Scale, Derivatives & the Most Important Ratios

Since we have agreed that math is the key to escape the middle class, we must go further to how to apply math in your business.

Everything operates on first and second derivatives, marginal effects, and ratios.

Algorithms are the key to scale:

  • Find a problem that you can address that will bring value to customers.
  • Re-frame this problem as a function of time and build your process to deliver to the customer.
  • Continue to define and simplify your process to facilitate scale.

Derivatives tell you the marginal cost (change in cost/change in unit produced) of each additional unit of production.  Lesson: unless you scale a simple business, you should not grow indefinitely since the increase in size will increase the complexity to the point that profits will decrease. The second derivative shows that with each added unit, the curve in relation to the cost will get steeper as your costs disproportionately increase.

Systemization is important because even slight differences will cause your costs to go up disproportionately with the volume increases.  The cost of interruptions, cognitive residue, and communication between steps of your process between extra people will slow you down.  The solution is to sell a narrower range of products (or services marketed as products) to fewer customers (not applicable to e=commerce and casual dining) and have fewer vendors.

 

Avoid the traps: If you see poor choices, recognize that poor choices= poor character. Do not give second chances: if you see a single-character flaw (ie: blames others) you must not do business with that person. Also, don’t forget to measure the math strengths of your competitors. Find the minority fraction of your profits and revenue that are disproportionate to the number of customers it is generated by. Eliminate the product line/customers.

 

Analyzing the aforementioned for 12 years has allowed me to make several conclusions: Long-term sustainable business will need to have at least 20% pre-tax margins.  This is only possible by charging market rates, having a good reputation, the best people,  a high ratio of production vs support costs, and efficient quality – with efficiency defined as value created/time spent creating value.

 

The next most important ratio is your payroll: revenue. Remember, machines give 80% of a human at 20% of the cost.

 

Another conclusion is that there are 3 customers for us to work with:

  1. Skilled owners of software/equipment that is too costly for the average person to purchase + skills the average person can not learn from youtube.
  2. Amazon sellers
  3. Basic single-idea restaurants (ex. Vietnamese, Donair, Italian etc.) scales easily and costs are lower

What all 3 groups need to do is have high-quality product and marketing which scales to more employees and more capital assets (software, equipment, work van).

The pseudo-intellectual trend of Anglo-Saxon business has taken “accounting” too far, and to avoid analysis paralysis we subscribe to the simplicity of the math-based-Germanic-style. This is also representative of the simple, yet effective models of the Asian mass-market dominance, simple restaurant (ex. Pho), or nail salon.  Complex businesses are more difficult to scale.

 

A less significant conclusion from 12 years of processing billions of robo-accounting transactions: don’t indulge in furniture unless it’s from Ikea, Costco, or second-hand.

Here are MORE math hacks!
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