( Originally Published Early 1900's )
1. Gross profit.—As was pointed out in Chapter II, Volume 1, the word profit is the most significant and interesting one in the whole vocabulary of business. It is really the end and aim of business.
In every day speech the word profit is rather loosely used to include all the earnings of a business above its expenses. In general the expenses of any particular business consist of wages, interest and rent. When the sum of these items has been deducted from the gross earnings or receipts, we have a remainder which is popularly known as the gross profit.
To many men and to some women business possesses an almost irresistible lure. I once knew a young grocery clerk who was so faithful, accurate and obliging that his employer paid him an unusually large salary, and he saved money. When he was about twenty-three years old he married a fine girl who had worked as cashier in a large hotel and had saved money. She was more ambitious than he and had distaste for the dull routine of a job.
"Jack," she said to her husband, "we have money enough to start a little grocery of our own. You know the grocery business by this time, and I can keep the books, take care of the cash, and help you behind the counter. I won't mind working sixteen hours a day if it is for our own business."
Jack finally was persuaded, and when they calculated their profits at the end of their first year in business, they found that the net earnings of the store in which both had worked did not exceed the wages which Jack alone had been getting as a clerk. There were some important business lessons that he had had no opportunity to learn while serving merely as a clerk. For instance, he was not a shrewd buyer, and both he and his wife were a little too easy in their extension of credit. Furthermore, their capital was so small that they could not take advantage of discounts, nor could they carry such large and varied stocks as were found in the stores of their competitors. Nevertheless they stuck grimly at their business, gradually increased the number of their customers and the volume of their sales, learned a lot about buying, discharged their de-livery boy, and embarked upon a "cash and carry" business.
The profits of their third year, according to the wife's bookkeeping, amounted to three times what Jack's wages had been as a clerk, and some of that profit had gone back into the business, increasing the quantity and variety of the goods they were selling. They figured as profit the balance that remained after the expenses had been paid, and the main items of expense, besides the purchase price of the goods they sold, were rent, insurance, light and heat. As they did all the work and used only their own capital, no deduction was made on account of wages or interest. Profits calculated in this rough way should be called gross profits, to distinguish them from net or pure profit.
2. Net profit.—To arrive at what economists and accountants generally agree in calling net profit or net income, certain important deductions must be made from the gross earnings or gross profits. Part of the gross profit is evidently earned by the proprietor's own capital, and it should be treated as interest, not as profit. If the owner of a business is also its manager, devoting all of his time to it, part of the profit is clearly the result of his labor and should be credited to wages., His business should pay him a wage or salary as high as he could earn working for another. If he does business in his own building and pays no rent, he must charge his business with the rental value of his property. He must also set aside each year a sum sufficient to cover any depreciation in the value of his stock and equipment. If he has extended credit to customers, he must set aside a certain sum called by accountants a reserve, to cover the cost of collections and possible losses.
In the study of economics it is not necessary to go into further details on this subject. It belongs in the field of accounting and is fully treated in other volumes of the Modern Business series.
3. Earnings of business ability.—No argument or exposition is necessary to make clear the fact that profit, whether gross or net, is the product of business ability. The man who gets a profit has directed the employment of the labor and capital of himself and others, and has taken a "business chance" as to the amount of his own compensation. He has bound him-self to give the landlord a stipulated rent, the capitalist a definite rate of interest, and his employes a wage agreed upon in advance. He made all these positive commitments, risking his capital, his time and his labor, because he believed that he would be able to conduct his business so skillfully and wisely that its gross income would yield a profit to himself after all expenses had been paid. If his competitors are better business men than he, the chances are that he will fail, for in various ways they will render more satisfactory services to the community, will be more efficient in the employment of capital and labor, and will be able to undersell him in the markets.
Men differ in business ability just as they do in physique and muscular power. Some men are business giants, possessing such abilities to direct and command the forces of labor and capital that they deserve to be called generals of industry. Others of less ability we often speak of as captains of industry. The number of pigmies in business, small men incapable of vision, of planning big enterprises, or of inspiring confidence, is legion. The profits which these different classes of men earn when they undertake business enterprises vary almost in direct proportion to their business ability.
The human qualities essential to business success were discussed in the volume "Business and The Man." The most important ones are vision, judgment, initiative, courage and will power.
