Watching a colorized version of an episode of the I Love Lucy show, I ignored the colorization and kept thinking about Lucy’s get rich quick scheme. In this case, the Mertz’s (their neighbors and best friends) convince her that she should sell her homemade salad dressing.
After she and Ethel Mertz go on TV to advertise it, they start getting lots of orders, and Lucy goes to the supermarket (Were they called that in the 1950s? Were they even super then?) and starts making jars of salad dressing. In walks Ricky (her husband, for those of you who may not know the show.) He asks what’s going on, and she explains. That’s when the future Marcus Lemonis (of current day TV show The Profit) invades the body and brain of Ricky and asks how much it costs to make one bottle and how much she is charging. She recites the numbers, does some calculations and determines that it costs her $0.22 to make each bottle which she is selling for $0.25. Ethel reminds her that 3 cents of every sale goes to the person who got them on TV to advertise for no cost.
Lucy and Ethel realize that all their hard work will make them no money. And Marcus/Ricky points out that they haven’t even factored in the cost to ship to the customers. At this point Lucy says: “I’ll make it up in volume.” Ricky scoffs.
While Lucy should have known about what her costs would be before she priced her salad dressing and started marketing it, I’d like to explore her idea that she can make it up in volume. Having a gross margin of 0% is not a recipe (pun intended) for a profitable company. Nor is selling more and more of a product or service that produces no gross margin will not yield profits for any company. Yet, is it possible that she can make it up in volume? I say she could.
Since Lucy was buying the ingredients and jars from a grocery store at retail, her costs would go down considerably with higher volume as she is able to buy from a wholesaler and negotiate better and better pricing. Then there’s that labor issue. She and Ethel were making and bottling the salad dressing and were not factoring their cost of labor into their gross profit/margin analysis. Because their time is valuable and, moreover, because they can’t personally handle ever increasing volume of production, they will need to factor the cost of making the salad dressing as well as packaging it and preparing it for shipping. The good news is that there are efficiencies of scale available here too.
In sum, visionaries and entrepreneurs who are going to create a product or service need to think about their costs to make and deliver that product/service before they start making and selling the product or service. And if the profits at low margins are insufficient or negative, they also need to look the profit margins at higher volume levels and ask themselves is it worth the investment to cover the losses until they get to profitability. This is true whether you’re investing your money, your friends’ and family’s money or that of other investors. If the market won’t sustain a price that generates a sufficient gross profit margin after efficiencies of scale have been achieved, then they might find themselves chasing their tail and throwing good money after bad. And, if there are no efficiencies of scale available, no that going in.