The purported enemy we cannot live without

kw: book reviews, nonfiction, business, debunking, polemics

Whether you are reading this on a laptop or desktop computer, or on a tablet or a phone, that "device" is probably a cornerstone of your life, and it probably cost between two and twenty times the amount of pay you receive for an hour's work. The iPhone 10 or iPhone X currently retails for $999, about twice as much as a pretty good laptop computer, which is close to 40 times the hourly pay for someone with median income in the U.S. Most of the 200+ million iPhones sold in the past year cost between $500 and $800. The amount of money that changed hands was roughly $150 billion.

Why do people pay so much for an item the size of an open wallet? In a word: Value. These "devices" do, not just something people want, but a very great many things most people want, and they want it very much. So they pay.

Now look around the room you are in. If you were to count, from paper clips to furniture, the room you are in probably contains hundreds to thousands of items. Every one of those items was bought at some time, either by you or a housemate or family member, or by someone who gave it to you. In the basement room I am sitting in to write this, I have many books. Probably more than 1,000. There are nearly 30 cookbooks, for example. This computer is accompanied by two printers, a couple of scanners, several reams of paper, a big desk, and a router. A closet holds an oscilloscope and other electronics I use less frequently. On a bench behind me there are two microscopes and a great many things needed to use them effectively. Every one of these things was bought, mostly by me, at some time. The only things in the room that I did not buy is the mineral specimens on a display shelf, minerals I collected. Of course, I bought a lot of gasoline for those rock collecting trips, and I bought rock hammers and chisels, bags, etc., etc.

Every one of those purchased items, except for a very few "loss leaders", yielded a profit to the seller. Why was there a profit? Simply put, incentive. The chance to make a profit is the reason for the existence of any and every business.

Ask yourself this: If you were to go into business selling left-handed fribble widgets, and the materials to make them cost $10 each, but people are only willing to pay $8 each, why would you run such a business? You need a lot of cash to back you up, so you could effectively pay $2 each for people to take a widget off your hands! But if people were willing to buy them for $12, and no matter how many you make, you'd have a never-ending clientele willing to pay $12 each, and then you could really do business. Each widget you sell, you have a 20% capital profit. Assuming they don't take long to manufacture, so there is little time cost, that's pretty good.

But really, why do you need profit? Why not sell them for $10? The biggest reason is, you need to pay yourself for your work. You need the income to buy food, clothing, other things you want, and perhaps pay a mortgage and car payment. You have bills to pay for electricity, water and so forth. There might be a machine you could buy that helps you make widgets faster (though the materials still cost the same). Making more widgets in less time, you can earn more money, but you'll need some of that to pay off the loan you have to take out to buy the widget making machine. So, for a while you have to operate on a thin margin. Maybe net profit for a while is only 5%. But later, you'll have more income each day. Then you can get better clothing and eat out more often.

That is why there is business. To make money for people so they can buy things they don't make for themselves. Now consider, what if instead of widgets you want to make jumbo jets, and compete with the companies that make the Boeing 787 or the Airbus A380. It takes thousands of workers to run such a company. It is not just business, it is Big Business.

Does all business need to be Big Business? No. For every big company there are thousands of small ones. But many people are suspicious of Big Business. Folks complain about all kinds of things, from the high pay of executives to the "cookie cutter" nature of many products that seem like all the others. When my father ran a manufacturing company, he said the profit margin was close to zero; less than 1%. That is long term net profit, after materials, salaries, dividend payments on stock, taxes and utility bills, plus upkeep of machinery. The upkeep was the biggest uncertainty. In most years, there was a profit figure more like 4%, but the company saved it all, because every few years a big, expensive machine would need repair or restoration or replacement, and it would use up most of those savings. The profit figure in such a year might be negative 15%, but they amortized it (spread the cost out over all the years since the last time) to avoid panicking the stockholders. This company was on the boundary between small and big, with about 500 employees. It didn't need to grow any bigger; it fit its market pretty well.

If a company wants to grow, it needs a bigger profit margin. Growing companies have to get the money to grow from somewhere, and there is ultimately nowhere to get it but from current sales. You may borrow to invest in the needed equipment or facilities, but you have to pay it back…with money from current sales. I came across a good quote about profit:

"Any business arrangement that is not profitable to the other person will in the end prove unprofitable for you. The bargain that yields mutual satisfaction is the only one that is apt to be repeated." —B. C. Forbes

Considering that everything you own was sold at a profit, it is odd that so many people are so down on business. In recent years (30+) there has been an increasing attitude that big business is bad in almost every way. Article after article, and many books, are published on this theme, that big business is a big problem.

