In this podcast, Seth discusses the idea behind marginal cost and why it matters in our culture today.
Physical goods cost money to produce, and they have marginal costs. The marginal cost is the cost of making the last unit from the assembly line or manufacturing process. Many goods have low marginal costs once the assembly line can churn out those goods at scale. Like buildings and houses, some goods have high marginal costs because it is still difficult to produce them at scale.
We need to aware of the marginal cost because it affects how a provider makes their products and services available to us. The marginal cost concept also can affect an industry because technologies have fundamentally changed many industries. The decline in physical bookstores and book printing access on-demand is just two apparent patterns of change currently being experienced by the book industry.
Technologies can impact the marginal cost differently for a different audience, even in the same industry. Take the book industry as an example again. While the printed book’s marginal cost from the printing press may be low, the marginal cost for books printed-on-demand is still much higher than the one from the printing press. While books can go out-of-print with the printing press process, the same books will always be available for the print-on-demand route. Advance in technologies has given us more choices.
Things get interesting when we talk about books available in digital format. For digital books, the marginal cost approaches zero. This phenomenon has interesting implications for both the producer and consumer of the book. The same approaching-zero marginal costs scenarios are playing out for many products and services that may be available to use via digital format.
But what is even more interesting is when the marginal cost goes negative. When the marginal cost goes negative, each additional unit sold generates even more value for the producer. There are many examples of negative marginal costs in our digital world today.
The network effect has made negative marginal costs possible for many digital services. When something is benefiting from the network effect, it becomes more valuable as more people use it. The social network is one prime example of a network effect.
When a producer has goods or services that benefit from the network effect, they want to get more people involved with the goods or service. Those producers need the right people in the circle, or its product or service will not work. And they will create all sorts of incentives for people to join and not to leave.
When we are involved with a product or service defined by network effect, we should not be naïve to think that someone is doing us a favor by producing those products and services. We are doing them a favor by being in the circle because that is their business model’s essence.
This ultimately means that we are not the customers any more for those business models where the network effect is the foundation. We have become the product.