David Ricardo (that’s him in the picture) was a member of the British Parliament in 1817 when he developed a concept that is inherently counterintuitive: that countries engage in international trade for goods, even when a country can and does produce all the needed goods more efficiently, at less cost than their trading partners.
Even if you can make everything yourself, it still benefits you economically to sell some goods and buy others. In effect, specializing leads to wealth.
Ricardo stirred up some trouble trying to convince his colleagues of this principle. So he used an example. Both England and Portugal produced cloth and wine, trade-able commodities. Portugal produced both more efficiently than England, giving Portugal an absolute advantage in both. It broke down this way:
To produce one unit (say, $100 worth in $US dollars) of the commodity:
England – cloth: 100 hours
England – wine: 120 hours
Portugal – cloth: 90 hours
Portugal – wine: 80 hours
If Portugal sells wine to England, it’s more valuable to England that to Portugal, because it costs 50% more to produce. Even more advantage is gained if Portugal puts all its resources into wine and trades the wine for cloth made in England, because the profit on wine outweighs the smaller loss on cloth. England can make cloth more efficiently than wine, so this trade works for England too.
Take a moment to think this through. You should all your effort into doing what gives you the greatest advantage, even if it means you have to pay a little more for other things.
What does Ricardo’s Law of Comparative Advantage mean for you, the overburdened leader of a business trying to grow?
When you start a business, often there isn’t enough money to pay others for things you need, so you (the founder) end up doing almost everything yourself. As you grow, this is unsustainable, but you still keep trying – old habits are just plain hard to break!
The most important thing for a leader to do is to maximize their time and effort on the things that generate the most growth, the most customers, the most profit. All of us are used to wearing many hats, and it’s often true that we are the best at the things we’re doing: we are the expert, and the buck stops with us, and who else will care as much as we do?
Sorry, but we’re talking about leadership, not competence. Delegation is a tough skill to learn because it usually involves assigning something we’re good at to someone who is not as good (at least not yet). Hiring a contactor is tough because skilled help is expensive, and it’s easy to convince ourselves that we should save money and do it ourselves. Teaching an employee to do something new takes time, and we rationalize that we don’t have that time, so we do it because we can do it faster.
These are all rationalizations founders and owners use to avoid letting go of things that make us feel in control and productive.
The opportunity costs of trying to do everything are simply too high.
Ricardo’s Law shows how you gain an advantage by giving up some things that you can do – efficiently, and even at an absolute disadvantage – if doing so allows you to do something else that is more profitable. Give up the absolute advantage to gain the comparative advantage.
Any time you can do something else with your time that generates more of what you want – growth, customers, profits – you should. Right now, as an owner, you can:
Here are some things you can do right now to begin thinking about using your comparative advantage:
If you’ve been through these exercises and learned to let go of lower value, there’s another level of mastery – a Jedi Master mastery of your comparative advantage. Start looking at your life – your achievement in business, your wealth and financial well-being, your health and fitness, your family and relationships, and your happiness.
Do you want some practical ideas for maximizing your Comparative Advantage from someone who has been where you are? Set up a call with me. I would love to hear about the company you’ve built and what you want to achieve with it.