Q. Dear Zenagos, I keep hearing that “it takes money to make money.” What does that really mean, and is it true?
If you can collect payment in advance of performing work, and your cost is your own labor, then it really doesn’t take money to make money. You use your customer’s cash to fund the operations of your business, so you don’t need to have a lot of money to get started. Having customers pay up front is a wonderful business situation.
However, most customers hesitate to pay up front, and for good reason. They may be willing to put down a deposit, but they want to hold back the balance until they are certain that the product or service that they are purchasing meets their requirements. Still, for a lot of businesses, getting some payment up front is enough to make it possible to start the business “on a shoestring” (using very little start-up money).
The phrase “it takes money to make money” is a truism that applies to businesses that require a large investment that must be made a considerable time before the revenue or payment is received. These businesses are called “capital-intensive,” and they cannot be “bootstrapped” or started on a shoestring. They must be funded by investors with deep pockets.
High Fixed Costs
Businesses with high fixed costs require large investments in advance. Examples include airline manufacturers, semiconductor fabricators, and infrastructure like railroads or cable networks. Sizeable real-estate projects also fit this description, including commercial real-estate development and the construction of luxurious physical facilities such as casinos.
Businesses that need to achieve a certain size before they start making money also require large investments. This includes businesses with multiple locations, such as chain restaurants, retail stores, and franchise businesses. It also encompasses scaled delivery networks like UPS, FedEx, and Amazon.
Economies of Scale
Some businesses only become profitable when they produce at very high volume. These businesses are said to have “economies of scale.” This describes most public utilities, auto manufacturers, and software providers such as data centers like Microsoft Azure, Amazon Web Services (AWS), and IBM Cloud (Hilker, 2021).
Some products and services are regulated by government agencies and must spend several years going through approval processes before they can begin earning revenue. For example, investors in the development of a new biotech or pharmaceutical drug must put in millions of dollars and wait an average of 10 years before selling products and beginning to recoup their investment (Perkins, 2001).
So, for some businesses, it really does take money to make money. You simply cannot start the business (and make money) without having investment money up front. Even for businesses that do not require big initial investments, it takes additional marketing money to increase the pool of customers or to replicate a model quickly (“scale”). So, it usually takes money to make money, and it almost always takes a pile of cash to grow quickly.
Hilker, H. (2021, August 5). Economies of scale: 3 industries that benefit most: Economies of scale are an old-school economic concept every investor should understand. U.S. News & World Report. Retrieved on September 11, 2022, from https://money.usnews.com/investing/investing-101/articles/economies-of-scale-industries-that-benefit-the-most#
Perkins L. (2001). Pharmaceutical companies must make decisions based on profit. Western Journal of Medicine, 175(6). Retrieved on September 11, 2022, from https://www.ncbi.nlm.nih.gov/pmc/articles/PMC1275981/