Starting an Online Vs Local Business

Economics of an online business

As someone who has a BA in economics, I cannot help but to bring those economics lessons to what I love best, which is making money online and starting online businesses. Even though I may be biased because I love online business and internet marketing, the economic analysis is simple, yet undeniable.

Lets compare a local retail business to an online business. The amount of people that are willing to buy your product or service is much smaller locally than on a national level. In general, your profit potential is much higher at a national and international level because there are simply more people willing to buy your product. Obviously this all depends on the supply and demand of each market, but generally there is far more reach online. Although your online prices may be lower than locally, the number of people who are interested in purchasing your product are much greater online.

The Economics of local traffic vs national traffic

If you think about it, the amount of traffic you can drive to your website or to your local brick and mortar store is directly proportional to the amount of money you can make.
The following supply and demand graph show that when you have a local retail business, there are only so many people who are interested in your product or service at the local level. As you offer your products to a national market however, the demand curve shifts to the right, allowing much higher profits.

 
You may be able to reach hundreds or possibly thousands of people through foot traffic alone. The drawback to a local business is that your traffic can hit a ceiling. You may find that at first your growth of the business was great until you hit that ceiling. You need more customers to satisfy your desire to grow, yet there aren’t any more people because you’ve already tapped your local market.  After you’ve reached everyone in your town, there is no expansion in your business unless you open a new location in another market (another town for instance).
If you were to start a successful local business, you can earn a decent income. However, if you start a successful online business the potential is much greater. The amount of potential buyers is so much greater, allowing you to easily grow year after year, assuming you have learned some internet marketing techniques.

Diminishing Returns from a Local Physical Store

Pizza Example

Diminishing returns is a popular idea in economics. To gain a conceptual understanding of diminishing returns, here is the pizza example:
Say you are starving and you buy a pizza for lunch. The first slice of pizza is delicious. You get a lot of pleasure out of it because you were so hungry. The second slice is almost as good. The third slice is still good, buy you are not starving at this point. The fourth slice, you are starting to get full. The fifth slice, you are really full and don’t get much pleasure from it at all.
In the beginning, you get a lot of benefit from a pizza slice. Towards the end however, each additional pizza slice gives you proportionally less and less benefit than you were getting from first slice.

Diminishing returns of a Local Store (fixed space)

Since the square footage of your building would be fixed at a local storefront business, you can only have a certain amount of people in your building before it’s just too crowded and people start leaving. In the beginning, each new customer that walks in, brings extra profit to the business owner. At some point though, there are too many people and each extra person in the store adds (proportionately) less and less profit.

The graph shows that from the first 200 customers that walk into a local store, the owner gains $2,000 in profit. But what about the next additional 200 customers? What happens when there are 400 customers in the store? The store owner would only gain $500 more from the second group of 200 people waling in. The first 200 customers brought in much more profit than the second group of 200 customers.
The reason is that physical space causes diminishing returns because the amount of space is fixed. Only a finite amount of people can enter the store. Of course this would be a good problem to have as a business owner, and they would likely move into a bigger building.

An Online Business Doesn’t have this type of diminishing returns

The point is, with an online business the business owner wouldn’t have this issue. Since it is a digital space, thousands and thousands of people could view and place orders on a website at once. Of course after you get incredible amounts of traffic you may have to upgrade your server. This is a much easier task than having to move all your inventory and things over to another location if you were the local business owner experiencing rapid growth of customers.

Local Businesses Typically have Higher Overhead

You can literally start a business online with no money. All you need is a little perseverance and a desire to do so and you will have as many successful online businesses as you want. If you wanted to start a local business though, most of the time you will need to pay for a local storefront or an office. Commercial retail is not cheap and can really add up, especially when you are in the growing phase. You may also need employees, insurance, etc when running a local business.
With an online business all you need is a website. Website hosting doe not cost a lot. You can start online businesses in your spare time from your home. That is the beautiful thing about the internet. You have access to millions of people through SEO, Paid advertising like google adwords, and many other methods.
Starting an Online business may not be for everyone. It really comes down to where your preferences lie. There are still a lot of great opportunities that entrepreneurs can find locally. I personally love the low barriers to entry and the ease at which I can start an online business.