We’re reading a lot about the economy lately, which is expected during times of crisis. Rising unemployment and a sharp decline in economic activity is forcing governments to make tough decisions. Do governments drop interest rates to reduce the debt burden for borrowers? Are central banks printing more money to fund government spending? What does it all mean and how does this apply to the economics of your business?
Economics can be a complex subject. For many of us, the Economist is a taxing read, so I’ve broken down some key principals.
What is economics?
By definition economics is the branch of knowledge concerned with the production, consumption, and transfer of wealth. Therefore the economy comprises of the accumulation of all the ‘buy’ and ‘sell’ transactions whether you are trading money, time, products or services. Economics is also about weighing up choices or alternatives. For example, if you decide not go out for a meal, your local restaurant may have one less table filled. Your babysitter doesn’t get work. You redirect your spending to the local butcher and wine merchant, effectively transferring the wealth. These choices, made everyday, and stacked up, can have an impact on the greater economy. We’re seeing these economic shifts during the Covid-19 crisis. Restaurants have closed. People need to eat, creating a higher demand for certain groceries such as flour.
The Schumpeter theory of entrepreneurship
Let’s dive a little deeper. Economist Joseph Schumpeter (1883-1950), regarded as one of the 20th century’s great thinkers, introduced the concept of entrepreneurship. He set out that [economic] growth occurs, usually in spurts, as a result of additional competition or declining profits, when entrepreneurs innovate and shift the competition away from traditional pricing mechanisms. Schumpeter popularised this cycle as Creative Destruction.
A society cannot reap the rewards of Creative Destruction without accepting that some people might be worse off, not just in the short term, but also perhaps forever. A good example of Creative Destruction is the continuing innovation of transport. Society benefited as cars and aeroplanes replaced horses and mules, bringing in new industries and destroying the old. An aeroplane may have allowed the creation of a global workforce. How will this mode of transport be affected by the innovation of remote working?
Dalio’s Economic Principles
In his economics 101 video, Ray Dalio, founder of Bridgewater Capital, outlines three economic principles – productivity growth; short and long term debt cycles, and how levers are pulled by governments to stimulate or slow the economy. In one example Ray explains how a person earning one hundred thousand dollars can borrow ten thousand dollars on credit to increase his productivity or to innovate [entrepreneurship], contributing to growing the economy. However if that person uses newfound credit to fund a lifestyle, then spending exceeds earnings, which on a larger scale, can lead to a recession. The lesson here is that we need to increase our collective productivity to grow the economy. Ray ends his lesson with three rules that you can apply to your own situation.
- Don’t have debt rise faster than income because your debt burden will eventually crush you.
- Don’t have income rise faster than your productivity, because eventually you will become uncompetitive.
- Do everything you can to raise your productivity because in the long term, that’s what matters the most.
The economics of your business
It’s important to step back and think about your business like an economist, particularly during boom-times. Ask yourself:
- Are your investments leading your organisation to be more innovative?
- Are you still competitive?
- Does the customer who you are competing with for their share of wallet, still need your product
- How does your organisation needs to transform to increase output?
For example, say you are in the business of providing instructor-led Excel training and prior to the Covid-19 lockdown your team of instructors hired out hotel conference rooms to facilitate training, then how did you adjust your business model to accommodate for the lockdown. How are you leveraging video conferencing technology to provide the training online? Does this create an opportunity to unlock a larger Internet based audience? Do you continue renting out hotel conference rooms or can your team facilitate this training from a single studio location?
Positioning for the new economy
Peloton is an example of a company perfectly positioned to scale during Covid-19. Peloton provides an at-home interactive cardio experience using custom equipment connected to online classes. Who are their competitors? The brick and mortar gyms, which are all shut and could remain so for months to come. Where are their potential customers? Locked down at home wanting desperately to exercise and searching for home gym equipment. It’s the perfect storm. Peloton have been in business since 2012 and are growing quickly. This Pandemic is working in their favour. When lockdown restrictions ease, the big question is: will people want to flock back to the brick and mortar gyms? Wealth has been transferred which is economics in play!
Update: 2nd September. Since first posting this article in April, the Peloton share price has increased over 190% from $30 to $87.
I’m no economist but I’m curious about the different levers that get pulled to stimulate a country’s economy. If this article has sparked your curiosity and you want an excellent 101 economics lesson, then I recommend watching Ray Dalio’s 30 minute video How the Economic Machine Works. I also recommend subscribing to Irish economist David McWilliams’ weekly podcast, an entertaining ‘fireside’ chat on current economic trends with a good measure of humour.
To find out more about transforming your business, why not book a complimentary discovery session with Saltwater Consulting today.