A fundamental principle in economics is that rational people often make decisions by comparing marginal benefits and marginal costs. Rational decision makers will tend only to take action when the marginal benefit of a proposed action exceeds the marginal cost.
Two key implications of marginal thinking for businesses are the following:
- The costs of production, and firm profitability, is a result of choices. For example, choosing to make one more unit of a product is a marginal decision – as long as marginal revenue exceeds or equals marginal cost, making one additional unit is a reasonable course of action. Therefore, products and services do not have costs – it is the decisions associated with them that do.
- Competitive advantage may well rest on the degree to which a firm can provide value that exceeds a customer’s willingness to pay. Willingness to pay is a function of the marginal utility a customer perceives they will receive from consuming a product or service. As a firm increases the value it offers, consumers’ utility also increases, but at a decreasing rate. This decreasing marginal utility in turn results in a lower willingness to pay. Decreasing marginal utility among consumers is a key factor firms should consider when making value or performance improvements.
From the above, it can be seen that marginal thinking and decision-making impacts a firm on both the supply and demand sides. Decomposing marginal thinking into key demand and supply drivers can be instructive for strategy development and formulation.