During Digital Transformation of Consumer Business, Understanding “Marginal Cost” is Important

If you are doing digital transformation designed to drive consumer digital product sales on the web, one cost element you must watch carefully is marginal cost. Simply, marginal cost is the cost of serving an additional user in your ecosystem; understanding that cost is extremely important to architect a scalable business. You can also read this my Harvard Business Review piece.

In a perfect internet market, the marginal cost of a digital product is zero. The implication is that only companies with natural equilibrium tending to near-zero marginal cost for consumer markets tend to experience huge growths. Google and Facebook are largely offering products at close to zero marginal costs. For accomplishing that, they make the products free, triggering huge scalability.

And of course, the scalable advantage is possible since the companies are also delivering huge value even as marginal cost is going low. Your goal is to move your product towards the LEFT of the plot where value is high even as marginal cost is lower.

The freemium is possible because under that near-perfect market system, the marginal cost of producing a digital product becomes zero [Facebook cost is negligible when a new user registers on Facebook]. And if that zero production cost is attained, selling cost can be set at zero, marginally. By doing that, scale comes, and network effects set in – yes, more users will bring more users in a positive continuum that create virtuoso circle.

I give lectures on marginal cost as part of our workshops. I do spend two hours explaining to digital technology companies why they must understand marginal cost to build scalable strategies. Marginal cost is broadly broken into Transaction Cost and Distribution Cost. If your distribution does not go lower as you grow, your unit economics will struggle online.

That is why ecommerce does not scale in Africa as the distribution cost does not marginally reduce as scale happens. Why that does not happen is because logistics is a physical component of the distribution cost, not a digital element, and cannot be reduced via codes online. In other words, ecommerce is nothing “electronic” when it comes to Africa; it remains an offline business because the marginal cost is dominated by offline logistics as we have no efficient postal system which startups can leverage for growth.

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It is the same marginal cost paralysis that hinders banking services from reaching every corner of Nigeria, at scale. Because in some cases, you are likely to encounter scenarios where cost of providing the services outweighs the revenue accrued there; making it obviously an unsustainable practice.

So most times, when you question why companies aren’t in a rush to set up businesses in certain locations, the supposed goldmines; bear in mind that business activities don’t always equate profitable returns, and without thinking things through, you are likely to fizzle out after starting on a high.

What happens in digital businesses also takes place offline, that is why you do not go about opening up branches just to count the number of outlets; if you open without analysing the cost implications, economics will help close them after a while.

In other words, if the marginal cost is not moving towards zero, then you are better off saying goodbye to massive scaling.

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