This is a Short Note.
I just spent one hour talking Marginal Cost to a new digital business opening in Africa. They are coming to run an ecommerce business. Very brilliant team with solid business vision.
At a time, I asked one question: what is your marginal cost? It was very tough as we spent minutes looking at cost. Largely, to have scalable advantage, your marginal cost must tend to zero in a digital business. In other words, having an additional customer must not carry any new cost.
For great digital businesses, that is a possibility. Facebook and Google enjoy that in their internet units. The scalable advantage ratio is close to 1. That is why the marginal price is zero (they make their services free for all of us).
My client had a great marginal cost in the web side of the business, but in the logistics side, the amount goes high. To add an additional customer in a new city will require cost, even though the marginal cost in an already covered city may be low. So, the only way to bound the cost is to narrow the service region. By coming to that conclusion, the company is no more an Internet business. That scalable advantage has gone and the unconstrained distribution channel which Internet offers has been made meaningless.
At the end, I told the team to go and build a new business model for a logistics company because indeed their success will be largely dominated by logistics and not just on what happens online. That your business receives customers online does not mean it is a web business. What really matters is where the cost elements are. For this particular ecommerce company, the business is simply a logistics firm, as far as cost is concerned.
The firm will also explore how to eliminate that marginal cost exposure through partnership with a local logistics firm. It does not want any logistics capex and in Africa, except South Africa, that will be challenging. They will have a lot to do to make the business an e-commerce. At the moment, I see a logistics firm with a website. As a logistics firm, the valuations will come down to reality because you cannot be a meatspace business, and yet build your growth and valuation models with numbers that mirror truly digital companies.
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