I often find myself trying to explain “adding value” to business owners who are new to business and confused about how things work. I finally came up with what I call the margarita example as a way to illustrate the concept.
In case you’re not aware, a margarita is a tasty tequila based cocktail typically served in Mexican restaurants but widely loved all over. I am usually a beer drinker, but when out at my favorite Mexican restaurant, I will often order one of their delicious $12 house margaritas (rocks, no salt).
The margarita question that follows simply asks- where does my $12 go? Or more specifically, who are the players in the equation who should rightfully expect a cut of the $12 I spend to get this drink?
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First, there are the makers of the ingredients- the tequila and the flavor mix. But also, the providers of the glass, the ice, the straw, etc. Each of the companies behind these ingredients spent time and effort to make those things; some used once and some, like the glass, used many times. All in let’s say the component parts of my drink are worth $4.
Second, there is the bartender, who takes the order from the waiter and assembles those parts into the drink. He has the skill to do it and does it efficiently and without him it wouldn’t be a margarita, just a bunch of components. He gets $1 for his effort.
Third, there is the waiter, who took my order for the drink, communicated it to the bartender, then when it was ready picked it up and brought it to me. Let’s say for this effort, he also makes $1.
So now we have accounted for the $6 of the $12 I am paying. Who gets the rest?
The restaurant owner. What did they provide? The table, chairs, location, ambiance, the services of the waiter and bartender, fronting the money to buy the margarita ingredients in bulk as well as the glasses to serve it in, insurance, the utilities to keep the lights on and the marketing that drew me into the restaurant in the first place. For all that, the restaurant owner gets $6 and these things might have cost $4.50 so on the $12 drink the owner makes $1.50.
In each of those steps, there was value added by each party who added something to enable the collective effort of getting me my drink.
Why does any of this matter? Because the way you tell if a business is good is by seeing how much value it adds and how efficiently it can do so to maximize the spread between what it costs and what it can charge for what it can deliver. You want to have the biggest spread.
And sometimes, this can help you understand why there is no spread.
Suppose in the above scenario you wanted to insert yourself into the mix. Suppose you decided to stand at the bar, and as soon as the bartender finished making the margarita, you grab it and then turn around and hand it to the waiter. They were going to get it anyway, all you’ve done is take one step out of the journey. How much should that be worth? Virtually nothing, right?
Now look at online arbitrage. What is that? You find a product for sale on Amazon and you list it on eBay for a higher price. You don’t make, buy, store, or ship the product. If someone buys your eBay listing, you just hop over to Amazon and place the order and put the customer’s shipping address in the order form. You may make a few bucks. But you did nothing to add value to the process at all. So you shouldn’t expect to make much and you shouldn’t be surprised when that little spread goes to zero.
If you are simply inserting yourself into a chain of events that doesn’t need you and you don’t add anything to the process, then you reasonably shouldn’t expect to extract any profit.
Look at MLM businesses- you buy a product for a lower price and then sell it to someone else for a higher price. Why is the price higher? So you can pay your upline- the people who sold it to you. And why are the people you sell to then charging more again? So they can pay you. All this does is add layers to a process that doesn’t need layers and add cost to a product so people who haven’t added any value can get paid. No one is actually adding any value here by having these layers. So is it any surprise that only the people at the top make money and that 99% of people who get into MLM lose money?
In your business, make sure you understand your role and the value you add to the process.
If you don’t make the product or provide the labor, or you don’t own the relationship with the customer, or own the relationship with the manufacturer, then chances are you are not in a position of adding much value and very likely will be the first to be squeezed into accepting zero profit (or worse, losing money) because the process doesn’t need you.
So the margarita question is who am I in the chain and how much value am I adding? How can I add more? And if I’m not really adding anything, then how do I make changes now to avoid getting squeezed out? A real business adds real value in a way that the market appreciates. Make sure you are adding real value!