Economics for One

Prostitution, Drugs, Pornography, Gambling, and Religion

When I revamped Stanford’s program in Entrepreneurship in the early 1990s, I got to thinking about all the types of businesses people start.

As I thought about the various business models, I realized I could boil them down to some basic characteristics, mostly around what they were selling.  Some companies were based on people (e.g. services companies), some required large up-front investments, but had low marginal costs (such as software), and so forth.  I found that people who were good at one of these business models often had trouble understanding or working in the others.

The basic business models I identified could be loosely identified as:

  • Prostitution
  • Drugs
  • Pornography
  • Gambling
  • Religion

These are business models, and have nothing to do with the specific products or services being offered.

Prostitution

These companies focus on services, such as law, accounting, or consulting.

People are billed out by the hour or the project (“trick”).  Since there is a limit to how much you can charge for someone’s time, and most of that needs to be paid to the individual contractor, you can typically only leverage up the business by hiring a lot of people.  So you are limited by how many people you can reasonably manage.  It is difficult to get extraordinary margins.

There is typically very little investment needed to start these businesses.  They focus on having highly productive individuals, and may be filled with a lot of prima donnas.

Most people who work for a salary are following the prostitution model, even if their employer uses some other model.

Drugs

These are product-oriented business.  Profit is not based on the number of people you employ, it’s supply and demand and how much product you can obtain and sell, and at what margin.  To sell more product, you need to manufacture or acquire more product.  To make more money, you need to make bigger deals, and at a higher margin.

These businesses are often concerned with having good supply chains, and may even sacrifice the individual productivity of their people in order to achieve higher overall operational efficiency.

Pornography

These are publishing businesses.  They require a significant upfront investment before they can get any revenue.  But having made the investment, they have very low marginal costs.  They do not need to maintain any inventory; if they sell a copy of their product, it does not reduce the number they can sell in the future; they simply sell another copy.

These businesses will often give away a lot of product, in order to seed demand – at levels that other businesses could not imagine.  Whereas other businesses might use “loss leaders,” or give away perhaps 5% of their total volume, pornography businesses may turn that around and give away 80% or 95% or more of their product, making all of their revenue on the remaining 5-20%.

Examples of pornography businesses include: software, magazines, newspapers, music, movies, and even Intellectual Property licensing shops.

Gambling

These are financial services firms.  They make their money by understanding risk, by having a large capital base that allows them to lend money, and by providing the services that allow other companies to make financial transactions (thus playing “the house”).

Gambling businesses can grow very, very large in terms of dollar volumes, with a relatively small number of people.  However, they require significant care to prevent any one set of risks from swamping the rest of the business.

Gambling businesses often mitigate their own risk by creating a portfolio of risky businesses which balance each other out.  This can create a tension within the employees, who often want to be compensated for their individual successes.  The result is these firms can be somewhat unstable if incentives are not set up properly.

Gambling businesses are concerned with ensuring a steady supply of capital, as well as excellent “deal flow” allowing them to participate in the good bets.

Religion

Religious businesses include self-improvement services, such as education, gyms, and coaching.  These businesses help their customers improve themselves, but make no guarantees as to whether that help will result in tangible benefits.

There are are fewer examples of these businesses than some of the other models.  However, they are pervasive.  Colleges and graduate schools attract a lot of people each year; these people pay a lot of money for an education which may or may not help them achieve their personal economic goals.  (This is not to say that they do not help – just that it is a characteristic of these businesses that there are no guarantees.)  The evidence is often ambiguous, and thus requires a certain degree of faith.

Summary

Keep in mind, I developed these as business models, with no value sentiment attached to them.  I certainly would not want to draw any comparison between prostitutes and attorneys, banks and loan-sharks, or universities and churches.  But I do find these distinctions helpful when thinking about and evaluating different businesses.

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1 Comment so far

  1. Rob March 21st, 2009 11:22 am

    Are you sure it’s not Pimping instead of Gambling? ;)

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