Enough With The Marginal Cost Argument

Economists love to talk about, “marginal this, marginal that”.  Two relevant terms to producing and pricing widgets are, Marginal Cost (cost to produce and sell one additional widget) and Marginal Revenue (additional revenue by selling one more widget). The commonsense rule is no one should sell widgets at a price lower than its marginal cost, otherwise you are losing money on each marginal unit you sell.

Now there is wider uptake of the marginality concept among the some of the well known names of the digital media world. The first is Mr.Chris Anderson who makes a case for his “FREE” based on the argument that marginal cost of digital goods is $0. Recently, Mr. Seth Godin, author of several marketing books made  this same marginal cost argument about education. He  is making a valid point, except from cost and producer perspective and not from the consumer value perspective. He writes,

MIT and Stanford are starting to make classes available for free online. The marginal cost of this is pretty close to zero, so it’s easy for them to share. Abundant education is easy to access and offers motivated individuals a chance to learn.

Scarcity comes from things like accreditation, admissions policies or small classrooms.

The marginal cost is $0 only for units 2 through N, the first unit has a very high marginal cost (the cost to set up the operations and run it).    But that is still not relevant to the value argument.

Being admitted to the school, accreditation, the many learning opportunities from the classmates, the network and the complete immersion all are considerable value to the the customers (the students). The value-add  increases when schools restrict their class sizes and implement stringent admission criteria – in other words by creating scarcity.

Even for the digital course one could argue that with proper segmentation there exists a segment that is willing to pay for it or some aspects of convenience. Again it is the value-add to customers argument not the cost argument that is relevant to pricing.

For any marketer the key is to know what their customer segments are, what they value , what they don’t and make a credible value proposition. It is not about the marginal cost!

7 thoughts on “Enough With The Marginal Cost Argument

  1. Seth Godin is may be wrong here. The purpose of business is to serve a market and if you do this better than others you maybe able to convince some of your customers to share of the value created. The competitiveness of the market is largely irrelevant from a customer’s perspective — that’s a marketer’s problem. Even youtube is a brand. People hang out there because everyone else hangs out there.

    The youtube example given above is interesting but youtube has nothing to do with videos and everything to do with ad space. Customers see youtube for video sharing but for google just a bigger foot print for its ads.

    If you build a video site, then you will die unless you offer something relevant that youtube doesn’t or can’t. Wistia seems to be competing well — it’s a video site for marketers. Apart from 3 free videos, there are no free videos. But Wistia does not have an ad infrastructure and it would be suicide to compete against Big G by going free.

    Similarly, university example assumes these universities should compete — some may want to compete in the ‘free’ market and hope to turn some of those free customers turn into paying on-campus customers but that is once again a marketing strategy question. The only way to survive is to differentiate. The cost advantage is only temporary.

    Cheers,
    JJ

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  2. Seth

    For these and other businesses that offer undifferentiated products is market share the right driver – shouldn’t they be asking,
    1. if I can gain market share by cutting my prices how can I expect to keep it when someone else cuts their prices? Am I the WalMart of universities with cost leadership unmatched by others?

    2. Given the presence of multiple free (or cheap) offerings with no clear signals of quality and the opportunity cost for customers to evaluate options – will they treat price as the value signal and hence prefer the paid option? To use Hershey’s experiment done by Prof. Ariely, what if he had offered Lindt for non-zero price and 20 other free candies?

    3. Shouldn’t profit be my goal? (You have written, it is the attention economy). For every decision I make, say make my content available for low or no cost, will that deliver higher incremental profit over other options available to me?

    4. I have already sunk my cost in big campus and resources now what options are available to me to turn a profit?

    -rags

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  3. You are correct on undifferentiated markets with excess capacity and I understand that. But I am not talking about those markets.I understand how the price spirals down to MC.
    I am talking about markets where there is differentiation and where customers perceive the difference and value it. In the context of MIT and Stanford education, these are not commotidized or undifferntiated right?

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  4. Rags, there may be a pony in here somewhere, but I’m having trouble finding it.

    In competitive markets with many substitutes, marginal cost is a the key to pricing. You may not like it, but it’s true. The start up costs may impact new players, but if the startup costs are already sunk, they are irrelevant. A rational player will grow market share by cutting prices until marginal cost is met. If you tried to compete with YouTube by charging to make up for your startup costs, you’d lose, right?

    In education, as institutions with fixed costs to cover discover that they can sell courses for $1, they will. Then others will sell similar courses for fifty cents, etc…

    Of course, tribes and scarcity and branding will create premium niches, but that’s not what I was writing about.

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