The fun part comes when you realize that absent monopoly conditions this is the natural stable state of a mature market, and think about what the future of software might look like, and what the current public policy fights are about.

This article claims that banks make 24%, and they are hardly a monopoly. It also claims the overall average is 8.5%.

The industry standard measure for bank profitability is something called ROA, return on assets, and it's an extensively studied academic topic, with the general consensus that an ROA greater than 1% is pretty good.

https://greyhouse.weissratings.com/ROA-ROE-and-What-These-Ke...

https://www.fdic.gov/regulations/resources/cbi/report/cbi-ro...

I'm sure there are some large institutional players that do consistently better than 1%, maybe up around 5 or 7.

But a longstanding industry with a sustained 24% returns would... sustained compounding 24% a year seems like it would lead to weird results. Like if a bank had survived fifty years and had a few hundred million in assets it would now be responsible for the entirety of US GDP.

EDIT: I looked at BOA as a random test case - 2.1T in assets, 22B in income, seems to match the ~1% rule: https://ycharts.com/financials/BAC/income_statement/quarterl...

I've talked myself into: maybe 24% is technically "profit margin," but only because banks are weird and profit margin makes no sense for them.

If you have a grocery store and you sell $100 of fruit, maybe $1 is profit. It makes sense to say you have a 1% return on investment. $1 Profit / $100 revenue.

That makes sense.

But a bank loans out $100 at 5% interest. It collects $5 next year while the loan is still outstanding, of which $4 go to operating expenses.

That is $1 profit on $5 of revenue, so 20% profit margin, by the formula. But it took $100 to get you there, just like the grocer, so 20% feels inflated for basically the same result. (In other industries you don't sell a peach only for the buyer to later give you a new peach back, so that throws all of this off.)

(You raised ROE, which I think typically ROE for banks is 5-8%, and it's really dependent on random factors like how they treat shareholders, so you might be right? But I think we can set that aside too.)

So none of this makes sense and maybe I give up?

I can see why the industry just decided ROA is the measure here. It's not completely crazy, and seems to generate reasonable results relative to other industries.

And if we're really asking, "hey, I have $100, maybe was loaned it by a lender or depositors, and I can magically run a buffet or a bank next year, what do I expect to earn?"

Then yeah, we really want to be comparing the profit margin of the buffet to the ROA of the bank, as incommensurable as those sound. Maybe this isn't completely crazy and the industry lit has this already figured out in the most reasonable way.

Return on investment is something else. A grocery store will have sales well above the invested capital. The profit margin may be low-single-digit while ROI is double-digit.

I was trying to shift to a lay voice in that bit and in the process totally misused one of the terms of art under discussion, was a bad oversight on my part.

I think my general explanation stands as to why we might want to shift between ROA/ROI and profit margin when comparing different industries though.

After all, if you're a bank you can create new money supply out of thin air by lending out money you don't have (fractional reserve). A money printing machine is a very valuable business. Every other service a bank provides is just icing on top of this.

Heck, every lessee on Airbnb is doing this.

As is everyone who has a mortgage and an investment account.

Consider for example the forces driving Uber/Lyft margins vs Google/Facebook margins.

A quote from Lucas at the time they were looking to build Singapore was "Why should I pay some prima donna animator in the US $80k when we can get several in Asia for that price with no complaints"

Yes, this was actually said by an exec at Lucas...

A percentage margin is expressed relative to the value of the sales.

Low margin on high value sales is as good as high margin on low value sales, in terms of how much money you make.

Low margin is only a problem in low value sales.

Why shouldn’t people running a business with extremely high value sales, due to low margins? I can’t see what you’d find that a bizarre thing to do?

I’d be happy making 5% if I was selling a jumbo jet a day, for example.

You can’t criticise just the margin in isolation like you’ve done.

In a low margin business, you don’t have such room for error, and you actually have to fluctuate with conditions. This isn’t a deal breaker: most business operate this way!

But it’s scary for someone looking in from a high margin business.

Restaurant workers are, of course, going to be fairly indifferent to restaurant bankruptcies especially if an existing restaurant is swiftly replaced by a new one that pays more.

The actual high-margin businesses wouldn't be taken out in the bust unless they were high margin only because they were selling into the boom.

Exactly.

I might even be post-paying for the inventory (net 30 terms, for example). I post-pay the labor as well. In this case, it's kind of meaningless how much the inventory that I'm turning over costs, given a fixed margin. What matters is how much capital I have invested in the business. It also matters how quickly I can adjust to changing market conditions. If I can respond to changing conditions instantly, it's impossible for me to lose money. In practice this is not possible because of leases and delivery schedules, though. That's where the risk comes from.

Of course, variability of demand is also an important factor. That's where the risk comes in, because there are fixed costs that don't vary with business.

The article is specifically discussing all you can eat buffets. I don’t think they are selling jumbo jets at Old Country Buffet.

I think there is some money to be made selling food.

