May 17, 2019

Follow up re Zero Incremental Costs

Sent by Jonathan Stark on May 18th, 2019

Fellow list member Leigh George wrote in with a follow-up question regarding my recent message about the New York Times promoting a “sponsor a student subscription” offer to their existing subscribers. (subject line: “Zero Incremental Costs”).

Here’s what Leigh had to say (shared with permission, bold mine):

Hi Jonathan! Longtime reader. This email sparks thinking around zero incremental cost and the idea that student subscriptions “costs them virtually nothing” Is there a tipping point where the pretty big cost of running a national newspaper in terms of salaries, fixed costs, etc. is exceeded by a certain level of subscription income beyond which everything--additional paid subscriptions, student sponsorships, etc. is profit? or to put it another way “costs them virtually nothing”? I’m guessing you framed the student subscriptions the way you did because of the logic that there are no costs or expenses around offering sponsored student subscriptions but is that only because the stuff that does cost them money (creation of content) already exists and has already been paid for? Hope I haven’t gone down a rabbit hole here! Thanks! Leigh

Thanks Leigh!

Leigh’s message touches on a few different business concepts:

I’ll talk about each of these individually in future messages, but to answer Leigh’s question from a technical standpoint…

Let’s imagine a newspaper business that only delivers physical newspapers to subscribers (i.e., no newsstand sales, no digital sales). They own an office building, a printing press, a small fleet of delivery trucks, and various other assets.

Also, they employ a few hundred people: writers, reporters, editors, sales people, truck drivers, delivery people, press operators, managers, execs, etc.

And every month, they buy enough paper, ink, gasoline, and other consumable supplies for the upcoming month.

The newspaper has to pay roughly the same amount every month for things like mortgage interest, salaries, and maintenance. These are examples of fixed costs. Whether they have 1 subscriber or 1,000,000, they still have to pay these fixed costs.

The newspaper’s variable costs, on the other hand, would be things like paper, ink, and gas. The more subscribers they have, the more papers they need to print and deliver… and the higher these costs go up.

There’s a direct connection between how many subscriptions they sell and how much paper and ink and gas they have to buy. If in one month they lose all their subscribers (and therefore don’t have to print and deliver any newspapers), then they don’t have to buy any more raw paper or ink or gas.

Running a break-even analysis for this newspaper would involve figuring out how many subscriptions the company would need to sell (and at what profit margin) to cover both the variable and fixed costs.

Okay, now back to the NYT example. Since we’re talking about DIGITAL subscriptions, there’s no paper, no ink, and no gas. Which is to say, there are virtually no variable costs associated with increased sales. Yes, the NYT still has all their fixed costs, but it has those no matter what. And sure, they might have to hire a couple people specifically to manage the marketing, sales, and support of student subscriptions but that’s a rounding error compared to paper, ink, and gas.

Here’s the thing…

Folks like us don’t run a capital intensive business like an old school newspaper. Our fixed costs are things like office rent, internet access, cell service, SaaS subscriptions, maybe a new computer or phone every year or so, etc.

If you sell your services on an hourly basis, your variable cost is your time. It’s tied directly to your gross revenue. For every hour you sell, it costs you an hour to deliver.

Which brings us to a key point:

If you’re billing for your time, there is no way to improve your profit margin per hour by becoming more efficient.

So… part of the genius of what the NYT did was to come up with an answer to the question:

“What can we sell based on these fixed costs that won’t increase our variable costs?”

If you can answer this question, you will have an extremely profitable offering.