The Expanded and Annotated My Life and Work

Managerial or Engineering Economics
Managerial economics or engineering economics deals with marginal rev-
enues, costs, and profits as shown in equation 2.1. The derivatives are for 
any given level of production N, e.g., 100 units per day, and dn refers to an 
incremental change in production.
 
Marginal Revenue
d Revenue
dn
sales pr
N
:


=
iice
Marginal Cost
d Cost
dn
materials
N
:


=
ccost plus genuinely variable labor
Marginal
:
Profit
d Profit
dn
Marginal Revenue
N


=
m
minus Marginal Cost
 (2.1)

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What I Learned about Business  •  29
The phrase “genuinely variable labor” is important because cost 
accounting systems generally treat all hourly labor as a variable cost. 
The truth is that this cost is a fixed cost, just like that of the plant and 
equipment, unless the business is paying overtime. The workers are 
there whether or not they have value-adding work to do. In this exam-
ple, then, the only marginal cost consists of the $10 in materials. This 
is why every unit the company can sell for $20 brings a marginal profit 
of $10.
If, however, the company has no excess labor capacity and must pay 
overtime to fill this order, the marginal cost is now $10 for the materials 
plus $37.50 (at time and a half) for labor, for a marginal cost of $47.50. In 
this case, the order should be rejected.
Another dysfunctional effect of overhead is the desire to make as much 
inventory as possible to “absorb” it, i.e., distribute the overhead over as 
many units as possible. This might even yield a favorable overhead vari-
ance (difference between standard and actual cost) for the product. This 
looks good to cost accounting systems that treat inventory as a short-term 
and, therefore, liquid asset, but this is the only place in which inventory 
is an asset. Goldratt and Cox (1992) define inventory along with operat-
ing costs as undesirable performance indicators, i.e., less of both is better. 
Throughput, or finished goods with customers who want them, is the only 
indicator of which more is desirable.
We therefore conclude that Ford’s avoidance of the use of cost account-
ing metrics for actual managerial decisions is worthy of particular atten-
tion and emulation.

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31
3
Starting the Real Business
This chapter begins with the identification of what Ford calls “universal 
demand,” whose achievement comes from a product or service that meets 
the needs of 95% of potential customers. These needs include high quality 
and low cost as well as functionality. Ford stresses that, even in his day, 
few people would buy without regard to quality. On the other hand, the 
segment that would pay for special or extraordinary product features also 
was very small, so it made no sense to meet that segment’s needs at the 
expense of the 95%.
* * *
In the little brick shop at 81 Park Place I had ample opportunity to work out 
the design and some of the methods of manufacture of a new car. Even if it 
were possible to organize the exact kind of corporation that I wanted—one 
in which doing the work well and suiting the public would be controlling 
factors—it became apparent that I never could produce a thoroughly good 
motor car that might be sold at a low price under the existing cut-and-try 
manufacturing methods.
Everybody knows that it is always possible to do a thing better the second 
time. I do not know why manufacturing should not at that time have gener-
ally recognized this as a basic fact—unless it might be that the manufacturers 
were in such a hurry to obtain something to sell that they did not take time 
for adequate preparation. Making “to order” instead of making in volume is, 
I suppose, a habit, a tradition, that has descended from the old handicraft 
days. Ask a hundred people how they want a particular article made. About 
eighty will not know; they will leave it to you. Fifteen will think that they 
must say something, while five will really have preferences and reasons. The 
ninety-five, made up of those who do not know and admit it and the fifteen 
who do not know but do not admit it, constitute the real market for any prod-
uct. The five who want something special may or may not be able to pay the 
price for special work. If they have the price, they can get the work, but they 

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32  •  The Expanded and Annotated My Life and Work
constitute a special and limited market. Of the ninety-five perhaps ten or fif-
teen will pay a price for quality. Of those remaining, a number will buy solely 
on price and without regard to quality. Their numbers are thinning with each 
day. Buyers are learning how to buy. The majority will consider quality and 
buy the biggest dollar’s worth of quality. If, therefore, you discover what will 
give this 95 per cent of people the best all-round service and then arrange to 
manufacture at the very highest quality and sell at the very lowest price, you 
will be meeting a demand which is so large that it may be called universal.