The Hierarchy of Earning Profit
1. Businesses
The joke has been around for years:
Step 1: Big idea
Step 2: ?
Step 3: Profit!
Business is so much fun when you dream this way. But the reality, as Elon Musk eloquently put it, is that running a company “is like eating glass and staring into the abyss of death.”
2. Accounting
How businesses go from sales to profit is taught through the income statement – start with revenue, subtract all costs and taxes, and finish with a bottom line of profit.
This is great for accounting, but it just shows whether a company went from Step 1 to Step 3, not what it took to get there – the glass-eating of Step 2.
No matter the business, there is a hierarchy of steps necessary to earning a profit. It’s like a qualitative income statement.
3. Profit
Here’s how I think of it. All of these steps have to be completed before sustainable profit becomes reality -
- Solve someone's problem
- More efficiently than they themselves
- At a price lower than their opportunity cost
- Done as well as Competitors
- At a price equal or to lower than competitors
- In a way that appeases regulators
- In an environment attractive to employees
- Convincingly enough to attract investors
- Focused yet willing to adapt any of the above
- Profit
These steps have to be checked off sequentially – each box doesn’t matter until the one above it is completed. If your product isn’t priced competitively, it doesn’t matter how cool your office is or how much free food you offer employees. A cheap product with no competition that checks all the regulatory boxes doesn’t matter if it’s not solving a legitimate problem that customers can’t solve themselves. And no business plan is worth the paper it’s written on without a willingness to constantly adapt.
4. Conclusion
People – especially really smart people – have a tendency to attempt solving big problems (like earning a profit) without first solving more basic ones (like how you’ll get there). This is why the “Step 1, Step 3” joke resonates. And it’s why understanding the hierarchy of earning profit is so important.
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