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How companies make money
What we'll learn:
1) What costs do a company need to know to calculate profit?
2) What's the difference between an initial cost and a daily cost?
3) Are lemonade stands worth it?
Maybe in some magical land filled with rainbows and lollipops, all companies would be out to help us live happy, productive lives. Alas, in the cold, cruel world we live in, most companies are here to make money.
How do they do this? First, they figure out how much it costs to set up the company. If you're setting up your lemonade stand, you'll have to make signs and buy a chair, a stand, and a pitcher. These are one-time costs.
Then your company needs to tally its daily expenses and figure out how much it will cost to buy the lemons, sugar, water, ice, and cups.
You also have to figure in how much to pay your worker: the guy who pours the cups of lemonade, undoubtedly with a smile on his face.
By adding one-time costs and daily costs, companies determine how much they have to spend to produce a cup of lemonade.
Next, the company has to figure out how many cups of lemonade it needs to sell, and at what price. This is where companies have quite a bit of flexibility.
Let's say the initial cost per cup is $0.20 and you're going to charge $0.50 per cup. That means you make $0.30 for every cup sold.
How many cups of lemonade do you need to sell to pay someone $10 per day to watch the stand?
Do the math — you have to sell 40 cups of lemonade at a $0.30 per-cup profit to make $12, but after paying $10 to the person sitting there, you make $2.
If you make $2 per day and you don't have to work there, that's pretty good.
If it's a hot day and people want lemonade, you can charge more. By charging $1 and selling 20 cups of lemonade, you make $0.80 per cup, or $16 per day.
After paying the person who poured all that lemonade, you're left with $6.
In essence, that's how companies make money — by offering the best product that people want at the right price.
Three Facts to Wow Your Friends at a Party
1) The "Ponzi Scheme" was devised by a New York grifter named William Miller, who bilked investors out of $1 million — nearly $25 million in today's dollars — in 1899.
2) In 2005, 21-year-old student Alex Tew made a million dollars with The Million Dollar Homepage, which was a 1,000 × 1,000 pixel grid where he sold each pixel for $1.
3) Coca-Cola was originally intended as a "patent medicine" when it was invented in the late 19th century by pharmacist John S. Pemberton.
Show Us the Money
So a company buys some things, makes some things, and then sells some things people want to buy. Whatever money they have left over is their profit. Pretty straightforward, isn't it?
You'd think so, but there are countless examples of companies that forgot how simple it should be to make money.
Take the dot-com era back in the '90s: Hundreds of small companies cropped up, and many people thought they were going to become millionaires.
Why? All because they had an idea of how their business was going to use the Internet to make everyday responsibilities (such as buying pet supplies) faster and easier.
Everything looked great for a while — until the bubble exploded and everything came crashing down. Why did things go kablooey? The answer is simple: Most of these companies weren't making any money.
They had an idea of how their company was going to rake in millions by going virtual, but they never actually sold anything that brought in any cash.
Looking back, it seems they forgot one simple axiom: You can't expect to stick around if you aren't making any money.
But then you have Amazon.com (AMZN) — they also weren't making any money when they started in 1994.
It took them seven years to finally start reporting profits.
The difference between Amazon and the dot-com duds? Amazon had a great idea that was already bringing in cash. It just took a while for them to make enough money to cover their start-up expenses and begin generating some profit.
Another factor companies can use to calculate their profit is how they're going to price their product. If you sell glasses of lemonade for $1 instead of $0.30, you'll make a lot more money on each sale.
But you would also probably lose sales, because not as many people would be willing to shell out that much for your precious — and pricey — drink.
Amazon is catching some flak for this right now with their electronic book reader, the Kindle HD. Some people think it's too expensive at $299. So Amazon could lower the price and sell more of them, or keep the price high and make more off of each one.
This will affect how much money Amazon makes, and it's an important balance all companies need to consider.
Of course, that comes after taking care of the most important part of a business: making money in the first place.
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