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?