The Seven Sources of Wealth

I spend a lot of time thinking about wealth creation. I like to find common themes and structures that can generate wealth. After thinking about it for some time, I believe I have identified the seven structural sources of wealth. These are business structures or transaction types that generate “profit,” which is a precursor to (legally acquired) wealth. As you go through the list, you may observe that some businesses actually combine two or more of these structures to generate wealth.

What is the purpose of knowing or understanding these seven sources of wealth? I think it is the first step in addressing a much more important question: which wealth structures benefit humankind economically the most? That is an important question, especially from a public policy standpoint. For if some of these structures benefit people more, but governments give favorable treatment to the others, then we are probably not maximizing our economic potential.

Here are the seven structural sources of wealth:

Product leverage Create it once, sell it over and over. Items that fall into this category include Microsoft Windows, Harry Potter novels, Toyota Prius and iPads. Note, that a discussion about structural sources of wealth does not include things like cost of goods sold or degree of profitability. Surely software, with its essentially zero cost of goods, will be, percentage wise, more profitably than manufacturing an automobile. But both can generate wealth by leveraging a single creation.

Financial leverage Take a percentage of other people’s money. Items that fall into this category include real estate and mortgage brokers, certified financial planners, mutual funds and hedge funds, as well as run-of-the-mill banks. As has been clearly demonstrated by these financial fiduciaries, a fortune can be generated taking a tiny percentage of a very large amount of money.

 

Service leverage Create is once, deliver it over and over. Items that fall into this category include Starbucks, H&R Block, Salesforce.com and even utilities. With legacy services, leverage is costly to scale up. Every time you want to open a Starbucks, you have to hire an entire store’s worth of employees. The exciting development in this category today is software as a service (like GoToMyMeeting.com) where you can scale up the service without having to staff up proportionally.

 

High hourly rate Charge a lot per hour. In this category, most people think of doctors and lawyers, but entertainers, professional athletes and subject matter experts also fall into this category. When Tom Cruise makes $10 million for a movie, he works an unpredictable, but ultimately limited, number of hours, which most assuredly translates to a high hourly rate.

Overrides Get a percentage of what is produced (especially by people below you). Items that fall into this category include partners at law and accounting firms, multilevel marketing and franchising. Even most sales managers have their compensation tied to the production of the sales people below them. This is different than financial leverage in that overrides are based on a percentage of what is produced, rather than a percentage of an amount of money.

Mark up Buy it at one price, sell it at a higher price. Certainly retail companies like Amazon and Wal-Mart fall into this category. But so too do many investing and arbitrage businesses. Private equity and house-flipping can also be included in this category.

Assets Any asset that can generate cash. Items in this category include gold mines, oil wells, commercial real estate, farm land and even securities. Any asset that generates more money than it cost to purchase can be source of wealth creation.

There you have it. The seven sources of wealth. How do you want to make your fortune?

The Box – Economics Explained in One Movie

It is not the government’s job to spur the economy, it is their job to get out of its way ~ Carl Weisman

[This post was inspired by the book, Economics Explained in One Lesson, by Henry Hazlitt]

In 2009, a movie came out called The Box, starring Cameron Diaz and Frank Langella. If you have not seen it, and not many people have, it is a pseudo science fiction movie, and very average. On the movie website IMDb, it received 5.6 stars out of 10 from about 46,000 users. When I saw the movie, it left me with two thoughts: that was a very average movie but, there is something subtly profound about it. I just did not know what at that moment.

The plot of the movie is pretty straightforward. A mysterious stranger delivers a box to a young married couple that promises to bestow upon them $1 million if they press a button on the box. However, pressing the button will simultaneously cause the death of another human being somewhere in the world, someone they do not know.

Of course not too long into the movie, the character played by Cameron Diaz presses the button and soon after the mysterious stranger returns with a briefcase filled with $1 million. And in true Hollywood fashion, the movie culminates with another couple being offered the same deal and when the wife pushes the button on that box, the Cameron Diaz character dies.

Economics is such a complicated subject to grasp, people are always trying to find metaphors to explain certain aspects of it. It turns out that The Box is an exemplary metaphor.

Every economic transaction is really two transaction: the one you see—which usually affects you, and the one you do not see—the invisible one—the one that does not affect you. If you go down to your local Apple retailer and buy the latest iPad, the transaction you see is your handing money over to the cashier in exchange for the product. What you do not see is the person getting laid off at Google because you chose not to buy an Android-based tablet. And that is the story of The Box—the box with the million dollar button.

Whenever you get something in life you did not rightfully earn, for whatever reason, you are pushing the button. If you collect ninety-nine weeks of unemployment, you are pushing the button. If you receive union wages that are above the wage rate that the free market would ordinarily offer for your job, you are pushing the button. And when you live off food stamps or welfare or other unearned government assistance, you are pushing the button. Somewhere, out of sight, somebody else is “dying.”

But it is not just  individuals that push the button. Companies do it too. When a big corporation pays a lobbyist to make sure a beneficial tax loophole makes it into the tax code, it is pushing the button. And when farmers receive crop supports—or worse, get paid to not grow crops—they are pushing the button too.

Whether as an individual or part of a company, when you get something you did not earn you rarely think about the person you hurt. But when you are on the receiving end of the button, that is all you think about. The only question is, do you need to be on the receiving end of the button before you stop pushing it?

What Happens When Walmart Moves In?

I’d rather be a lousy salesman selling iPads than a great salesman selling buggy whips. ~ Carl Weisman

What Happens to Local Businesses When Walmart Moves In? makes the classical economics mistake of focusing on only half the story.  Here is what happens when Walmart moves into a community, according to the presentation:

  • Local entrepreneurs lose their livelihoods
  • Net job creation is negative
  • Civic participation, voter turnout and nonprofit organizations all decline

 

 

These are the consequences of focusing on a small subset of people: those who own or work at local businesses. But when Walmart moves into a community, those same local people choose to shop at Walmart—nobody puts a gun to their head. And why do they shop there? Because they can get the same products for less money. And that means these same people, thanks to Walmart, have “extra” money they did not have before. And they will not light that money on fire to stay warm. They will spend it: on the Internet, to pay for college tuition or in a retirement account. Somewhere, out of sight of the local community, jobs will be created. Because of Walmart.

As way of analogy, Walmart is an iPad and the local stores are buggy whips. I am sure when the automobile first appeared, the buggy whip manufacturers decried their evils and tried with all their resources to slow down the oncoming deluge. But the world wanted automobiles. And so the buggy whip manufacturers went out of business and their employees lost their jobs. And then found new, higher paying ones, making, you guessed it, automobiles.