Why Marginal Cost and Cashflow Rule Markets

Why Marginal Cost and Cashflow Rule Markets

On the feed on OyaPay exit, a community member dropped a great line “… businesses don’t usually fold because of lack of capital. They usually fold because of lack of cash flow.” If you have managed a business, no matter how small, you will understand the potency of that line. When people say Cash is King, they do not necessarily mean physical cash in your drawers or cash registers. They mean the capacity to have liquidity through superior cash flow framework.

I will add one line at the other end of it: the most important cost that matters in scaling (online) businesses is marginal cost. (From Wikipedia, in economics, marginal cost is the change in the total cost that arises when the quantity produced is incremented by one unit; that is, it is the cost of producing one more unit of a good.) If you take care of that cost, you will find new markets and territories. Remember, in a perfect internet market, marginal cost is near-zero, meaning that web products tend towards being free. So, if you want to scale and thrive on the web, the marginal cost (practically, your transaction cost and distribution cost) of your product must be close to zero. Sure, I do not expect you to sell at zero!

This is the heart of the freemium model where you get many things free, which is possible because of the aggregation construct, where companies provide those digital products and then create an ecosystem to sell adverts. The firms benefit more than the suppliers by providing the platforms [Facebook makes money for photos supplied by families. Sure you like the Likes]. As shown in the Figure, great companies deliver the near-zero marginal price for high quality product, making it challenging for anyone that carries a non-zero marginal price to compete, exacerbated if the product is even not top-grade. This is one of the biggest challenges digital entrepreneurs face.

 

As you watch the marginal cost and have a laser-focused attention to cash flow, you will not meet surprises in that business.

Marginal Cost And How To Price Digital Products

LinkedIn Comment on Feed

  • To succeed in any business, three key skills are essential: knowledge of product, marketing and finance. The truth is that not many business owners and entrepreneurs understand how important the third component is; and that is where majority of the problems lies. Consumers will always demand for cheaper prices or even free offerings, while producers – in their bid to appear ‘nice’ and outdo competitors, go on to plan their own downfall, by offering deals and going on expansion drives that are clearly unsustainable. You cannot have access to free money forever, so your business should be able to take care of its financial needs. Just know that when the party is over, consumers will always move on, while you are left alone to rue your past misdeeds.
  • Yes, cash flow and marginal cost are lifelines that must be kept at optimal levels as business structures navigate growth. Keeping a balanced scorecard between funding, payment and sales models is essential if the outlook must remain positive. However, there is another risk factor that must be managed-Profits. Yes, misrepresentation of short term profits is a big risk. Embarking on an aggressive growth plan by leveraging short term profits as an indication of cash flow adequacy will certainly pile up opex and marginal cost. To this end, if funding options are no at near zero rates, good start ups run the risk of kissing the dust. In Africa, caution is the deal maker!
  • You’re so right. Cashflow is so important that it’s sometimes necessary to sacrifice potential profits for cashflow i.e. for money to come in faster. We in the real estate industry are especially faced with this dilemma on a daily basis. In general, it’s good for businesses to understand this and plan for it
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