Why, How, Where and When Entrepreneurs Make Money
The final purpose of an entrepreneurial venture is to successfully establish a new business and generate windfall profits from it. Social entrepreneurship may not necessarily have profit as its target, so this article will remain focused on profit generating entrepreneurial ventures.
You've done all your hard work and planning, secured funding and established your business. But what about the rewards? Where, when and how can you expect your high-yield rewards to be realized, and why should your entrepreneurial venture succeed where others have failed?
Why Should Entrepreneurs Make Windfall Profits?
Imagine two hypothetical workers.
Peter goes to the office each day, works a standard 40 hour workweek and gets paid a standard salary. He is great at his job, but his contributions to the world remain confined to his work.
Paul has a passion to change and improve the world by introducing new products and services. He works many more than 40 hours a week, investing his time, capital and energy to try something new that he hopes will make the world a lot better than it currently is.
Clearly, the world would be a less dynamic place, if there were only Peters and no Pauls around. Paul takes more risks and puts in more effort than Peter. It seems logical that Paul will have a greater impact on the general welfare through his contributions. If the reward for Paul is more or less similar to that of Peter, however, Paul will not be happy to put in the extra effort to improve the world's wellbeing.
Who do you think should get more credit for his contributions?
According to neoclassical economic theory, a lack of suitable rewards discourages entrepreneurs to take on risks and put in extra effort, without which the world becomes stagnant. Government authorities rightly offer entrepreneurs special rewards through patents, copyrights and royalties. Entrepreneurs won't do their job without windfall profits on their invested time, effort, energy, money and risk taking.
How Do Entrepreneurs Make Windfall Profits?
Entrepreneurs introduce new, innovative products or services that may result in significant improvements in productivity, cost reduction and improvement in quality of life.
Knowing their offerings much better than anyone else and being aware of customer needs, the entrepreneur can charge a heavy premium for their path breaking innovations. This high premium gets translated to big rewards, justifying the big risks taken by entrepreneurs during development.
If competitors are not able to build and introduce similar products or services in short span of time, the product becomes a monopoly for the entrepreneur, and he or she can expect windfall profits from being the sole manufacturer or sole service provider.
Even if the competitors find it easy to replicate and introduce similar products quickly, the entrepreneur can seek safety and protection for their innovation through the patents, copyrights or royalties. These channels offer protection to the original inventor and act as a major safeguard for successful entrepreneurial ventures.
But how long can this monopoly continue? Not indefinitely, else it will again lead to economic and social stagnation. Without government intervention in the form of patents, profitability continues till competitors start offering similar products and services. Without patents the market becomes open and competitive where further innovations and new variants or upgraded modified offerings appear. Entrepreneurs usually keep a close eye on such developments and are circumspect enough to upgrade their products and maintain their upper hand in the market.
In the case of patents, protection is available for a certain amount of time which can span a few months to a few years. (In the United States, patents usually last for 20 years.) Depending on the local laws, the royalties may still apply after the patent has lapsed, but the formerly patented item loses profitability as it no longer remains a one-man show.
This again encourages healthy competition: either entrepreneurs start work on something new or they succumb to market Darwinism.
Where and When Do Entrepreneurs Make Money?
When it comes to money matters, timing is very important. Here is an illustrative graph indicating all possible cash flows and their timing during the different phases of an entrepreneurial venture:
Term 1 to Term 4 (The Pain Period) – This is the initial investment period, where different activities will be performed including but not limited to product idea development, feasibility and market study, prototype building, and customer identification. The order may differ depending on the venture, but the concepts remain the same. It is assumed that funding from angel investors becomes available in Term 4.
Term 5 to Term 6 (The Introduction Period) – Activities covered here may be applying for and securing patents, building sales channels and a distribution model to final product introduction to the market.
Term 7 to Term 9 (The Profit Period) – These terms are the profit taking monopoly periods – either protected by patents or no competitor scenarios.
Term 9 is assumed to be the peak profit period, just prior to competitors coming to market. It is during this term that further development is initiated for introducing new product variants to the market, and hence investment is needed for the same. However, reinvestment, research and development can come earlier depending on the product's lifecycle and other factors. This can also be the time to introduce this offering to new markets.
Term 10 – Term 11 (Sunset Period) – Lots of options are available here. Either exit this venture completely by sunsetting the offering, selling the venture to interested parties or continuing with newly developed variants. Profits will vary depending on all external factors, market scenarios and competitors.
The Bottom Line
The above is an illustration of a general entrepreneurial cycle. The duration and activities mentioned will vary depending on the nature of product and markets. For example, a pharmaceutical drug may have a longer monopoly period owing to the patent, while a mobile technology may get replicated within very short span of time.
All business ventures aim for profitability. Owing to the high risk, high reward scenarios of entrepreneurial ventures, the entrepreneurs are expected to make windfall profits, provided they plan their activities carefully with due diligence.