So evident is the relation between profit and business ability that some economists, notably General Francis A. 'Walker, treat it as being analogous to the rent of land. Just as there is "no rent land," so there are men of such poor ability that they fail to earn a profit if they undertake any business enterprise. Other men in business barely make a living, being like what the economists call "marginal land." Pursuing the analogy still further, it is concluded or assumed that the profit earned by any man in business measures the difference between his business capacity and that of the man who might be called the marginal business man, the one just able to get a living out of his business. This idea that profit is a kind of personal rent is interesting and illuminating, but does not deserve to be called a theory of profits. The wage or salary paid to a man by his employer is more analogous to rent than is profit.
4. Corporation profits.---The greatest amount of the world's business is carried on by corporations, and here as a rule we find no single individual assuming the risks and making the advances essential to enterprise. The risks are assumed by the stockholders, altho they usually have very little to say about the conduct of the business. The management of corporations, altho nominally controlled by boards of directors, is really in the hands of salaried employes who have proved their ability as business men or as entrepreneurs, and the salary of any corporation employe in a managerial position is, as a rule, made dependent upon his success as a manager, as evidenced by the rate of dividend the corporation is able to pay to the stockholders. In all civilized countries the biggest business men are, as a rule, the servants of corporations, but their salaries represent their profit-making ability.
5. Business risks.—Business gets much of its charm from the satisfaction which men feel when they successfully overcome difficulties and dodge perils. Men go into business, of course, to make money, but their enjoyment of it is due not so much to the money they get as to the fact that they are every day struggling against odds under which a weak man is certain to go down. Every business has its speculative side, its perils and risks, and in some businesses these are greater than in others. Here we will consider only certain important ones to which all business men are in some degree exposed.
Every business man is in danger of being out-generaled by his competitors. He may have been drawn into his particular line of business by the large profits which have been made in it during recent years, but other men may have been attracted into it for the same reason, and he may discover too late that the business is being overdone, that too many men are engaged in it, and that he must sell his goods in a weak and declining market.
Unseasonable weather may stifle the demand for his goods, and reduce the volume of his business so much that he will make no profit. A mild, open winter, for instance, may wreck the hopes of dealers in furs and heavy clothing.
The general level of prices may be tending down-ward, as it did between 1873 and 1897, and again after the close of the war in 1918. Then the business man must beware lest he produce goods which he may have to sell at less than cost.
Finally he is always confronted by the menace of trouble with his employes. At the most critical moment his men may demand an increase of wages and walk out, tying up his plant if he does not yield, whereas if he grants a higher wage, he knows that the increased cost may imperil his profit.
6. Unforeseen profits.—Some of these perils that we have just been enumerating have their bright side and sometimes yield to the business man a profit larger than he had expected or planned. For some unforeseen reason the demand for his product may be in-creasing very rapidly so that he will be able to sell at prices yielding him an unusual profit. Some unexpected happening, such as the outbreak of war, may give an unprecedented demand for the articles in which he deals, and the general level of prices may be tending upward instead of downward because of the cheapening of the money metal, or because conditions have encouraged the banks to give to the public a larger use of their credit.
These sources of profit, and others like them, cannot be foreseen, but every business man knows that they exist, and that in the long run they offset the unforeseeable sources of loss.
Some of these unforeseen profits are called conjunctural gains by certain economists, since they are due to an unexpected combination of circumstances. War brings great profits to the manufacturers of military supplies. The death of a king enriches men who happen to have on hand a large stock of mourning goods. An extensive fire increases the profits of the contractor as well as the wages of masons and carpenters; the undertaker profits from an epidemic; the "gasless Sundays" enforced for a while in the United States during our participation in the European war brought a profit to the few livery stables that were in existence.
Profit of this sort is not the result of personal ability, and cannot, as the economist uses the term, be classed with net or pure profit. It is an accidental gain, quite as likely to fall into the lap of the poor business man as into that of the good.
7. Elimination of the unfit.—It is a common saying that 90 per cent of the men that go into business are failures. Whether this statement be true or not, it cannot be denied that the percentage of failure is large, or that many men are in business who might get a steadier income if they worked for others. Every-body knows the type of man of' whom it is said, "He is all right when he works for somebody else, but he is a failure when he tries to work for himself." Men lacking the executive qualities necessary for success in the business they take up are soon forced to the wall by the competition of men of superior ability. Most of these men give up the attempt to be independent business managers and content themselves with salaried positions.
