I am a student of scale — a collector of scale-tales.
It all began decades ago with the wonderful book The Seven Mysteries of Life, by Guy Murchie, a life’s-work sort of undertaking for him, full of interesting notions interspersed with the author’s cute drawings and beginning with a chapter on scale (ok, Ok, OK! Yes!!! I admit it! It’s true. I never finished the book. There: I said it. But I did read the chapter on scale, and I did read that chapter several different times . . . ).
What really got a hold of decades-ago me in Seven Mysteries was Murchie’s discussion of how, if we were somehow able to make a human twice as tall, it simply would not work. That is, if you were to stretch a 6-foot tall human into a 12-foot tall human without any further tweaks, the structure of the now-taller human would be quite unsound; the 12-foot tall human would crumple into a figurative and near-literal bag o’ bones because, when doing that stretching, you would also need to make the structural components of the 12-foot tall human somewhat bigger — not twice as big, I imagine (that would look out of scale, yes?), but, as an engineer could no doubt calculate via slide-rule and square roots and pi and such, a very certain amount of biggening to afford the double-tall human a structural soundness sufficient to pass code and muster (alternatively, you could just remove the 12-footer to a place where the gravity pulls less hard and some of the mountains up ‘n float).
So size is of a given context; everything exists within a scale so that, when taken out of its scale, something quite drastic is apt to happen.
My current scale-tale fave is the notion that the human scale of things is just about midway between the scale of the subatomic quantum world and the scale of the universe at (very) large. Wild, eh? We are, all of us, Goldilocksian — somewhere just-rightly betwixt the large-scale structures of the universe and the small-scale structures that are way, way, way within that which is way way way within that which is the stuff of atoms. Now that’s what I’m talking ’bout — that’s what being built into the fabric of the universe is all about!
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Scale informs everything, including our economic lives.
I’m on record saying that numeric financial health is best measured via a person’s savings rate, which is tantamount to saying that numeric financial health is all about scale — about how much you spend relative to how much you make, about the degree to which your spending is in scale.
The same can be said for businesses: a financially healthy business is one that keeps its expenses in line with — scaled well with — its revenues, thereby allowing the business to invest and ably compete over the long run, which in turn allows it to support many people in many different ways. Indeed, every single ratio a business tracks — debt-to-equity, say, or its quick ratio, or something as simple as actual vs. budgeted comparisons — is about scale, in the sense that they all compare one numeric thing to another numeric thing and either produce a smile or a grimace, all depending on the scale of the one thing compared to the scale of the other and what it says about the financial health of the business.
When it comes to the financial health of both individuals and of businesses, though, sheer size does, unto itself, count for something because, in both contexts, existences at the small end of things and at the large end of things differ not only in terms of quantity, but also in quality.
And this raises a nice little swarm of questions:
What is big? And what is small?
Where does one stop and the other start?
And what happens at the transition from small to big and vice versa?
Or, to use a favorite MBAism:
As we travel along the path from small to big or from big to small, might we encounter some discontinuities?
So now let’s take this scale-tale to a more concrete level, shall we? Adding the concrete in this context means bringing in some numbers — bringing in a cast of characters who just happen to be numeric, and who just happen to play key roles in the scale-tale I’m about to tell.
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20 and 400 and 10% and 40%.
That’s our cast.
First up is 20. A fine number, that one, being the sum of our normal allotment of digits, surely, but also being somewhat of a magic number in business.
It’s said that when a business goes from 20 employees to 21 employees, it’ going through a step function, i.e. that it’s going through something other than a mere addition of one person and everything lockstep-increasing by ~5%, something more than a simple linear addition to its scale. There is a discontinuity.
This might be because it’s possible for the person who started the business to manage 20 people (no easy feat!), but at 21 or thereabouts that person needs to manage at least one person who is in turn managing others. And in a more-than-lock-step way, all sorts of other things change, too, not just in quantity, but in quality, by going from 20-or-thereabouts employees to, say, 25-or-thereabouts.
Because, as it happens, there’s just something about scale and business that says t’is necessarily so. It’s built into the numeric fabric of business, which in turn is built upon the numeric fabric of how we humans interact and behave and accomplish and endeavor together.
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Next up is 400. 400 is way more than 20. In fact, it’s twenty 20s. It’s also a number Dave Ramsey mentioned in passing on his radio show today, when he said that he had 400 employees. (Aside for those who don’t know who Dave Ramsey is: Dave Ramsey is a radio personality who does a personal finance call-in show from Tennessee. His radio show is the third highest rated in the country, playing particularly well in the South. He hates debt more than just about anything else, and he is very upfront about being a follower of Christ Jesus, whose name he says in that reverse way. He hates government about half as much as he hates debt, which is to say that he really hates government a lot, especially when it’s being run by Democrats; he appears on Fox News with some frequency, and is treated as “one of the good guys” when he is on there. I often listen to a few minutes of his radio show weekday mornings; in SFCA he is on at 9 a.m. on AM960. After listening, I just about always have something to write about, and every once in a while I actually do the writing. I agree with Dave Ramsey’s advice more often than not, but I disagree with him very strongly on a fairly large number of topics, mostly having to do with arithmetic and negative numbers. He is strong on budgeting, less so on investing and balance sheet design. I do hereby certify that I believe all these traits are objective verifiable facts, except the estimate of the degree to which he hates government compared to how much he hates debt, which is my own estimate, and except the statement about his third place ranking, which I heard him say recently and which I believe to be true based on what he said. And, oh yea, the part about the South I am supposin’ to be true.)
