, the manufacturer knows the exact number of units they need to produce, as the “investors” have already paid for them. This may lead to “economies of scale” advantages, because parts can be purchased in greater volume and for less. The manufacturer will have fewer marketing expenses, because they have already sold the first batch of products to “early adopters” who will spread the word for them.
Light Harmonics developed a bulletin board-style forum for their virtual community of Geek fans – that LH called the Geek Force –to voice their opinions, requests, and concerns. LH was able to leverage crowd-design to create a customer-centric world. In fact, LH even solicited a vote on which enclosure design to deploy for a Geek Pulse accessory. They also held a headphone-stand contest that they allowed members to vote on their favorite design.
Now, let’s consider crowd-funding from the customer’s viewpoint. You pay upfront for a product that you will receive later. But you aren’t paying the $10.00 at the dealer, rather the $4.00 on the crowd-funding site as an “investor”. And this is only slightly higher than price-point the distributor typically pays. As you invest in the campaign you get access to the Geek Forums which allow you to suggest other products and help Geek refine the feature set. You feel as though you are supporting something at the ground level and helping the product itself come to fruition. This is rewarding. And you get to hang with other like-minded souls and talk audio and learn how to get better sound. It’s truly a win-win situation.
Except for the reviewer. The poor reviewer is pretty much left out in the cold.
Yes, sad to say, in the “Customer is King” scenario, your fellow audio buddy will probably have an opinion that you value more than the writer for one of the audio rags. Not only that, but with the magazines you have to afford the time to wait for a writer to review the product (even though the opinions of seasoned reviewers would otherwise be valuable, given their experience with dozens of similar products, more than the average enthusiast could ever afford to spend time with).
This is different. The investor, the customer, is taking a leap of faith that the company they fund will produce a desirable product. But remember that you are buying in at the lowest price point possible. Your risk is slightly increased, but your potential reward is exceptionally increased.
And yes the dealer doesn’t fare that well in this situation. This is frankly a modern end run around the dealer. The dealer loses a $10.00 sale for the $4.00 that goes directly to LH. However, we need to put this into perspective. I don’t think the dealer will ever die. It’s one thing to buy a DAC from LH Labs for a few hundred dollars, but a $20,000 Da Vinci DAC is another story. If the Geek Pulse is shipped and it doesn’t work, LH will fix or replace it within warranty because their reputation is at stake. And it won’t cost much for shipping or repairs. There are many more complications that arise when buying expensive and highly specialized items. I’m not sure I would buy a Porsche sight unseen or un-driven. When it comes to higher end products, we simply need more assurance. We need that test drive when so much money is at stake. We need that audition in the chair at the local dealer. We need immediate and comforting attention – and service – from the dealer if that expensive DAC goes on the fritz. When the stakes are very high, we need the confidence of having a local dealer on our side.
Who Moved My Cheese?™
The world is changing. The genie is out of the bottle. Now, the customer really is King. High-end audio should embrace companies like LH Labs and Schiit Audio, who showcase the promise of the direct-to-consumer models. In doing so, the industry will solve a huge problem, which is a depleted customer base. There are new customers out there and they hold the same enthusiasms and passions that built this industry, only the game has changed. Companies like LH Labs have noticed the change and, by adapting to those changes, they reap the benefits.
Some percentage of these young customers will gain income as they age. They will eventually want more. Perhaps even stop by a dealer and audition those amazing speakers or that impressive preamp. And they will gladly buy such products because it is time for them to do so, and because the dealer has created value by minimizing the risk of acquisition to the customer by maintaining a showroom with products available for demonstration.
These new, younger customers will eventually buy better equipment and they will then possibly look to more seasoned reviews for advice. Everything is going to be just fine – casting editorial stones only demonstrates how out of touch the old-guard press seems to be. These new business models only serve to grow the customer base. In the end, more people will enjoy music with terrific sound quality. That helps everyone.
The cheese has moved – the future of audio is already here.
Adapt or die.