Well, no doubt some problems are there. But some of the things we hear about and read about are not quite so dire. In 2009 Michael Medved published The 5 Big Lies about American Business: Combating Smears Against the Free-market Economy in an attempt to set the record straight. I recently heard about this book, and bought the e-book. The quote above is from that book.

For me this was an experiment. I wanted to know how much different reading an e-book might be from the paper books I love, my exclusive fare before this. It was actually a great convenience. Since I always have my phone with me (a $150 t-Mobile REVVL, not an iPhone), I could open the book and read whenever I had free time. I have been reading another book at the same time (not finished yet), but that book stays at home, usually by my bedside, and it is big. In another few days I'll finish that book and review it then.

What are the big lies? Putting them more briefly than the author:

1. The current downturn means capitalism is dying
2. When the rich get richer the poor get poorer
3. Executives are overpaid and corrupt
4. Big business is bad, small business is good
5. Government is more fair and reliable than business

Let me state at the outset: If you believe #5 is true, stop reading now and go start a business. You might learn something. You can't possibly have had any meaningful experience of either government or business. The Law of Government Spending is, "Nobody spends someone else's money as carefully as they spend their own."

I don't intend to rehash these 5 points. It is well worth reading the book to get the appropriate impact. I do want to address #2. In some cases, the rich really are corrupt and wasteful. But most of the rich got that way by making value where there was none. They did indeed gather a lot of riches, but the people that worked for their companies, the supplier companies they paid for intermediate products or materials, and the people who were able to pay less for their product than the competing one they had been buying before, all were richer than before.

Key learning: Business is not just about moving money around, from one set of pockets to another. Business is about creating or adding value. There is a centuries-old debate about the source of value. People say, "Oh, Gold has value intrinsically. It is valuable just because it is gold." Others say, "Gold has value because people want it." Both are right. Gold is useful and so has intrinsic value. It is also beautiful, so people want it as an ornament. There is a third reason: "Gold has a certain intrinsic value, but when it is in the ground, it isn't worth much because it takes a lot of work to mine it and refine it, and it takes more work to make things out of gold that people will pay for, such as jewelry, or special kinds of wire for electronics, or coins and medallions. Most 'value' comes from labor." This is also right. Much of the value of gold, or anything else "of value" is from the labor of those who mined, refined, produced, or manufactured it. Business creates value.

I'll also touch on #3. Is "income disparity" a bad thing? Some kinds of work, anyone can do. The classic is "digging ditches". When I was a kid, parents would say, "Get a good education. You don't want to become a ditch digger." I never saw anyone digging a ditch by hand (yes, there were backhoes in the 1950's). But we got the point. "Minimum wage" jobs are those that need little or no skill. I made my living for more than half my life as a software coder. That is a skill that is less common, and really good coders (Ahem! Yes, I was really good) are well paid because a lot of code needs to be written, it has to be high in quality, and there are not nearly as many coders as there are unskilled workers. My dad was a business executive. He was paid more per hour or month or whatever than I ever was. He had skills that were less common than mine. Not only that, a good executive or manager doesn't just do work, but facilitates the work of others so they are productive and more work gets done.

Side note: I often eat fast food, including Wendy's. The Wendy's nearest us recently went out of business and was closed. A Starbucks came in a few weeks later. There are other Wendy's places I can go to, and do you know what? I went to the nearby one because it was convenient, and it was "good enough". But compared to the others, the servers were second-rate and slow, and the parking lot was in serious disrepair. At least it was clean; one can always look into the kitchen to see that, and I'd also check the tables and floors. But it didn't do enough business to stay in business. The other Wendy's places I go to now are busier than it ever was. The difference? Management.

Back to #3. Why did the president of DuPont (Mrs. Kuhlman) earn a million dollars per month during my last few years there? Even assuming that she worked a 60-hour week (maybe she worked more), was her time worth upwards of $3,500 per hour? Could she really produce more "value" for DuPont in one hour than I could in a month? The board of directors evidently thought she could. I do know that the company was better run under her, and more profitable, than it had been under the prior two presidents (those between the legendary Mr. Woolard and her). But really, here is who I think is worth $3,500 per hour: the guy who goes in with a screwdriver and disarms a terrorist's bomb. Anybody else, I wouldn't pay more than about a tenth of that, company presidents included. But Medved's writing on this point had me about half convinced that CEO's really are worth their pay. Let's call it a draw.

And…I'll leave it all right there. Do you fear, suspect, or loathe business, especially Big Business? Remember the jumbo jets. You aren't going overseas on your vacation without one. Small business can do a lot, but it can't do everything. There's a place for businesses of all sizes. And that's as it should be. The book is a great read.