Not everyone can be the marginal cost consumer…

Punch line: Netflix got into a hole by initially giving away its video streaming offerings … in essence, pricing based on marginal cost.

That can work, when everybody isn’t a marginal customer …

Excerpted from The Atlantic by Megan McArdle:
The Qwikster and the Dead

Netflix tried to build their streaming video service by giving it away for free, as an add-on to their snail-mail service. 

This was a good way to add customers.  But the history of the internet indicates that once you convince people something is supposed to be free, or close to it, you will have a devilishly hard time getting them to pay for it. 

People decided that they were supposed to be able to stream unlimited movies for free.

This never made any sense; people were confusing the marginal cost with the average cost. 

You can always get a sweet deal if you are the customer who gets marginal cost pricing

Medicare does this — reimburses hospitals at above their marginal cost, but below their average cost, so that private insurers have to pick up most of the hospital overhead. 

European countries do this with prescription drugs: reimburse above the marginal cost of producing the pills, but below the total cost of developing the pills, so that the US has to pick up most of the tab for drug development.

The problem is that as voters and as customers, we often get the notion that marginal costing can be extrapolated to everyone. 

So liberal policy wonks want to save money by putting everyone on Medicare, or some equivalent program that uses the government’s monopsony pricing power to get lower prices for everyone.

But, it doesn’t work that way.

Everyone cannot be the marginal cost consumer. 

Someone has to cover things like overhead and development costs. 

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