There are different grades and classes of business men, just as there are different grades and classes of laborers. The lowest grade of business ability is represented by the man who is able to run a small grocery store, meat market, newsstand or cigar store, and earn a living for himself and family, and perhaps a little more. He is in competition with men of his grade. If he fails to make good as a manager of his small business, he usually becomes a clerk or salesman for one of his competitors. Occasionally these small dealers find themselves in competition with men of much greater ability, who organize chain stores and attract customers by the superior quality of their advertising and service, even tho the goods they sell are no better. The recent development of the chain stores in the United States has caused many a small dealer to give up his business and become a salaried man. Men of large caliber attempt large enterprises and are in competition with one another. The manager of a department store does not worry much about what small, dealers do, but he keeps a keen eye upon the doings and policies of his competitors, the managers of other department stores, for these are always liable to draw great tides of custom away from him.
The case is somewhat different with manufacturers, for production on a large scale makes numerous economies possible, besides the profitable utilization of by-products. The small manufacturer is always in peril and must usually be content with a smaller rate of profit than is earned by his larger competitors. If the larger concerns with their lower costs of production become able to supply the entire market demand, the small fellow is forced to close down. He may sell his plant to one of his competitors and become its hired manager.
Thus, as a result of competition and the desire of men to earn the largest income possible, the process of elimination of the unfit is constantly going on, with the net result that the control of business and industry is in the hands of men who are able to use it most effectively.
8. Minimum pro fit.--On account of the keen competition among business men, economists sometimes speak about profits tending toward a minimum, and they assume that minimum to be a rate equal to the salary which the business man can command if he works for others. Nothing less than that would tempt a man, it is argued, to risk his capital in a business venture.
We must grant the correctness of-this view if we restrict its application to business -men as individuals. In any country where there is keen competition among entrepreneurs, the profits of some are large and satisfactory, while the profits of others are so disappointing that they give up business and seek salaried positions. If legislation makes business more difficult, it is inevitable that the incomes of certain business men will fall below the minimum, and that they will be forced out of business. This means a lessening of the demand for capital and labor, and a depressing effect upon the rate of interest and upon the rate of wages. If laboring men combine and insist upon an unreasonable wage, the effect is the same, for the lower grades of business men, whom we might call the marginal entrepreneurs, are obliged to throw up their hands and quit, being unable to earn what seems to them to be a reasonable profit.
By a reasonable profit we mean a net income at least equal to what an entrepreneur can earn if he sells his services to others. In the latter case, his employer will be pretty careful not to pay him more than he is worth, and he has a right to feel that when in business for himself he ought to earn at least an equal amount.
Whether a man's wage or salary is reasonable or not depends very much upon the keenness of competition among entrepreneurs and upon the man's ability and willingness to change his place of residence and employment. Because of the reluctance of men to give up old associations, or because of their inability to move without great sacrifice, they sometimes accept a lower rate of compensation for their services than they are reasonably entitled to. But the entrepreneur, as a rule, insists upon a reasonable profit. If he does not get it in business, he seeks it as an employe.
9. Is there a rate of profit?-It must be evident to the reader that there can be no such thing as a general rate of profit, just as there is no such thing as a general rate of wages. For men of a certain low order of business ability, who undertake only small enterprises, there is a minimum rate of profit which they unconsciously demand as a condition of their remaining in business. They figure this rate in relation to the amount of capital they have invested, and of course it must greatly exceed the current rate of interest, for otherwise they are not compensated for their labor and worry. Men of a higher grade of ability demand a higher rate of return upon their invested capital. If we suppose that the entrepreneurs of a country might be divided into ten groups, and that the current rate of interest on capital is six per cent, the members of the lowest group might be satisfied if their business yielded to them a return of six or seven per cent plus a reasonable 'wage. But there is no reason for sup-posing that they all earn the same rate of profit. If we could have access to the business records of the men in groups higher up in the scale, we should, doubtless, find higher rates of profit, but we should certainly not find any uniform rate prevailing among the members of any one group.
Not long ago a prominent New York accountant, having in his possession the balance sheets and income statement of many business concerns, calculated the rate of profit that had been earned in a certain year by several hundred of them. He found that some had earned over 100 per cent on the capital invested, while the business of others had been carried on at a loss, the average net profits of all amounting to about 16 per cent.
