From the Director
The Trap of Marginal-Cost Thinking
Many information-development managers are frustrated when their carefully hewn business cases for an investment in XML, DITA, and component content management are turned down by senior management. “Too expensive,” they’re told. “What’s the return on investment?” they’re asked with considerable skepticism at the promised results. “Why can’t we keep doing what we’ve always done?” they’re asked by their own staff members.
Clayton Christensen, Harvard Business School professor and author of the previous CIDM theme book, The Innovator’s Dilemma, argues in his forthcoming book, How Will You Measure Your Life?, that many common business principles that lead to poor decision-making are “misguided and even dangerous.” The trap he describes can be called marginal-cost thinking, exactly the kind of thinking that leads senior management to turn down appeals for changing the way we develop customer-relevant content in our organizations. According to a brief overview of the new book in the Harvard Business School’s Working Knowledge newsletter (May 9, 2012), Christensen believes that marginal-cost thinking, focusing on marginal costs and revenues, can “lead to personal, professional, and moral failure.”
The example in the short article points to the success of the innovator Netflix in overwhelming Blockbuster, the dominant company in the movie rental business. Netflix was the disruptive innovator, offering a new way of renting videos through the mail rather than going to a brick-and-mortar Blockbuster store. Blockbuster executives and investors recognized the threat but, considering their enormous investment in existing stores, the executives couldn’t support the new investment required to move into mail-order rentals. In 2002, they decided to do nothing.
In 2010, Blockbuster declared bankruptcy. The upstart innovator had won.
Christensen describes the decision-making process that led to Blockbuster’s disastrous decision. When managers evaluate new investments, like buying a new content management system, they are taught to ignore startup costs and fixed costs. They are supposed to look at the alternative investment opportunities and calculate the “marginal costs and revenues.”
For an information-development organization, the marginal cost of producing technical content today only takes into account the cost of your people and activities for, let’s say, the next year. The marginal cost calculation ignores everything you’ve had to spend over time to train people, bring them up to speed, and provide them with computers and software and any other equipment that they use in doing their jobs.
When looking at a new opportunity, managers are trained to calculate the cost of the new venture, which means doing something new and differently, by looking at the full cost of the change. Of course, the new venture will require additional funds and resources not already being spent on the existing solution. Everything that was ignored in looking at the old ways of working (the marginal cost) is included in the new calculation. That means that the money spent always looks greater than continuing to do things the old way. That encourages organizations to stay with their current practices.
As a manager, you understand the tendency to keep doing things the way you’ve always done them. Let’s say that you’ve already invested in a desktop publishing system that your staff already knows how to use. You know that a new system will cost more because you’ll have to purchase new technology and retrain your staff. You look at the high cost of doing that and turn away.
What gets ignored is the earlier startup costs, the money you’ve already paid for a solution that isn’t really getting you ahead. One organization we work with is reluctant to abandon a costly, difficult publishing system. They’ve already sunk money into that solution. A new solution will cost new money to put into place. However, their current solution is actually more costly than a new solution will be in the end. The current solution requires excessive staff time with work-arounds. The outcomes are often bad, requiring patches and fixes that cost a lot of time and money. But the full cost of the current solution, which is ignored, appears to be lower than the cost of doing something new and better.
An additional assumption made about the current solution is that it will continue to work about the same way as it does today. However, the future requirements are almost always different, and staying with an outdated and unresponsive solution will get even more costly in the future.
When your management considers the evidence that you bring about the advantages of new technology and processes, they are most likely to base their decisions on the total costs of investing in something new. Without better information, those new costs will always appear higher than the costs of staying in place. Christensen points to the typical response of a reluctant management: “You just don’t realize how much it’s going to cost to change how we do things today.”
An innovative organization responds quite differently by saying “we’ve got to make this investment now, or we’ll be in worse trouble in the future.” They recognize that the full cost of staying in place is in fact much greater than the cost of a new investment.
Christensen quotes Henry Ford:
“As Henry Ford once put it, ‘If you need a machine and don’t buy it, then you will ultimately find that you have paid for it and don’t have it.’ Thinking on a marginal basis can be very, very dangerous.”
So, how should you present your case to your management? Let’s look at the graph.
The area under each curve equals the total cost. At the break-even point, the cost of the improved process equals the cost of the current process.
- Start by calculating the startup costs of the new processes, training, and new tools that you want to put into place.
- Add the regular costs of running your department during the transition.
- Next calculate how much you will save by working in the new way over time (translation costs, duplication of content, desktop publishing all can be decreased or eliminated over time).
- Finally, calculate how long it will take you to pay off the original investment (generally one to two years).
If you can demonstrate that your marginal costs in the future will be lower than your marginal costs today, you should have a winning business case. The greater the difference between the present and future marginal costs, the faster you will pay for your investment.
Remember that Blockbuster felt it was too expensive to invest in a new way of delivering their product. They figured that their current marginal costs were already high enough. What they ignored was the potential for decreased marginal costs in the future by substituting mail-order for brick-and-mortar stores. Their short-term profits would have gone down by trying to compete with Netflix. However, had they moved to mail-order, their marginal costs would have decreased significantly and probably very rapidly in the future helped them avoid bankruptcy.