The High Cost of Marginal Thinking

In his excellent book How Will You Measure Your Life, renowned Harvard Business School professor Clayton M. Christensen distills decades of business research into thoughtful advice about how to live a meaningful life.

The book, which started out as a speech to Harvard Business School’s 2010 graduating class, toggles between business case studies and personal advice ranging from how to navigate career and family life to how to stay out of prison.

As an HBS student himself, Christensen was classmates with Jeffrey Skilling, the now-disgraced former CEO of Enron. Christensen searches his encyclopedic knowledge of business case studies for a plausible explanation for how his former classmate with sterling integrity could have fallen so far from grace.

The answer Christensen arrives at: marginal thinking.  As an example of how marginal thinking plays out in the business world, Christensen points to the battle between Netflix and Blockbuster in the late 1990s and early 2000s. Then, he says, Blockbuster dominated the movie rental industry, having made significant investments in inventory for thousands of stores across the U.S.

At first, Christensen writes, Blockbuster was a proverbial Goliath and Netflix a David. But in the early years of the last decade, Blockbuster had a chance to respond to Netflix’s growth among a niche market. In 2002, Netflix had racked up $150 million in revenues and a healthy profit margin. Rather than challenging Netflix, Blockbuster balked: Netflix 36 percent profit margin, after all, was smaller than what the Goliath company had come to expect.

The problem with that line of thinking, according to Christensen:

“Blockbuster followed a principle that is taught in every fundamental course in finance and economics: that in evaluating alternative investments, we should ignore sunk and fixed costs (costs that have already been incurred), and instead base decisions on the marginal costs and marginal revenues (the new costs and revenues) that each alternative entails.

“But it’s a dangerous way of thinking. Almost always, such analysis shows that the marginal costs are lower, and marginal profits are higher, than the full cost. This doctrine biases companies to leverage what they have put in place to succeed in the past, instead of guiding them to create the capabilities they’ll need in the future. If we knew the future would be exactly the same as the past, that approach would be fine. But if the future’s different—and it almost always is—then it’s the wrong thing to do.”

Christensen then deftly applies marginal thinking to our own personal lives, and the idea of integrity—one of Vantage Cost’s values. “The marginal cost of doing something ‘just this once’ always seems to be negligible,” writes Christensen, “but the full cost will typically be much higher. …It suckers you in, and you don’t see where that path is ultimately headed or the full cost that the choice entails.”

Marginal cost thinking—whether made in life or in business—can seem to be the right way to approach a problem. But often, even though costs might seem low in the beginning, they often are much higher than we can imagine.

Question: Have you ever found yourself resorting to marginal thinking? How is it creeping into your life or work?

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