TAKING STOCK : Celebrate profits

Assume that you have developed a brain software ‘pill’ which when swallowed gives us the knowledge it would take 16 years of school and college education to acquire. Assume that it costs you Rs 2,500 to manufacture this pill. Assume that with the orders flooding in, you are easily able to sell each pill for Rs 10,000 giving you a profit of Rs 7,500 — a 75 per cent margin on sales — for each pill you sell.

Should you be hailed as one of the greatest scientist of all times or be denounced as a profiteer? To answer this, let us look at the role profits play in our economy.

We are willing to pay you Rs 10,000 for the pill, because we expect to derive a benefit greater than our Rs 10,000 expense. We think of the years of effort and the money we are going to save. We reckon that school and college are going to cost us at least Rs 1,00,000, even if we ignore the value of the time we would save.

The pill suddenly begins to look cheap, real cheap. We know that we are better-off by at least Rs 90,000 by buying the pill. To us it doesn’t matter how much you gain as long as we gain too. This is a win-win situation.

Profits which you make, further benefit us in two ways. Firstly, your high margins give you the means to expand your production to meet the burgeoning demand. Knowing that your pill has a worldwide market, you begin to put factories in every part of the world. Looking at your margins, many are willing to fund you, and within a short time your pill is available at drugstores across the world.

Secondly, your 75 per cent margin attracts the attention of every developer in the world. The R&D divisions of Merck, Pfizer, Microsoft, Google, Ranbaxy Laboratories, Dr Reddy, Glaxo Smithkline, and many other firms work round-the-clock trying to find a better and cheaper pill to compete with yours. Before long they come out with their own products, and you see your margins decline. You again start to concentrate on your R&D to bring out an even better pill, with an aim to provide double the knowledge at half the cost.

This in essence is the role played by profits. The example I have given is a science fiction but it bears close resemblance to what takes place everyday in the marketplace.

Take cell phones. An incredible revolution is underway. Almost every week a new mo-del hits the market. This we-ek it may be Samsung, brin-ging us a phone with a camera, next week it will be a Motorola with sleeker looks, and the week after that it will be a Nokia with a video in addition to camera. All this happens as earlier mo-dels crash in prices and the size becomes even smaller. The same story, is being repeated with computers, TV’s, DVD’s, refrigerators, and cars.

Let us look at the real world profit margins and whether they bear any resemblance to the 75 per cent margin, that you obtained by manufacturing the knowledge pill. The April 12, 2004 issue of Fortune carried the profit figures of the 500 largest US corporations.

These Fortune 500 companies, roared back to life in 2003, raking in a record-breaking $7.5 trillion in sales and $445.6 billion in profits. As against a hypothetical 75 per cent of sales margin which you had in your pill business, these companies earned a record 5.9 per cent of sales as profit. Fortune called this great because in 2001 and 2002, these companies had lost a total of $275.8 billion. In other words, over 60 per cent of the 2003 profits were just recovery of the last two years of losses.

Most of these mega corporations, which are supposed to rule the world, would easily settle for a guaranteed profit of five per cent on sales if they could. When we attack profits, we attack, this tiny fraction of the sales price, this infinitesimally small amount, that we pay for constant innovation, newer products, and our ever improving standard of living. We need to celebrate profits not condemn them, for they are the root of our prosperity.