Let's say the toy I wanted cost $100 and a pitcher of Kool Aid yields twenty servings in tiny paper cups. If I sell my Kool Aid at $5 per cup, I'll end up with the hundred bucks. I can close up shop, take the bus to the store, buy the toy, and live happily ever after. Right? Uh, nope.
Nobody would buy my Kool Aid for $5 per cup. That's too much to pay, even for some adult passing by who thinks my little venture into entrepreneurialism merited encouragement. After my ice started to melt, and a few people told me my price was way too high, I'd change my strategy. I could ask someone how much they'd be willing to pay for a nice, cold, refreshing cup of tasty Kool Aid. Let's say they tell me they'd happily pay 25 cents. No problem! I'll sell them for 25 cents a cup and make only $5 for the pitcher. I can always make 19 more pitchers, sell them all, and end up with my hundred bucks. Right? Uh, nope.
When I run out of Kool Aid and sugar, mom tells me I have to buy some more. I can't run my Kool Aid business at her expense. So I learn the first lesson in Business 101: Stuff you sell costs money to make. I give mom my $5 and ask her to buy more Kool Aid, sugar and cups. She does, and I make another pitcher. Great! At this pace I'll have my toy in my hands in no time! Right? Uh, nope.
Because it costs me $5 to make $5, my profit margin is zero. I can make and sell Kool Aid at that rate forever and I'll never get ahead. I may have a zillion happy customers, but I'll be working for nothing. No problem. I'll raise my price to 30 cents. Maybe fewer people will buy at that price, but at least I'll make a nickel a cup in profit. My total earnings will be $1 per pitcher, after expenses. I'm on my way to getting that toy now! Right? Uh, nope.
I get a bunch of my friends together and hire them all to run Kool Aid stands all over the neighborhood. Since I make a buck a day from my stand, twenty stands should make me $20 a day. Heck, I'll get my toy in less than a week now! Right? Uh, nope.
You see, I was working for free. My labor costs were zero. As sole owner of my corporation, I was taking the $1 profit out in the form of a dividend. You could also call it wages. My friends don't get anything in return from investing a day in their life selling Kool Aid for me. If they demand $1 a day in wages, my profit from each of their stands would be zero. Therefore, there's no point in expanding. It's not profitable. Besides, I might flood the market with Kool Aid, making it much harder to sell. The "Supply" of Kool Aid would now exceed the "Demand," to put that in business terms. I'll just have to work for 99 more weeks before I can buy my toy. Right? Uh, nope.
Let's say it takes me all day to sell one pitcher of Kool Aid. But, over the course of the day the ice melts and I have to waste the last five cups. I would have made $6 selling 20 cups at 30 cents each. But selling only 15 cups leaves me with only $4.50. Instead of making a dollar profit, I've lost 50 cents. The next day, I'll just raise my price to 50 cents a cup. That should do the trick. Right? Uh, nope.
When I get out there and open my stand the next day, people who used to buy my Kool Aid just keep walking. They glance over, see the new price, grumble something about "ripoff" and then walk across the street to a little girl who has just started selling Lemonade for 30 cents a cup! I've got to go back to the 30 cent price. I can't compete with that girl if I don't. I don't know how she does it, but she MUST be making a profit at that price. I just KNOW it! Right? Uh, nope.
I ask my dad for help. He says he'll go find out how my competitor is able to make a profit. In business we call this intelligence, market research, competitive analysis, maybe even espionage. My dad learns that my competitor's parents have been subsidizing her little business venture. They're "helping her learn business" by making her pay only HALF the cost of the materials and GIVING her the rest. Little do they know, they're not actually helping her. In the real world, nobody gives you anything for free. Well, unless you're a "green energy" company and the guy you supported became President and handed you some taxpayer money. But I digress. My dad won't help me, even though he could, because he doesn't think that would teach me how business really works. I hate him for it now, but I'll thank him later. But all I have to do is stick to the original plan, except to make sure I sell all 20 cups in every pitcher. I'll make my $1 profit every day, plus I'll come away from the experience with a more realistic view of how business really works. All is good. Right? Uh, nope.
At the rate of $1 per day profit, it will take 100 days to earn the money to buy that toy I want. Well before that happens, Winter will come and it'll be too cold to sell Kool Aid. The best I can hope for is that my parents will get me that toy I want for Christmas. Maybe if I bribe them with the $40 profit I made during the summer? Perhaps.
Now lets break this down from a purely business perspective:
The Kool Aid and sugar are my raw materials. They cost $5 per pitcher.
The $6 I get from selling each pitcher are my gross receipts.
Costs:
Materials = $5
Total operating costs = $5
Income:
Inventory = 20 cups of Kool Aid
Unit price = 30 cents
Total gross receipts = $6
Profit = Income minus Costs = $6 - $5 = $1
The profit is paid to the only shareholder, me, as a dividend.
Now imagine that the Kool Aid stand is Apple Computers. They make something called an iPhone and sell them for $500 each. Of course, they have a LOT more things going into the "Costs" side of the balance sheet. But, essentially, the principles are the same. This is hypothetical, because I don't have access to Apple's financial records, but:
Costs:
Materials = $550,000,000
Research & Development = $35,000,000
Legal expenses = $10,000,000
Marketing = $50,000,000
Labor = $800,000,000
Shipping and Distribution = $250,000,000
Taxes and fees = $100,000,000
Total operating costs = $1,800,000,000
Income
Inventory = 5,000,000
Unit price = $500
Total gross receipts = $2,500,000,000.
Wow, Apple is rich! They make $2.5 BILLION dollars a year from this one product! Uh, nope.
Profit = Income minus Costs = $2.5B minus $1.8B = $700,000,000
Still, that's a LOT of money. If they had 70,000,000 shareholders, each one would get a $10 dividend for this one profitable product.
Again, I have absolutely no links to support these numbers. They're completely made up and probably WAY WAY off. I wasn't trying to analyze Apple Computers. I set out to prove another point.
Let's say that Apple pays $800,000,000 to Chinese workers who each make about $2,000 a year. Let's say that American workers doing the same job would cost $30,000 a year to do the same job. That means that the American workers make about 15 times what the American workers make. Good for them, right? Uh, nope.
If Apple made those iPhones here, their labor would cost 15 times as much, or a whopping $12,000,000,000. That would raise their total operating costs to $13,000,000,000. If they kept the prices the same, they would lose money. In fact, that would turn a $700M profit into a $10.5B loss! In order for Apple to break even, making NO profit at all, they'd have to sell each iPhone for $2600. Just like my 50 cent Kool Aid, most people would just walk on by mumbling something about 'ripoff' as they passed without buying. That's the end of the story, right? If Apple didn't outsource their labor, there would be no iPhones at all, right? Uh, nope.
You see, some other company, either in America (think Google or Microsoft), or in some other country, WOULD make the iPhone, and they WOULD outsource, and they WOULD sell their equal quality phones for $500 each. Apple would no longer exist, but someone else would take their place.
What's the solution to this nightmare? Certainly American workers cannot feed their families on a $1500 a year wage! We certainly can't afford $2600 iPhones!
I think I know the solution, but I'll save that for the next post. In the meantime, I hope somebody tries to dispute my math. Plug in the real numbers, if you can. See if you can show me where I'm wrong. I'm willing to learn! When you realize that I'm right, see if you can come up with some actual solutions to this problem. We'll see how close we come to the same conclusion.
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