So Dave mentioned that he has 400 employees working for him. And that sent my mind a’whirrin’.
Interesting, I thought. 400 employees, eh? I always figured it was somewhere in the hundreds, and now I know which one of the hundreds it is! I’ve been wondering about just how big DaveRamsey’s business is, and this is great information to have in that regard because I can’t think of a better scalar for guestimating the size of his business than this 400-employee number. And, oh yea, kudos and congrats DaveRamsey; you’ve built one hell of a business there. That’s 400 families — probably a thousand humans and then some — that you can help have better lives, in the sense that, but for you, they’d all be working somewhere else, and, with respect to at least some of them, perhaps not working at all. And you have it within your power to make their endeavoring wonderful.
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So here’s how a student of scale hears that 400-employees number.
We start with an idea of how much revenue each of those employees might generate for the company. Or, stated differently and a bit more realistically (since not every employee directly generates revenue), if you took all the revenues of the company for a normal year and divided that figure by the number of employees the company has, what would you get?
Most successful businesses have annual revenues per employee somewhere in the six-figure dollar range — something between a hundred thousand dollars and a million dollars.
As always, there are exceptions. Putting my mind to the low end of it, and having just returned from the beauteous, verdant Northshore burbs of the Chicagoland area with the sound of cicadas and lawn mowers still resonating in my aural memories, the idea of a landscaping business generating less than $100k in annual revenues per employee seems entirely plausible. At the other end of the spectrum might be a hugely successful software company doing BFS installs — with BFS standing for Big Fyou-know-what-ing Software — with a blockbuster product that can save its customers tens of millions of dollars fairly quickly. That sort of business might well be generating per-employee annual revenues exceeding $1 million.
Let’s get more concrete on this, by looking at some familiar business names. According to a site named Advfn.com, at last look Google, no spring chicken nowadays but clearly still in a commanding position, had $931,565 of annual revenues per employee, and Apple, still on a record-breaking business-roll, though clearly sputtering a bit compared to a few years ago, is still racking up a truly incroyable $2,149,835 of gross revenues per employee per year. Sheee-eeeeesh! Such are the benefits of doing none of your own manufacturing coupled with sales numbers that are in the tens-of-millions of units each month.
But more often than not, companies generate revenues in the $150k to $350k per-employee-per-year range, so I usually think of annual revenues of $250k per employee as being about the center of gravity in the annual-revs-per-e’ee world.
Of that $250k per employee annual revenue figure, a major chunk goes to salary and benefits, with other major chunks going to the direct cost of providing the company’s goods and/or services, another major chunk going to real estate and other costs necessary to the company’s functioning, and lest we forget, there’s always another couple’a major chunks going to etc., etc., etc. and to dthis, dthat and dthe odther dthing, after which you might find a remaining, say, 10% that is pure profit, baby, just pure profit.
Add all that up and subtract it all out and what you might notice is that each $250k-of-revs-per-year employee helps the boss make $25k per year in profit. Why, that’d be a very good reason to, as a default, love one’s employees, and to want more of them, wouldn’t it?!
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And what of that 10% profit number? How common is that?
I think of that 10% profit margin as also being a center-of-gravity sort of number. At the very nasty end of things, negative numbers happen here, as in net losses. And then there’re businesses that come in right around a 0% net profit margin — but usually not for long (unless that 0% margin is a 10% margin masquerading as a 0% margin for tax purposes . . . in which case it can be sustained because it’s not really a 0% profit margin business). And then there are the notoriously thin-margin business, such as grocery stores, which might be along the lines of 2.5% profit-margin businesses.
At the other end, my all-time favorite frame of reference is tied to the pre-Vista, pre-Ballmer, pre-iPod/Zune Microsoft of old, when Gates was running the joint on monopoly-drive, and the company typically turned each of its revenue dollars into four dimes’ worth of bottom-line pre-tax profit, as in a 40% net profit margin. Today, though, Advfn.com tells us that the much-humbled Mr. Softee is chug chug chuggin’ along at 28.1% (we should all chug so well).
More recently, we can again look to the Two Wonders of the (Silicon Valley) World, where Advfn.com shows Google sporting a pre-tax profit margin of 25.1%, again falling short of Apple, which takes the prize by a fairly substantial . . . er . . . margin, at 31.5%.
But these are no ordinary companies, right? So, all together then, when we return to earth and to normal businesses, it’s just about right to think of that 10% profit margin as being the profit-margin center of gravity about which most business revolves — as being the number built into the fabric of most business’ing.
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Once I heard DaveRamsey spout out this 400-employee figure, I turned my thoughts to the running of the zeros, i.e. to multiplying all these big numbers together. Now, as regular readers know, when listening to DaveRamsey in the a.m. I am not close to a computer (to say the least), so, even though I fancy myself a bot of an Excel Jockey, I actually had to do the calculation in my head.
