My BIL is starting a new business, selling trinkets and doodads and whatnot - think airport gift shop - engraved with whatever the customer wants. Not a bad idea, I guess, though I’m not sure how good the market for these things is.
Anyway. He’s planning on selling these for as cheap as he can, and when I pointed out that his current price plan means he’ll be losing money on each transaction (due to overhead, etc), he said, “Oh, don’t worry, we’ll make it up on volume.”
I didn’t take Economics 101 or anything, but, um… how? I don’t Get It. If you’re losing money every time you sell something, and that’s your only source of revenue, then HOW do you ever ‘make it up’?
Is this one of those things where people just want to believe and are deluding themselves?
There’s a slim chance he meant that, if he sells them one at a time, he’ll lose money, but if somebody buys them ten or 100 at a time, he’ll make a profit, because the overhead doesn’t change relative to how many he sells.
Typically the ‘volume’ argument works because you buy in bulk and can sell stuff cheaply.
I imagine what’s going on here is that they’re making a bunch of stuff for a loss to see what sells. Then bulk order that so that it makes a profit.
Say there are 10 different types of widget, it costs £11 to make a batch of ten of one type and £90 to make a batch of 100. All types sell for £1. If I don’t know which type sells then if I might invest £110 in ten of each type. Then I can see what sells and get more of them at the profit-making rate.
Otherwise I’d have to buy spend £900 pounds but my profit would be wiped out if widgets X and Z sold badly.
Alternatively the ‘volume’ in question is foot traffic, and the cheap stuff is a loss-leader to get people into the store so their encouraged to spend money on other stuff.
Actually, re-reading your post you say due to overhead etc, it also depends what overhead. Some overheads are obviously per-widget but some are fixed or time based and so are improved by volume.
Sorry, that’s a bit rambling, hopefully you get the idea.
Yes. He is deluding himself. (At least, as you described it).
You have to have a profit margin, no matter how small, or you’re not going to make it. When people “make it up on volume”, what they mean is that they are accepting a small a profit margin as possible on each good sold in order to make larger overall profits by selling greater volumes of goods. For example, if you earn $1 on every $5.00 widget and sell 10 of the things, you make 10 in profit. However, one day you run the numbers and learn that you can sell 500 widgets if you lower the price .90 to $4.10.
Initially, the $.90 comes out of your profit of 1.00, leaving you to make .10 on every widget. Do you do it?
Of course, because
500 X $.10 > 10 X $1.00
You accepted a smaller margin for the purposes of increasing sales to the point of increased overall profits.
Your brothers store is likely not in that category. If he’s losing money on every item sold, it is definitely not within this category, and he won’t make up the losses on volume. It’s mathematically impossible.
It’s usually stated as a joke. Hopefully, your BIL realizes that, but maybe HE heard it before and didn’t realize it’s a joke, and is about to lose a nice chunk of money…
The theory, I think, is that you can start to build a client base this way, and that as your sales increase, you can start buying your materials in larger lots at a lower price per unit. Eventually, you are selling enough that your materials cost per unit drops to the point that you start making a profit.
Loss-leaders can work at already-established companies. Like, say, you were taking your billions in free operating cash flow from your Office suite and Operating Systems and using them to subsidize your newly released game console. Or something like that.
However, that’s not a strategy I recommend for a start-up.
Ditto. And more to the point, it’s one of those off-the-shelf jokes that I’ve heard at least a dozen times. It seems likely to me that your BIL is experimenting with his business model – figuring out the market, and what the price sensitivity is.
I think SpaceDog and JohnT nailed it. Thanks, guys.
His overhead consists of payroll (with all that implies), maintenance (power and bits for the engraving machine), and the usual business stuff (garbage, etc). He operates out of a portable mini-trailer type thingy, so he doesn’t have a site, per se, but does need to pay usage fees or whatever on the place he sets up (currently he’s negotiated a trial period at a busy parking lot here in town).
I whipped up a handy-dandy Excel spread for him that gives him a per-unit overhead ‘cost’, and that’s what led to the discussion. He’s not losing much, but he is losing money on each transaction (all the widgets are the same price, though not all have the same cost - he thinks this’ll even out in the end and people will like the ‘one-price’ philosophy).
He’s not a dumb guy - I don’t like him, but I have to give him that - so I think the plan must be to do the whole ‘buy in bulk once he figures out what sells’ bit. I don’t know what his bulk cost is on these things, all I had to work with was the unit count and total cost.
I guess I’m glad to see he’s not totally off his rocker (in theory); I just didn’t get the ‘volume’ deal.
Look at all the failed internet companies that worked on the model of make money later at volume. You shouldn’t be starting in the way you just discribed. Be leery of what your about to start. You may wish to consult a bussiness consultant, or at least somebody running a small bussiness that can tell you what expectations you have that are doable, and what is unrealistic.
aye, aye to that. He just didn’t feel like discussing the particulars of his business model with you at that moment and gave you a joke answers. A standard, often used joke, at that.
Thus, indeed, since most of his overhead are "fixed’ costs, an increase in # sold will bring him into profitability.
The joke only comes into play if the costs are per unit, thus no matter how many you sell, you lose the same amount per unit thus you lose more $$ the more you sell.
There is some truth to it in overall business practices.
The big reatilers out there (Wal-Mart, Best Buy, Target) operate on very small margins. Best Buy operates on a 5.5% operating profit margin. They can sell a 27" RCA tv for $200 that they paid $190 for.
Then there are little retailers out there operating on huge margins. High end jewelers, super high end audio dealers, Coach handbag store, etc. The types of stores that make just a handful of sales a day. Were talking markups of over 400%. They can sell a purse that cost them $25 for $500.
So who makes more money at the end of the day? The big retailers.
The problem with the Internet companies was that their sales predictions were unrealistic. Since there was a low barrier to entry, everyone and his dog started one, no one would ever get enough market share to make money (assuming there was a market) so they went under. If the OP’s bil will never sell enough to reduce the contribution of overhead to a reasonable number, he’ll never make money.
And there are few companies who make money starting out, and I don’t think there is an expectation that a business plan should show that. What’s important is that there is a path to profitability, the path is realistic and short enough, and that there is enough money to fund the early losses.
