Understanding our digital future

Passive Income, Part 1: Pipe Dream or Sound Business Strategy?

Posted by: In: Blog, Passive Income 27 Aug 2010 Comments: 0

Passive income. It’s the Holy Grail of lifestyle entrepreneurship. It sounds great – work four hours a week and make a full-time living. Spend your time on the beach, with your family, or doing whatever else floats your boat.

I know people who’ve done it, but they’re few and far between, which has a tendency to make a lot of skeptics, who then dismiss the concept entirely.

Big mistake!

Most entrepreneurs don’t start their business with the goal of one day owning a second home in Colorado or the Caribbean. (Or both.) They either saw a great opportunity, had an itch that needed to be scratched, or had a big idea of how to change the world.

And most of them fail. Why? One of the most common reasons is cash flow. All too often it’s not even a very big shortfall, nor a very long one, but the business owner simply doesn’t have any more available cash or credit and the orders just aren’t quite there yet, or the product’s not quite finished, or whatever.

And that’s where passive income comes into play.

Entrepreneurship is a rollercoaster ride – passive income just makes sure that you don’t bottom out in the natural dips that come with the territory. Think of it as a heavy-duty shock absorber. And for all those businesses that don’t have piles of VC cash sitting in the bank, it can be a critical business survival strategy.

Passive income isn’t just a startup strategy, though. For a mature company, it can be a path to increased profitability, or a way to expand your business without an external capital infusion. It can also be an exit strategy for the founder – the way to transition from managing your business on a day-to-day business to owning it as an investment – an “asset under management.”

Let’s first understand what passive income really is, and what it isn’t. There are two general categories of passive income:

Residual income is received over time from work done once, for example:

• An insurance agent who gets commission every year when policies renew
• A direct sales rep’s income from her customers when they reorder consumable products
• A dance instructor who produces a video and sells it at the studio where she teaches
• A life coach who creates a workbook and sells it online
• A photographer who makes his photos available through a stock photography clearinghouse and gets paid a royalty whenever someone buys one of his images

There are many different ways to generate residual income across a wide variety of businesses. It may be recurring income from current customers, or automated sales of a product to new customers. It doesn’t have to be fully automated, but any human involvement must be minimal.

Leveraged income is money you make off the work of other people, for example:
• An information product publisher selling through online affiliates
• A network marketer who builds a downline and receives commissions on those sales
• A general contractor who makes a profit margin on the work done by sub-contractors
• Franchising your business model to other entrepreneurs

Again, there are many different models in many different businesses. The key is that you are making money off of other people’s labor, rather than primarily your own, and that you are only paying them when revenue is actually generated, i.e., little or no overhead expenses.

Passive income is not merely recurring income, such as a consultant on a monthly retainer, or a subscription-based publication. While these structures may offer more stability, they also come with an obligation to perform in a timely manner, which has a tendency to rear its head at the most inconvenient times for your core business activity. With truly passive income, basically all you do is process transactions.

There are a lot of misconceptions about what is really passive income and what isn’t. Blogging is not passive income – unless you’ve outsourced everything to a team of writers, designers and virtual assistants and are still making money on top of that. Buying and selling on eBay isn’t passive income – unless you’re selling exclusively items that can be drop-shipped, without you ever touching them. Self-publishing a book which gets sold primarily at the back of the room at your speaking engagements, by you, is not passive income. Making your speaking deal include a copy of the book for every attendee…is.

In part 2, we’ll take a look at specific ways you can apply passive income concepts in your business.

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