Turnover and Profit – or – Economy for Beginners

Due to the very complex structure of real enterprises, discussions concerning them often end in chaos. Instead of technical questions, you get dogmatic questions. Even the most basic relations get jumbled up into philosophical and almost bellicose disputes. Instead of added insight and more knowledge, you get frustrated and de-motivated.

I myself often witnessed it. Especially the (theoretical) question: “What profit is adequate for an enterprise?” caused me quite some frustration in my entrepreneurial life. That is why I came up with the Kiosk Parable:

Imagine a very small railway station kiosk. Only one person can enter at a time. The room for products is limited. Customers are served through an open window, just like at a counter. The kiosk salesperson does all the work single-handedly.

You can buy two kinds of products at the kiosk. Small bottles of Jägermeister and cigarettes. Since the salesperson buys the Jägermeister for 1 € and sells it for 2.50 €, the extra money the customers pay for the Jägermeister is 150 %. The margin for the cigarettes is not quite as good. He buys them for 4.50 € and sells them for 5 €, which means 0.50 € more. In other words: a margin of 10%.

As a general rule, the average customer buys one Jägermeister and one pack of cigarettes. So the salesperson gets 7.50 € for products he bought for 5.50 €. We get an average margin of 2 € or 11/15 or 26,666… % of the turnover. The rent for the Kiosk is quite low. There are no employees to pay and the kiosk does quite some business with travellers and bummers.

Consequently, the kiosk salesperson gets a dream of an EBIT and, even if the turnover is not too high, he is quite happy.
One day, the kiosk salesperson decides to enlarge his range of goods. Now he also sells strip tickets. Basically, it seems a very good idea to sell strip tickets at the railway station. After all, it does not take much room, being only a small product. Since he never over-exerted himself, he can easily manage the extra work.

Naturally, from a business point of view, the consequences of this extension of his range are hard to predict.

Will he now sell more Jägermeister, because people buying tickets will spontaneously decide to buy some alcohol? Or will there now be queues in front of his kiosk, causing people to decide against waiting for their spirits and cigarettes and instead do without?

The risk management, too, will be more demanding. Will there be more risk because the kiosk is now more attractive for thieves? Will he now have to install better locks?

We do not know why he wanted to extend his range of goods. Does he want to earn a little extra? Or is there some hope that, by extending his range, he will actually sell a few more Jägermeisters or cigarettes? Or did the owner of the kiosk just force him when the time came to sign the next contract? To give the passengers a chance to buy their strip ticket, even if, as often happens, the ticket machines broke down?
But hey – from the business point of view, we are heading for a fiasco! In our model, the strip ticket costs 12 €. That is a lot more than both the alcoholic beverage and the pack of cigarettes taken together. But the margin with the strip ticket is only 40 cents, which is around 3 %.
So the inevitable happened: since people prefer buying their strip tickets from the kiosk, rather than at the ticket machine, the turnover of strip tickets bought at the kiosk exploded. Most strip ticket buyers, however, are non-smokers and do not drink their spirits out of small bottles. Consequently, the turnover of cigarettes and alcohol grew only marginally. To be sure, the total result was a little more, but the Ebit per cent plummeted.

This development made the kiosk salesperson so sad that he started doubting his own entrepreneurial competence and closed the kiosk. Since that day, you no longer get cigarettes and schnapps at the railway station. And the strip tickets have to be bought at the always defunct ticket machine.

RMD
(Translated by EG)

P.S.
The story, including all the numbers, are purely fictional. Similarities with real persons or situations are purely accidental and were not intended.

P.S. 1
For all the articles of my entrepreneurial diary, click here:  Drehscheibe!

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