The Game with Alex Hormozi - Arbitrage 101 | Ep 251

Episode Date: November 20, 2020

All big businesses run off of extraordinary degrees of arbitrage. Today, Alex (@AlexHormozi) talks about what arbitrage is, how you can harness, and leverage it in your business.Welcome to The Game w/Alex Hormozi, hosted by entrepreneur, founder, investor, author, public speaker, and content creator Alex Hormozi. On this podcast you’ll hear how to get more customers, make more profit per customer, how to keep them longer, and the many failures and lessons Alex has learned on his path from $100M to $1B in net worth.Timestamps:(0:45) - The definition of "Arbitrage" and how all businesses are arbitrage(3:13) - The difference between economic profits and accounting profits(6:28) - What factor is going to dictate if it's one market or another?(7:46) - One valuable concept to understandFollow Alex Hormozi’s Socials:LinkedIn | Instagram | Facebook | YouTube | Twitter | Acquisition

But the more I thought about this concept, the more I realized that all business is arbitrage. And how much money you make and the extent to which you crush it will be dictated by how big the arbitrage is. Welcome to the game where we talk about how to get more customers, how to make more per customer, and how to keep them longer, and the many failures and lessons we have learned along the way. I hope you enjoy and subscribe. What's going to be talking to you about my favorite, one of my favorite topics, arbitrage. And so the first time I heard this word was actually in a fancy dinner I was sitting at and I was like, I don't know what's going on. And these dudes in finance were talking about derivatives and crazy stuff, right? And they just kept saying arbitrage.

And I was like, what is it? You know, like finally I was like, what does that mean? And they were like, oh, it's like when you just take advantage of an inefficiency in a marketplace. And I was like, how? And so then they explained it to me. And they were like, well, it's sort of like when you go on eBay, right? and you can buy something for $5, and then you can take the same thing

and then just go into Amazon and sell it for $50. Well, that would be a big example, but you get the idea, where you buy it for five and you sell it for $50, and it's because there's an inefficiency in a marketplace where there's, that's where the arbitrage happens, right? And so the definition of arbitrage is where you buy in one market, right, at one cost, and then you sell in another market at another cost.

So you sell high, and you buy low. Pretty simple, right? Everyone understands that. That makes sense. And here's you in the middle making all your money, being happy. Yay, there's you. All right. So that is basically what arbitrage means.

But the more I thought about this concept, the more I realized that all business is arbitrage. And how much money you make and the extent to which you crush it will be dictated by how big the arbitrage is. Even if you think about basic business, a service business, you're buying labor in the labor market, this is market one, this is why this is important, is that you're buying and selling between different markets.

This was a point of nuance that I didn't understand when they first told me how this worked, and I also didn't want to ask because I was embarrassed that I didn't know what I mean. So hopefully you can watch this and not be embarrassed if someone says it, all right? So market one and market two. So there's an inefficiency, this little line here,

is the inefficiency between the marketplace, what you're buying at, what you're selling it, right? Right. And so market one can be a laborer, market, you're buying labor at X price, and you know that you can sell the labor at another price to market too, right? And then that's how you make a profit. But every business fundamentally works this way. I can buy from a manufacturer for a dollar and sell it over in market number two for five dollars, right? Now, and

even the manufacturer buys from raw ingredient producers who buy it from farmers at one dollar and sell it for five dollars, right? And so that's the game that continues gets played between market one and market two. And a a supply chain is literally a series of markets in a row of markets buying and selling, buying and selling, and then the person in the middle, the business owner, is technically arbitraging all of these things, right? Right. Okay. Now, here's where I think this is interesting. So take this concept, pocket it into your mind for a second. And so one of the concepts that I've tried to explain, and I'm partially making this video so that I can,

I know that I learn things better when I teach them. All right? So it's the difference between economic profits and accounting profits. If anyone took economics, if you did, right, then they would talk about this. And the difference, I'll start with accounting profits because it's the, it's the easier one to understand. They're not hard to understand, but it's the easier one, all right? So economic profits versus accounting. Accounting profits are revenues minus all costs, right? That is an accounting profit, right? That's what most of us do when we do our tax returns. That is an accounting profit. Simple. Everyone should understand that one. And economic profit is where you take the revenue minus the explicit cost of doing business.

