Why Start Ups Need to Understand Consumer Surplus

Many start-ups fail because they can’t generate sufficient consumer surplus. What the heck is it anyway?

When someone says, “consumer surplus”, I strongly doubt that the first thing that comes into your mind is a burning urgency to make your customers happy.  And yet, it should.

Julesdupuit
My man Jules

Consumer surplus was pioneered by a French engineer, Jules Dupuit, in the 1840s.  He proposed the idea that the difference between what you would be willing to pay for something, and what you actually pay for it, is a benefit to you the consumer.  This is a surplus in value, that makes you happier.  He called it, consumer surplus.  For example, you may be willing to pay a lot more for that cool phone in your pocket than you really paid for it. I’m hoping you didn’t steal it, that would be illegal surplus, but I digress.

When you create a new company providing a product or service, you have to think about consumer surplus.  If your offering does not generate a massive amount of consumer surplus, beyond other substitutes and competitors in the market, then no one will buy your new stuff and your company will fail.

However, if you can aggressively price your service where people feel like they’re getting a steal, then you can create a position for yourself and actually sell something (assuming you’re even charging money to the customer).  Of course, Mark Zuckerberg decided to give Facebook away for free, thus creating massive consumer surplus for the billions of people using his service and not paying one thin dime for it.

However, Zuckerberg also creates a massive consumer surplus in another market: advertising.  Before Facebook, it was pretty tough to find customers who fit your companies demographic and consumer profile.  Most companies did mass mailings to zip codes where they suspected most of the readers had the most affinity for their product/service, or took out massive media campaigns most people saw and ignored since it didn’t apply to them.  This advertising was like firing a shotgun into a crowd and hoping you got your target.  Not only that, it was very expensive to reach everyone, and that was your only option.  For advertisers, Facebook created the opportunity to identify your most likely customers with pinpoint precision, and then only buy the marketing that specifically focused on them.  In this way, advertisers were able to save money over traditional campaigns, and get better, measurable results on their advertising (read: boat loads of additional consumer surplus in the advertising market).

So, now that you understand that to grow your business and sell a ton of cool stuff, you need to find ways to increase consumer surplus for your customers as much as you can.  Now, look over at your business partner and say, “hey buddy, lets start to brainstorm how we can create more consumer surplus.” If he looks at you funny, please share this post.  Well, even if he doesn’t, you probably should share it anyway.  It is a nerdy/cool article.

Author: Joe Merrill

I'm a VC in Austin, TX.

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