Wednesday, October 27, 2010

How Does a Business Make Money?

“The first rule is, you must not fool yourself. And you are the easiest person to fool.”
~ Richard Feynman


How does an enterprise make money?

I submit that a business derives economic value (profit) through a combination of value for labor, intellectual value (skill/strategy), and chance (luck, good or bad), nothing more, and nothing less. Further, I submit that labor and chance are essentially the same for any enterprise, making intellectual value the only variable that is not constant.

Thus;

V=L+I+C

One might counter that he could skew the chance part of this equation through superior strategy, but would this not go under intellectual value? Another might counter that his labor value is higher than another's, but again, would this premium not instead be a part of intellectual value? The only possible exception to this non-variability might be geographic, as labor, for convenience and infrastucture (to include language and culture) reasons, is different in one place than in another. Regardless, I'd submit that labor is constant (and low) in any particular geographic region, such that one can ignore the difference for different regions without compromising the integrity of the concept.

A quick note while I'm discussing labor. I'd submit labor value is not defined by minimum wage, but instead is some other number, likely lower than minimum wage (otherwise there would be no need for a minimum wage law). The difference between the true labor value and minimum wage is essentially a redistributive tax, which is another subject to itself. This "tax" effectively slightly stacks the odds against a business as one must overcome this "tax" to make a profit.

So what does one do with this, if anything? If one manufactures a gumball machine with a dispensing rotor powered by a 400 horsepower engine, does it make it a better gumball machine, or it more a case of misplaced horsepower? Is the business and/or industry you are in one that optimally uses your team's horsepower, or is it more of a case of a Ferrari engine on a economy car transmission? If the latter, is there something you could do differently (perhaps some complete other version of your business) from the way you do it now that would improve the efficiency of your transmission? Finally, are you in the right industry to begin with, or should you leave it for the economy car engines engines of the world?

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