And then you also subtract out the opportunity cost, which is the implicit cost, of using the resources that you have in that particular market or path versus another opportunity. So let me give you an example. Hey, Mosin, a quick break just to let you know that we've been starting to post on LinkedIn and want to connect with you. All right, so send me a connection request and note letting me know that you listen to the show. I will accept it. There's anyone you think that we should be connected with, tag them in one of my or layless posts,

and I will give you all the love in the world. All right, so let's get back to the show. So let's say you owned a paper mill, right? And your company owned a forest, and that's where they cut the trees down, and then they turned it into paper, right? Simple. Now, the economic profits of that business,

the opportunity cost that would be factored into that economic profit, is whether or not you could make more money just selling timber. or selling sawdust or selling wood. Those would be different examples of things that you could do with the existing resources you have, which is this guy in the middle here, he's got resources, he's got people,

he's got maybe equipment, skill sets, talent, et cetera, that if you were to apply those skills to a different market, he could then make more money. And that is the difference between economic profits and accounting profits. And the reason this is important to me as an entrepreneur is that when I'm looking at,

What I want to get into, right, with what things are interesting to me, or for investing, because I invest in businesses now, which is kind of wild to me. But anyways, is that I'm looking, is this, given these resources of humans and skills and equipment and software and everything, we're currently pursuing arbitrage opportunity A, right? But what if, with these same skills, I could have arbitrage opportunity B, where I'm by, buying in this market for rock bottom prices, and there's another market over here that is paying top dollar, right? So between the first example I have where it's a normal amount of money that's being made,

compared to this arbitrage opportunity, I would wanna be in this one, right? Now what's gonna dictate whether or not it's gonna be one of these markets versus one of these markets? Well, the growth of the marketplace, overall, there are growing markets like online fitness is a growing market,

market, right? And so it means that there's likely going to be arbitrage, a greater degree of arbitrage, because there's going to be more demand. And so if I can find markets where I feel like there's more demand for the same things that I can buy cheaply, then I want to go to those things. And so when I'm thinking about all opportunities, because I think that that's one of the biggest superpowers that we have to have as entrepreneurs is not sure, like right now, I could go and run a gym and make money. I could. I could also run a massage parlor

and make money. I could also run a supplement company to make money. I could run a lot of different businesses to make money. But of all the opportunities under the sun, of all the different ways I could make money,

which is the best, given my resources, skills, talent, team, etc. And then if I look at all of those things on a board, these are the things that we're absolutely amazing at. And these are the different

arbitrage opportunities that exist. Which of these arbitrage opportunities will be best fit for the skills, talents, trades, team, etc., that I have, and then by answering that question, we'll inherently answer the very important question, which is, what can we be the best in the world at? And so I think for me, this has been a really valuable concept to understand, is that all businesses arbitrage.

It all functions off of an information advantage between the buyer and the seller. The seller always has the information advantage, or many times has the information advantage. And so fundamentally, when you find out that an iPhone cost $17 to make, people are shocked by this, but that's because there's obviously other costs besides the manufacturing, obviously, but all big businesses run off of extraordinary degrees of arbitrage, right? Facebook is able to have eyeballs and sell eyeballs at a significant amount cheaper than it costs them to manufacture them, right? Right, right.

Verizon, it costs them pennies to add another user to their base. And so the reason this is important for me to at least express is that for a very long time, when I was earlier on in my career, I had these weird morals and ethics around how much more I could charge for something. The reality is, there is no limit. It is simply based on the market demand. And so whether it costs you a penny to make something that's worth $1,000, or it cost you a penny to make something worth two pennies, that price that you charge should never be in any way relation to what it costs you

and only related to what the market will allow. And then it's up to us as entrepreneurs to look at which arbitrage opportunities exist between marketplaces that best fit our skill sets. And by doing that, we will then find ourselves in the best opportunity vehicle for us to grow in the long term and probably make the most money. So anyways, I hope that was valuable for you. I hope this made sense for me. This is a topic that I love talking about. And I hope that you find value in that. And otherwise, have an amazing day.

I'm reading for you, keeping awesome. Leave a like, comment or review already or a subscription or something. subscribe or tap the button or all this stuff. Keeping awesome. Get you soon. Bye.