[1] https://restaurant.org/Downloads/PDFs/Research/SOI/restauran... [2] https://www.statista.com/forecasts/963597/software-revenue-i... [3] https://www.ifpi.org/news/IFPI-GLOBAL-MUSIC-REPORT-2019

I don't die if I miss out on the latest version of ServiceNow or Adobe. Or the new Taylor Swift album.

You can see net margins for US public companies here:

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/...

The average is 7.7%

There's an economic 'law' that basically states that the return on investment of a business in a mature market (read perfectly competitive) will always trend towards the interest rate (plus the cost of whatever sort of barriers to entry are in place) because of the arbitrage principle. If a business makes higher margins, everyone will pile in and undercut the incumbents until the margins are reduced to the cost of entering the business.

For most sectors of the food industry, there's very little product differentiation. Some restaurants do make higher margins, but they're typically small and highly differentiated.

In fact I suspect you can reasonably look at large chain operations as figuring out a way to reduce the factors that keep the average return lower than it "ought" to be...

When you set out to do a business plan, you should be looking at differentiation. Not producing a commodity with slim margins...

  Nah 5% is shit (but also the average)

20% is pretty high margin in general for business.

> This article quotes a 5% margin. I know food industry margins are low in the first place, but as a business owner in a different field I'm left wondering why anyone would even bother. The same business prowess and attention to detail you need to make a buffett run profitably could get you very far in another industry.

This is because you are assuming entrepreneurs act only for the purpose of profit.

Entrepreneurs act for the same reason all people act: to achieve their desired ends. These ends are established based on emotional desires, which do not necessarily correlate with things like maximum ROI.

If you look at risks involved and potential loss of money instead of only looking at higher margins, it is easy to see why people would rather earn their 5%.

But I think it’s an interesting point. Why fight all day long for a 5% margin when you could put your money in index funds?

Are you serious? You're making such a critical mistake. The business owner isn't paying for the products. The customers are. Every time a customer spends $100 you get $5 in pure profit after paying all the salaries (including your own) and all other costs. The 5% margin is applied on the money your customer is spending, not your own money. If you have $100 and get a 10% ROI then you would have to wait a year to get $10. If you have 10 customers each paying $20 for the all you can eat buffet then you have $200 * 5% = $10 profit.

Let's assume you spent half a million on your fancy restaurant. How long does it take to pay that back? You don't pay it back from the profit. The cost has already been taken into account and therefore lowered the margin which means the margin clearly doesn't influence the ROI. The final profit is $1 per customer with 300 customers per day which translates to $75k of pure profit per year or a ROI of 15% in the first year. The real numbers probably look completely different. 300 customers is probably a below average day. The restaurant may be more expensive or cheaper to set up (especially if they are renting instead of owning).

Also at many small restaurants the owner and the owner's family is also working full time, and that 5% margin doesn't include their salaries.

This is something that often seems lost in this discussion.

The profit margin is usually after the owners themselves have taken a salary. If they are paying for themselves appropriately, and the margin is 0%, this is often described as "making no money".

What's making no money here is the business as an entity, not the owner, despite the frequent rhetorical conflation of the two.

Payout of positive margins, if they exist, are often classified as "profit sharing" in the simplest of businesses, like sole proprietorships. In more complex large businesses, they become dividends or employee bonuses.

Most people can't afford to pay themselves nothing while running a business.

2. The company isn't going to accumulate many assets if the owners are paying for gas, travel, food, and rapidly depreciating assets.

The least you can expect is that a business sale is much larger than the capital stopped at it. Otherwise it is in great trouble, even on high margin markets.

It doesn't really make sense to compare things this way, they're so different. Better to do an income flow analysis. For a given amount in invested capital, how much profit will a profitable restaurant generate in a year vs the stock market. The restaurant is gonna come in way ahead, though of course it's a very active investment (a full time job plus some) vs the passive index fund investment.

I can't parse this but am curious what it means; can someone explain?

If you have the industry know-how, money and time to change industry, sure. In reality...

Because they don't have a choice.

An economic profit is defined as making enough profit (and intangible benefit) to not want to do something else.

For a small business owner it's "am I better off selling it off and getting a regular job?"

For a larger chain, it's "is there a more profitable line of business?"

No one just goes out of business; read a story about a failing business and there will invariably be a series of attempts they made to rethink their operation, failed acquisitions, etc.

So there we have to go back to the original argument: do they have a choice? I'm claiming their choice is the strategy they employ, they don't have control over the outcome, obviously.

The only case where you don't have a choice is when there's a sudden shock to your business; new laws put in place or something like mesothelioma crushing Lloyds. I don't think this applies because the changes we're talking about here are not sudden at all.

It's also not an all or nothing affair: you don't have to completely shut down one operation to start doing something else.

But other corporations can gradually enter and exit different lines of business, and this happens all the time.

Restaurant chains are a confusing example since they're really a mess of franchises. Even there, the parent corporation can create new branding and restauarant layout and effectively move into a new line of business.

There is a lot of ego in a decision like that. Easy economically, very very hard emotionally.

Not saying this is a typical fee on government contracts, but the company I was working for (big dollar government contractor) was happy with that.