““A billion here, a billion there – pretty soon it adds up to real money.”” – Senator Everett DirksenSilicon Valley has produced a whole generation of billionaires. There are the hardware billionaires, including the Hewlett-Packard families (whose $10 billion family fortune now exceeds that of the Ford Foundation), the Intel fortune billionaires (Gordon Gates alone is worth $15 billion), and, of course, Michael Dell, the 34-year-old Dell Computer king (worth an estimated $20 billion).

Then there are “application” software billionaires, including three of the five richest people in the world, all from Microsoft (Bill Gates, Steve Ballmer, and Paul Allen). Application software is what people use for work or fun, like word-processing programs, computer games, and “systems” software used to run businesses or the computer networks themselves.

The interesting thing about software (vs. hardware) is that it benefits from something economists’ call “increasing returns to scale.” I can’t tell you how they came up with that term, but it has to do with products that cost a lot to develop but not much to produce. Software programs, for example. Microsoft must have spent millions to develop its Office 2000 professional software, but, once its sales recouped the several million in expenses, it gave Microsoft a very nice ride. That’s because the software product itself, including packaging and support materials, costs only about $20 to manufacture. Yet it sells for $349. If you can get a good market share with a product that has these economics, you can make a lot of money.

This phenomenon of “increasing returns to scale” is one of the main reasons Microsoft made an amazing 39% profit on $7.78 billion in sales. (Compare that to Exxon’s sales of roughly $40 billion with profits of only $6.4 billion.)

When you are considering which wealth-building business is best for you, include this factor in your thinking. Among the many ventures that will cross your mind, some will have this characteristic and others will not.

If, for example, you want to make money selling dance-instruction videos (as my brother-in -law wants to do), figure the initial filming and production costs compared to the cost of replicating the videocassette in varying quantities.

If it costs you $20,000 to produce the video and you only plan to sell 500 of them, your per-unit production cost will be something like $40. Add to that your marketing costs, and you’ll very quickly see that you’d need to sell them for at least $100 apiece to make any money.

But if you could sell 5,000 of them, your per-unit cost would drop to four dollars – a much healthier number for a product that normally sells in the $19 to $39 range.

There are plenty of products that enjoy this economic characteristic. Many of them, however, are simply too expensive for the individual entrepreneur. Drugs and pharmaceuticals, for example. And most manufactured goods. (The days of building your own car in the back yard are long gone.)

But there are still plenty of businesses that benefit from both relatively low start-up costs and scale. Information publishing is a prime example.

Let’s say you are an expert public speaker. You decide to reveal all your secrets in a special report. You write it yourself, produce it on your laptop, and print up 10,000 copies at a cost of $5,000. Your average cost per unit is fifty cents.

You survey the market and decide that other such information products are selling for about $50 to $100. You price yours at $39.

If you sell only 100 of them, you lose $1,100. Sell 500, and you are in the money. Strike it right and sell all 10,000, and your business career is launched.

I’d like to get your ideas about other businesses that benefit, or could benefit, from increasing returns to scale. Please post them on Speak Out, the ETR message board.

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