Multiplying 400 employees times $250k of revenues per employee is kinda hard to do in your head, due to the multiplicity of zeros and the odd couplings of those zeros, with a couple here and a couple of couples there (though 4 times 25 is wicked easy). So instead of running the numbers straight as-is, I multiplied DaveRamsey’s 400 employees by $1 million per DaveRamsey employee and got $400 million, but then I took one-quarter of that figure because $250k is one-quarter of $1 million. No doubt engineers and math folks and rocket scientists would run these zeros in their heads using scientific notation or by simply counting the zeros. But the method I just described is the one I use because I find it to be the most idiot-proof to thwart the brand of running-the-zeros idiot I possess (results may vary; figure out which way works best for you and stick to it).
And thusly did the a’whirrin’ thoughts arrive at a figure: assuming $250k in annual revenues per DaveRamsey employee, those 400 DaveRamsey employees would generate $100 million in revenues, which, at the 10% profit margin center-of-gravity, would generate $10 million in profits.
But Dave Ramsey’s business strikes me as being closer to a BFS software company than to a grocery store — more like a 40% profit-margin software company than like a 2.5% profit-margin grocery store or a 10% profit-margin normal business. I say this because, first of all, there are the legions of churchgoing Financial Peace University disciples out there doing much DaveRamsey work, including being FPU teachers, for which I assume they receive either very little or no compensation, and whom I assume are not part of that 400 employee headcount.
And second, there’s also DaveRamsey’s Endorsed Local Provider program, through which Dave Ramsey listeners can receive, from DaveRamsey’s business, the names of insurance agents and the like whom Dave Ramsey has, judging by the ELP name, endorsed, and from which I assume Dave Ramsey takes his vig when folks use, or perhaps simply talk to, an ELP. (I’d love to be wrong on this one, and I’d love to see the vig either go to the customer as a discount on the product s/he buys or go into something other than DaveRamsey’s profit because in general I do not like to see customers and prospects and leads bought and sold. Insurance agents, for instance, are often willing to pay a referer 50% of the agents’ commissions on referred-customer’s business. So DaveRamsey might — I do not know one way or the other — might be slicing and vigging a lot of money out of the businesses of ELPs, turning business leads into cold hard cash.)
All that is something that tends towards making it a high profit-margin business, but what really puts me hunching towards the 40% end of things is the intellectual property component of the DaveRamsey business. The way I reckon it, Dave Ramsey’s business has been built up from the radio show and then out, and the radio business in general, when it works, is a beautiful high-margin business. Think of it: when you add a new station carrying your program, your revs go up and your costs stay virtually the same. Of such things are empires built. Copyright interests are great interests to own if you want to make a ton of money off of your interests.
So I’m going to guess, based on everything I posited above, that the business is a $350k annual-revs-per-employee biz, and that it has a 40% margin. Yes, I’m guessing.
That works out to $140 million in revs, and a 40% margin applied to those revs works out to $56 million of annual profit.
That number sounds a bit high to me, so I will veto the bottom-up analysis and give it a top-down haircut — just because I can — and put it at $40 million per year. So what you end up with is a business consisting of one person writ large through the endeavoring of 400 people, with large in this context equating to, best guess, profits of $40 million or more per year (also known as $100k profit per employee per year). But I’m guessing.
Now, I don’t know about you, but, given that there’s a single name at the top of the business, and assuming that the person with that name owns all or nearly all of the business, I’d call that a large one-human business. Not Bloomberg-scaled gargantuan in size, but large all the same.
So that’s one way to weave a whale of a scale-tale.
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Sometimes my wife and I perform spontaneous scale-tales when we’re at a restaurant and have gone through our main topics for the day, entertaining ourselves by calculating our best guess for the restaurant’s daily gross (yup, my wife is the real biz-head of the family). The process is similar to what I outlined above, but different in the particulars. We start with how many tables the restaurant has, and then move onto the average table bill — the average tab. When you think about the average tab, you have to think about who boozes and who doesn’t, and how those who booze, booze. Do they order from the well or do they name their own tune? And how many tabs can the restaurant turn per table each day? And does it do brekky and lunch? Then, once you finish working-up your best guess of daily gross revenues, you can turn your attention to expenses. How about the employees? Does it try to get them for as little as possible or does it seem like the sort of place that would take some pride in paying their employees well or not? And is it a place where they spend a ton on decor? Etc., etc., etc.
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And, come to scale-tale think of it, just how big around would you need to make the bones of a 12-foot tall human being? And what would that human being look like? A bit more elephantine perhaps? A bit more thick through the bottom — a bit more pear’y? And would the knees need to be unusually bulbous? How ’bout the feets?
And just how tall is too tall for a building? It’s the same question, more or less, as how big you’d have to make the 12-footer’s bones, but here it’s pipes and elevator shafts and heating/cooling systems that you have to scale up, but not linearly, with each additional floor.
Yes indeedy, we do loves us some scale ponderings . . .