The Trap of Marginal Thinking

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  • April 10, 2017

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What do Jeffrey Skilling, the disgraced former CEO of Enron, and Blockbuster, the defunct video rental chain have in common? According to Clayton Christensen in his book How Will You Measure Your Life? both fell into the trap of marginal thinking.

When I first started learning about economics and finance, the concept of marginal cost was one of the first I learned. For those who don’t have the same background in those subjects as I do, marginal cost is the cost of producing one more unit of a given good. That is, when you’re looking to increase your production of something by one, the additional cost required to produce the next unit is the marginal cost. This includes all costs involved, not just the cost of the item in question. For example, if you have a car factory and you want to produce one more car than you are now, and doing so requires building a second factory, then your marginal cost includes the cost of that factory and any associated equipment or personnel, as well as the cost of that car.

“Thanks for the economics lesson, Todd,” I can hear you saying. “But what does that have to do with the Monday Motivator?” Well, Christensen, in his book, talks about an extrapolation of this concept: marginal thinking. Basically, if you’re going to make a decision, will the decision benefit you or will it cost you? What’s the margin on that decision?

Blockbuster’s Marginal Thinking

In the book, Christensen talks about the battle between Netflix and Blockbuster in the late 1990s and early 2000s. Blockbuster dominated the movie rental industry, having made significant investments in inventory for thousands of retail stores across the U.S. They were a multibillion-dollar business. Netflix, on the other hand, was a scrappy upstart. They focused on a very small segment of the market, so Blockbuster didn’t really see them as a threat.

By 2002, Netflix had seen $150 million in revenues and a healthy profit margin. They were clearly onto something. Blockbuster could have easily entered the same market, challenging Netflix, but they saw a small market and determined the cost wasn’t worth the benefit. We all know how that shook out.

Jeffrey Skilling and Nick Leeson

Christensen also applies the idea of marginal thinking to integrity in our personal lives. “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.” Christensen was classmates with Jeffrey Skilling, the now-disgraced former CEO of Enron. He remembers a man with impeccable integrity, but even impeccable integrity can be worn away over time by making choices that don’t seem to cost much. In aggregate, though, they can get you.

Christensen also talks about Nick Leeson, the 26-year-old trader who brought down British merchant bank Barings in 1995 after racking up $1.3 billion in trading losses before being detected. Leeson talks about how marginal thinking led him down an unthinkable path: It started with one small error, but he didn’t want to admit to it. Instead, he covered it up by hiding the loss in a little-scrutinized trading account. It led him deeper and deeper down a path of deception.

Marginal Thinking in Business

Marginal thinking often seems like making the smart choice. Costs that are low to begin with can spiral out of control, though.

In the case of Blockbuster and Netflix, Blockbuster had so much invested in inventory and stores that they failed to see that the niche DVD delivery and streaming business would eventually supplant the need for retail stores entirely. In 2016, Netflix had almost $9 billion in revenue and currently has a market capitalization of over $60 billion. Blockbuster, of course, is gone.

In business, marginal thinking manifests in the form of companies relying on what they already have in place and what’s worked in the past, instead of investing in the future. As Blockbuster learned the hard way, we end up paying for the full cost of our decisions, not the marginal costs, whether we like it or not.

In practice, the marginal-cost argument often overwhelms the full-cost argument. It leads to risk-averse behavior, which can dull a company’s competitive edge over time. 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.”

Marginal Thinking in Life

Marginal thinking can be even more dangerous in your personal life. Christensen says, “100% of the time is easier than 98% of the time.” The marginal cost of doing something “just this once” always seems to be negligible, but the full cost will typically be much higher.

And yet, unconsciously, we naturally employ the marginal-cost doctrine in our personal lives. We get caught in this trap of “small white lies,” “just one drink,” and so on. Being aware of this thinking is the first step to being critical of it, and avoiding it, when you catch yourself thinking about marginal costs.

People ask me why I work out seven days per week, or why I journal every day, or why I get up at 5:15 every morning. The simple answer has always been that doing it all the time is much easier than doing it some of the time.

How do you avoid marginal thinking in your life? What are some tools you use to develop good habits?

About Todd Zipper

President & Chief Executive Officer

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