Finance: What is marginal cost?

Marginal cost is a company's cost adjusted for manufacturing, shipping, and any other overhead involved in the sale of its product.

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Transcript

00:20

glory Our awesome lemonade stand So from a resource is

00:24

allocation perspective margins drive everything you ever read Animal farm

00:30

Well if you look in the very fine print you'll

00:32

see that it really says high margins good higher margins

00:37

better But margins are a contextual thing They're evaluated on

00:40

a relative basis Basically the more of a commodity Something

00:44

is generally speaking the more rivalrous the industry there in

00:49

meaning tons and tons of sellers all competing on price

00:52

for the same product and thus lower margins for that

00:56

highly competitive industry Think about the very mature in declining

01:00

paper in pulp industry long history tons of competitors They

01:04

all sell the same old dead tree product There's almost

01:09

no differentiation between one seller or another of paper and

01:12

pulp And they're filled with unions Yeah way low margin

01:16

world less and less demand for paper and paul peach

01:19

Year is everything moves online Polluters mostly overseas have a

01:23

structural advantage over non polluters because it's cheaper to make

01:27

paper pulp when you could just pollute dump everything in

01:30

the river right Well in the us where houser is

01:32

the paper and pulp gorilla And in a great year

01:35

this very commoditized company filled with union workers has only

01:39

ten ish percent margins where houser sells a ton of

01:42

pulp for some three grand or so which cost it

01:45

just two grand and change to manufacture But then if

01:48

you add in operating costs like shipping union pension funds

01:52

senior management lawyers rent and more lawyers will even its

01:56

scale that three grand of revenues from a ton of

01:59

pulps sold cost warehouses something well over twenty five hundred

02:03

bucks So that pretax they only make five hundred box

02:07

or less from every three grand of revenues right that

02:10

be their operating margin there Well compare warehouses with google's

02:13

search business Google owns the world in the search category

02:18

with over eighty percent of all searches going to its

02:21

servers Essentially no riel competitors today Sorry microsoft Just keeping

02:26

it real Google makes money by selling virtual real estate

02:29

Or cliques and views a typical click on ah highly

02:33

big keyword like taxes help or mesothelioma Ambulance chasing lawyers

02:40

is something like fifty cents per click or more Well

02:43

google's marginal cost for that click Well not a lot

02:47

the electricity to serve the page but well that's about

02:50

it Call it a penny So google search business alone

02:52

is like a ninety percent plus gross margin kind of

02:56

business Pretax They have almost no marginal cost of goods

03:00

sold Really amazing business way different from twenty five hundred

03:04

dollars to sell three grand worth of pulp Google has

03:07

no cost of shipping and a small handful of highly

03:10

paid engineers a call in a few hundred of them

03:13

who actually matter to the process today Well they created

03:16

a mathematical algorithm that truly scales meaning it gets bigger

03:20

and more profitable The bigger it grows well the marginal

03:23

additional cost of one more click to google is almost

03:26

nothing and it's a vast contrast to that paper and

03:29

pulp business where yet more forests have to be planted

03:32

more lumberjacks need to be hired and then probably injured

03:36

More trees need to be killed and shift and chemically

03:38

altered with bleach and on and on and on so

03:41

relative to its competitors wear hauser might be doing great

03:45

with ten percent plus margins But the fact is the

03:48

paper and pulp business is a lousy industry a lousy

03:51

business when compared with the search industry Who's n plus

03:54

one thor Additional units sold Cost google almost nothing The

03:58

basic idea is that you have to understand margin in

04:01

the context of an industry and in the context of

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an economic climate that could be good bad and or 00:04:09.298 --> [endTime] ugly