"Opportunity Cost" Might be the Biggest Downside to "Upgrading" Existing Product Lines

Marginal cost has proven to be a key concept for products sold in most mass markets, and telecommunications is not exempt from that trend.

Any number of retail prices and packages are set basically to reflect the marginal cost of adding the next incremental customer. In fact, over time, economists might argue, current retail costs for goods and services tend to move towards marginal cost.

The concept has lots of relevance in telecommunications, where large amounts of capital investment are “sunk,” and incremental usage actually imposes little additional operating cost.

The traditional way of illustrating the principle is to answer the question “how much does adding one more minute of use of the voice network cost?” In practice, the cost is almost solely limited to the cost of adding one more transaction on a billing system.

In the Internet era, we are accustomed to the notion that the next increment of usage of any consumer app actually costs the suppliers almost nothing.

In most cases, that next increment of usage costs the end user almost nothing, as well. You of course know the business problem thus created. When costs are nearly zero, retail price will tend to move towards zero as well.

As useful as that is for consumers, it is a huge problem for communications suppliers. Very low marginal cost explains why VoIP and messaging providers are able to offer their services literally for free, or nearly for free.

Low marginal cost is the foundation for the business model known as “freemium.”

Low marginal cost explains why suppliers of long distance calling, facing declining margins, try to compensate by encouraging additional usage volume.

And low marginal cost will be the reason why gigabit access services costing only $70 to $80 a month are possible, in large part.

Observers offer any number of suggestions to service providers about how to sustain their businesses under conditions where retail pricing for many products drops to marginal cost, and when marginal cost is quite low.

Many of those suggestions, though sound enough, have problems. Solutions that call for adding more value to existing products assume users will value the incremental new value enough to pay incrementally more revenue.

Strategies that call for creating new lines of business face execution risk (can telcos really do it?) as well as scale risk (will the new revenue streams be big enough to justify the effort?).

Assuming that creating new lines of business is both essential and realistic, the subsidiary issue then is how much to continue investing in legacy businesses that are declining in absolute value.

Two fundamental approaches can be taken: harvest or invest. The former essentially admits a business is mature, and will decline. The objective then is to preserve the magnitude of the revenue stream as long as possible, at the highest level possible.

The latter calls for spending more money to upgrade products, adding enough value that prices and usage can be sustained, or hopefully that usage and prices can even raised.

Low marginal cost might suggest harvesting is the more realistic strategy for most service providers. Adding more value might be capital and human capital intensive enough that the net result is a negative number.

Some of us would argue that if a given product line is powerfully affected by low marginal cost, the wiser choice is harvesting. The upside from big, or even significant investments, might not be large enough to justify the cost, time and human effort.

“Opportunity cost,” effort that might have gone elsewhere, also is a concern. No matter how large, organizations only have so much ability to invest in brand-new lines of business and revenue streams.