If we knew all the facts about the businesses of a country, we could easily discover the average rate of profits. That would be merely a mathematical problem. But it would not help us to decide what is a normal rate. There can be no such thing as a normal rate of profit.
10. Profiteering.—The conclusion reached in the foregoing section is not in accord with much current opinion. There is a popular notion that the earnings of corporations should be limited to what is regarded as a reasonable rate, and that they, therefore, should not be permitted to pay dividends in excess of, say, seven or eight per cent. Earnings in excess of this amount are stigmatized as "excess profits" and are held to be a most legitimate prey of the tax gatherer. A corporation which earns 15 or 20 per cent on its capital is censured as being guilty of what has come to be known as "profiteering." It is taken for granted that such a corporation has underpaid its working men and charged exorbitant prices for its product.
There are undoubtedly many corporations and many business men who are guilty of practices which deserve the name of profiteering, but we must not surrender to the fallacious idea that evidence of their guilt is furnished by the .are fact that they are able to pay high rates of dividends. The big earnings of a corporation, or of a single business man, may be entirely due to the wisdom a d efficiency of the management, and the community at large may be getting from such a corporation much cheaper and better service and greater benefit than it gets from another similar corporation whose earnings warrant the payment of no dividends at all legislation which is intended to prevent sharp practices, to protect the public against misrepresentatio, to guard the rights of labor and improve its condition is to be commended, but any kind of legislatioh which is based on the assumption that there is a norm. 1 rate of profit, and that any return in excess of this 's evidence of profiteering, is certain in the long run to retard the industrial development of a country, check the increase of capital, dull the initiative of the entrepreneur, and lower the wages of labor.
11. Competitive profits.—Thus far we have been discussing what the econo mists call competitive profits, having assumed that every entrepreneur or business man is in competition with others. When competition prevails, the largest profits as a rule are earned by men possessing remarkable vision and initiative, who do new things or old things in new ways. If their huge profits are to continue, they must never rest, for their methods, processes and policies will be studied by others and will be imittated. Hence the tendency under competition is toward an equalization of costs of production in the various lines of industry and business, toward a market price fairly close to the cost of production, and toward a uniform rate of profit. But this is only a tendency, for certain entrepreneurs are never asleep at their desks, so that imitators are never able to catch up with them.
The large gains of the entrepreneur, made despite the competition of imitators, must not be thought of as wealth taken from society. On the contrary, they are the product of inventions and ideas which have proved a benefit to society, and their beneficial influences continue long after the entrepreneur is in his grave.
A certain manufacturer of soap once remarked casually to his banker: "I made fifty thousand dollars this year out of stuff which in former years we always threw away, not knowing what else to do with it, but with the aid of our chemists we learned how to make it into valuable by-products."
The banker congratulated him. "That's like finding fifty thousand dollars, isn't it?" said the Banker. "I suppose that extra profit from the by-products will get larger every year."
"No, it won't; it will get smaller," was the reply. "In a few years our process will be known by every soap manufacturer in the country, and the net result is going to be cheaper soap for everybody."
Incidents of this sort are happening almost every day in the industrial world, and under our competitive system, every entrepreneur being free to develop new methods and processes and to imitate those of his competitors, all the people finally reap the benefit of the business man's initiative and enterprise.
12. Monopoly profits.—But when a man possesses a monopoly in the production or sale of any article or service, he is independent of competition and is able to demand a price much above the cost of production. The inventor of a new machine gets it patented, and for a period of years enjoys the advantages of monopoly. As was explained in Chapter VIII, he endeavors to fix the price of his machine at the figure which will in the long run make his sales yield him the largest net profit. Only the law could compel him to put the price near the level of the cost of production.
Monopoly, therefore, is able to withhold from society a certain share of the benefits of invention and progress, and the profits of the monopolist, if he wisely considers the tastes and prejudices of his customers, are larger and more certain than the profits he could earn if he were in competition with his fellows.
The most conspicuous and best known forms of monopoly are of three classes: First, natural monopolies—those possessing more or less exclusive control over certain resources of nature. Second, legal monopolies—those possessing franchises, patents, copyrights, trademarks, etc. Third, capitalistic monopolies—concerns which are able thru their control of a vast amount of capital to produce and distribute goods at costs which render competition on the part of smaller concerns dangerous if not impossible. These capitalistic monopolies are popularly called trusts in the United States.
