The Economist’s Free Exchange discusses the Nano: (from the Outlook)

The economist in me is puzzled: can you claim to have made a one-lakh car … if you are selling it at a loss? After all, if Tata Motors was prepared to make a loss to realise its dream of a one-lakh car, it could simply have repriced the Tata Indica, its existing small car, at 100,000 rupees and avoided all the fuss of a fresh design and a new plant.

It seems to me that until the one-lakh car breaks even, it does not exist in an economic sense. But by the time the profitable “long run” arrives, I am not convinced that the Nano will still be 100,000 rupees.

From here, and in part II it goes on to discuss the economics of demand outstripping supply, deposits that would remain with the company:

Suppose the initial allotment of cars is subscribed twice over: Tata Motors will get an immediate cash infusion of more than 20 billion rupees. If it can sustain the hype and expectation, it won’t have to return this booking money to the surplus customers. It will, in effect, have secured for itself a cheapish source of deposits, redeemable for a car, as production allows. The cash will come in handy—in June, Tata Motors has to repay about 100 billion rupees ($2 billion) to the lenders who financed its acquisition of Jaguar Land Rover last year.

There is a peculiar circularity to all this. By declaring an impossible price tag, the company has generated enough lucrative hype to make the cheapest car viable after all.

Well, the blogger at Free Exchange seems to miss the point. This is the basics of how new products and innovations are brought to market.

First, there is the vision. The 1 lakh car.

Second, the process of innovating. Creating a brand new car from scratch. Sorry, selling the Indica at a loss does not make sense. The idea is not to create a forever loss making product. As Tata said, this is a profitable venture and not philanthropy.

Innovations in business follows this path. Companies sell various versions of a product at different prices and some even at a loss. The mix matters. Tata motors is planning to produce in the ration of 75%:25% where 25% is the l lakh version.

Another model is what the MBAs call the Razor-blade model. You sell the razor at a loss or at cost and make money on the blades. In this case, it will be the spares for the car.

Another model is the mobile phone market. Give the phone for a subsidized cost and bring in the money through data and voice. Tata is using the iPod model too. Sell accessories and branded stuff on the Nano. This is common business practice.

And in the end, creating money through demand via applications and deposits to further the cash flow of the company.

All this does not mean that profitability is guaranteed. A lot of innovations in the world are never profitable. May be the Bajaj-Renault car will be more profitable, who knows.

However, the company has created worldwide appeal for the product, put the company on the world map, created a whole new segment of cars in India and can eventually be the biggest selling car in the country.

That is the way to create a new business/product from scratch.

I am surprised why the Economist is puzzled!