#TBT: Let’s Get Marginal

Happy #TBT. To celebrate, we’re sharing an oldie-but-goodie post from Jim: Let’s Get Marginal

There’s a very common analytical error that producers of live entertainment make. It’s the kind of mistake that comes straight from human nature, and so in a way, it’s hard to blame theatre producers specifically for making it. Most of them never claimed to be quant jocks.  In fact, many of them actively protest that numbers give them the heebie jeebies.

Fair enough, but the consequences of this mistake are profound, so even if the last time you voluntarily came into contact with calculations more complex than ‘buy six cappuccinos and the next one’s free’ you should still listen up.

I read recently on a blog that a theatre producer can’t afford to sell tickets at a certain price because it’s “below his cost.”

Hmmm. Let’s dig into that a bit. Suppose your play starts at 8 pm. You’ve sold 457 tickets. (Don’t worry … 457 could be any number. No math required.) Just before the doors close, somebody runs up to the box office huffing and puffing and buys tickets number 458 and 459.

What is your cost to serve these two last-minute patrons? That is, what is the CHANGE in total amount of money you’ll be spending to put on tonight’s performance?

If you said “damn near zero,” you’re right.

The fact is that serving one more patron causes almost no CHANGE to your costs. The word economists use for this is “marginal.” In other words, there is no marginal cost to serving a last-minute patron.

In fact, if you think about it, there’s no marginal cost to serving the previous customer either, or customer 406, or customer 322, or customer 189, or customer 66.

Or possibly even customer 2.

In the short run*, your costs are almost all “fixed.” A fixed cost is a cost that doesn’t change with the number of people you serve, and the live entertainment industry is mostly fixed costs: rent, lighting, costumes, that kind of thing. And within the context of a single performance, even things like actors salaries are fixed costs. It doesn’t matter how many people come through the door. In most cases, you’re paying the performer the same amount. (One conspicuous exception to this is the concert business, sometimes.)

So what’s the mistake I’m talking about? Theatre producers in particular seem to make all kinds of errors in judgment about what to do based on the notion that tickets have a “cost” to them. If I truly believe that my 412th seat “costs” me $25 to provide, then I will behave very differently than if I realize that the 412th seat is instead NOTHING MORE THAN A REVENUE OPPORTUNITY. This will eventually be reflected as a $0 revenue or something greater than $0.

And if you don’t believe me, do this mental experiment:

  • Make a list of all the costs to put on tonight’s show. Write them down if it helps.
  • Now estimate how many people are coming to your show and the average price they’re going to pay to be there. Tabulate the total amount of revenue you’re expecting.
  • Now subtract the costs from the revenue. That the “marginal” profit from tonight’s show.  (Hopefully, it’s positive.)
  • Now add five to the total number of people coming to your show. Change the revenue as a result.

We’ve definitely added revenue, but are there new costs? What exactly would they be and what’s the total you added to your cost line above? My guess is that “damn near zero” is what you came up with again.

So if these last five people cost you next to nothing to serve, ask yourself this: What’s the difference between them and the previous five or the five before that or the five before that? The answer is: There’s no difference. Only the very first patron has more than a trivial cost to serve in the great majority of cases. And really, that’s just another way of saying that deciding to do the show at all is the only thing that has significant costs.

Through this lens, the challenge is completely different. It’s not about selling the ticket above cost, because we now know that the marginal cost of providing that ticket is zero. In reality, the idea of a marginal cost on the ticket is absurd.

What you should be doing instead is managing revenue per available seat to be as high as possible. Every seat in the house is an expiring opportunity to improve the financial performance of your show. It’s a potential revenue-bearing asset, not a liability with a cost.

So go easy on yourself if you’ve made this mistake in the past. You’re not alone. Big companies all over the world made this kind of mistake for most of the 20th century. In fact, before good modeling software came along, it was pretty difficult to think “marginally” because it was too time-consuming.

But now, it’s easy. Even for theater majors! BTW, if there’s anyone who has questions about this or could use some help making sure they understand it, feel free to contact me. While not a theater major, my MBA was preceded by a degree in English Language and Literature. You’ve been warned! I do my spreadsheets in iambic pentameter.

*In the longer run, more costs are variable. You could cancel nights, bring in less usher staff, buy a smaller sound system, or whatever other decisions you might make to reduce the cost structure of a show. Even then, though, these costs are fixed relative to an individual ticket buyer. You’re still basically deciding to do a show or not do a show, even if you have reduced the fixed cost structure.

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