The reader will not fail to note that a capitalistic monopoly as above defined owes its control of the product to its ability to make a relatively low price. 'Whatever the profits of such a monopoly, it is clear that a restoration of competition could take place under the terms of this definition only at the expense of the public, which would pay higher prices for the commodity or service. The reader must not assume that large corporations which possess certain monopolistic powers are exercising them to the detriment of the community at large. In the United States the feeling against large combinations of capital has been fanned by demagogs into a very hot flame, and has been responsible for hurtful legislation. The advantages of large scale production must be preserved, for society has it in its power to control the operation of any form of monopoly, and thereby to obtain its proper share of the accruing benefits.
13. Profits and wages.—Many people have an idea that the profits of business really belong to labor, and that wages would be higher if the entrepreneur were permitted to take from the business only a reasonable wage for such labor as he performs. This is one of the doctrines of socialism, which is founded on the assumption that all wealth is the product of labor, and therefore belongs to the laboring man.
If the reader has understood our discussion of the laws governing wages and profits and the prices of goods, he will easily detect the fallacy underlying the socialistic view that profit is unjustified, and that the wealth now going to the entrepreneur in the form of profit should be distributed among the working men who helped produce it.
As we have seen, competitive profits in a static society where industrial progress and growth had ceased, would sink toward a definite minimum, every entrepreneur able to earn only a profit sufficient to make him willing to continue in business. Profit would then be merely the wages of superintendence or management, but the profits of all men would not be alike any more than the wages of all workmen. The good business man would earn more than the poor one, but none would get a profit in excess of the salary he might command if he worked for somebody else. The prices of goods as a result of competition among entrepreneurs would always be close to the cost of production. Under such conditions, it would be very clear that the entrepreneur, without whose directive and managing ability the forces of labor would be wasted, was a worker like any of his employes and was getting only a fair wage for his services.
But society is in a dynamic state and probably will be until the end of time. Men are not satisfied with the old ways of doing things and are constantly making improvements. The spur to improvement is profit. Many of our most successful business men spend little time at their desks and do practically no drudgery, but their brains are not resting. If they play golf two or three times a week, they do it not merely because they enjoy the game but because they know they must keep physically fit if they are to solve the problems of their business easily, or discover ways of making their organization more efficient, or find ways of opening up larger markets.
Altho the entrepreneur is thinking primarily of his own profit, nevertheless his thinking and planning inevitably lead to lower costs of production, to lower prices of commodities, to the increase of wealth and to higher wages for labor. If we should take away unusual profits from business men, we should deprive them of the very incentive which now makes industrial progress as certain as the rising and setting of the sun. The Bolshevists have tried the experiment in Russia, and we all know the result.
The reader will find if he consults the statistics of different countries, that wages are highest in those countries where the profits of business are largest, and lowest in countries where business is not prosperous.
14. Profits and prices.—The preceding discussion must have already prepared the reader to accept the truth of the statement that profit is not a factor of the cost of production and is not a price determinant. Here we are speaking of net profit, which does not include the wage of management, that part of the gross profit which the entrepreneur might have earned had he been working for someone else. The cost of producing goods is made up of interest and wages.
PROFITS 309 The rent of land and the net profits of business men do not enter into costs. The landlord gets a share of the
world's new wealth because he owns land of more than ordinary fertility. The business man gets a profit be-cause be possesses extraordinary faculties for the production of wealth.
Our great business men do not earn their large profits by charging high prices for the goods they have to sell or by paying low wages to their employes. On the contrary, as has been said several times, they are constantly hunting for better and more efficient methods of production in order that their costs may be lower than those of their competitors, and these lowered costs finally become general, bringing about thru competition a decline of prices.
Thus it happens that the entrepreneur's profit, in-stead of being an element of cost and raising the prices of goods, is a force working steadily toward lowering costs and lowering prices.
1. Distinguish between gross and net profits.
2. What are some of the risks assumed by men in business?
3. Who is the marginal business man?
4. Can there be a so-called normal rate of profit for business enterprises?
5. What constitutes genuine "profiteering"?
6. What is the relation between profits and wages; between profits and prices?