As Finance Professionals, we do come across various financial concepts, some of the ones that are close to my Heart are :-
1.Opportunity Cost of Capital
4. Time Value of Money (TVM)
5. Internal Rate of Return (IRR)
I always wonder if these are being really used by successful business owners in scaling their business or when they face dilemma in terms of trade offs of decisions involved.
Let us take the example of the entrepreneur I always look up to : Steve Jobs and see if they have been used by him in anyway. Again, there is no real evidence of those being actually used but anecdotal evidence does point out that it might have been used in building and scaling Apple and Pixar. Let's explore how each of these concepts might have played roles in his strategies:
1. Opportunity Cost of Capital
- Example: Jobs was keenly aware of the opportunity cost of capital when making investment decisions. For instance, when Jobs returned to Apple in 1997, he chose to cut many product lines and focus on a few key products like the iMac. The opportunity cost of continuing to invest in unprofitable products was too high compared to focusing resources on innovation that would yield higher returns, like the iPod and eventually the iPhone. This focus on opportunity cost allowed Apple to channel its resources into areas with the highest potential return, leading to significant growth.
2. Contribution Margin
- Example: Jobs understood the importance of contribution margin, particularly in the pricing strategy for Apple products. By maintaining high margins, Apple could ensure profitability even with lower sales volumes compared to competitors. The premium pricing strategy of products like the iPhone and MacBook, driven by their strong brand value and quality, allowed Apple to enjoy higher contribution margins. This was critical in enabling the company to invest in research and development and continue innovating.
3. Sunk Cost
- Example: Jobs demonstrated his understanding of the sunk cost fallacy when he returned to Apple. He didn't let past investments in certain projects or products influence his decisions. For instance, he famously killed the Newton project, a PDA that had already seen significant investment, because he believed it was not the right product for Apple's future. Instead of throwing good money after bad, he focused on new products that aligned with his vision, such as the iMac and iPod.
4. Time Value of Money (TVM)
- Example: While Jobs was not always directly involved in financial operations, the concept of TVM was evident in Apple's strategy of building up cash reserves. By holding large cash reserves, Apple had the flexibility to invest in opportunities quickly without the need to raise external capital, thus avoiding potential delays and costs associated with financing. The ability to act quickly in a rapidly changing tech environment was crucial for Apple's continued dominance.
5. Internal Rate of Return (IRR)
- Example: Jobs likely considered IRR when making investment decisions, especially in projects with uncertain returns. For instance, when Pixar was transitioning from a hardware company to a film studio, Jobs invested significant capital into producing "Toy Story." The project's high IRR was evident after the film's success, which not only recovered the investment but also laid the foundation for Pixar's future profitability. Jobs's decision to invest in this project, despite the risks, shows a clear understanding of the importance of IRR in evaluating potential returns on investment.
Summary
Steve Jobs effectively used these financial concepts to guide Apple and Pixar's growth. By understanding and applying opportunity cost, contribution margin, sunk cost, TVM, and IRR, Jobs made strategic decisions that positioned both companies for long-term success. His ability to focus on the right products, pricing strategies, and investment opportunities exemplifies the practical application of these financial principles in a real-world business context.
Please share even in few words what are the other financial concepts that you think other celebrity business owners have used which we can take inspiration from.