Posts Tagged ‘business’
“There are only two ways to establish competitive advantage: do things better than others or do them differently”*…
… so why is it that there’s so much emulation, so much sameness in the marketplace? Byrne Hobart explains Hotelling’s Law…
The economist Harold Hotelling has already inspired one Diff piece, on the optimal extraction rate for finite resources ($), but Hotelling has another rule that explains political non-polarization, fast-followers in tech, and the ubiquity of fried chicken sandwiches. Companies, parties, subcultures tend to converge over time, and a simple model can illustrate how.
Consider a stretch of beach 100 feet long, running east to west. Beachgoers are positioned randomly on the beach. There are two hot dog vendors who are both selling to beachgoers. Where should they position their hot dog stands?
One option is for one vendor to be a quarter of the way from one side, and the other to be a quarter of the way from the other side. This means that everyone is, at most, 25 feet away from a snack. That’s socially optimal. But let’s suppose the vendor on the eastern side moves a bit to the west. Everyone east of them will still patronize them, because they’re still closer, if not the closest. But some customers in the middle will switch! So the other hot dog seller responds by moving east, and the same result ensues. Eventually, you end up with two vendors in the middle of the beach, and now the median distance customers travel, 25 feet, is the former maximum distance anyone used to travel.
You can substitute any other cost or one-dimensional positioning feature for this. If there are two snack food manufacturers, the socially-optimal setup might be for one of them to sell something sweet and the other to offer something salty, but the same convergent force will eventually lead both of them to sell a salty-sweet combo; customers with specific preferences will be worse-off, but they’ll still have a favorite, while any convergence captures some of the customers who were close to indifferent before.
Making the model more reflective of the real world illustrates some of the assumptions it depends on. For example, we were always assuming exactly two competitors, but now let’s add in new entrants and departures. The model gets simpler if one of the initial two hot dog vendors quits—ironically, in this case the monopolist’s profit-maximizing position is also the social welfare-maximizing position (though they’ll probably respond to their new monopoly power with higher prices). In snack foods, if the formerly diverse market is now just a choice between salty-sweet and sweet-and-salty, a new entrant might introduce some product for the flavor purists and capture the market that way.
The model does describe cases where there are limits to new entrants. For example:
- In a voting system that tends to disproportionately reward winners, you’ll expect some convergence between parties. They want enough differentiation for voters to feel like they’re making a choice, but beyond that it makes sense for both sides to compete on similarity rather than difference.1
- Businesses that are dependent on continuously delivering products with low value density will tend to have a few national brands and lots of regional ones, as with Coke and Pepsi. Both beverages are pretty similar, and retain just enough differentiation for customers to feel like they’re making a choice. The amount is small, but nonzero: in the 1980s, when Coke was losing to the sweeter Pepsi in blind taste tests, they introduced a new, sweeter formula, a decision they reversed after a consumer backlash.
- Software products with high switching costs tend to get more complex over time, as standalone products get subsumed as features of a larger suite. As long as the pace of increased complexity is controlled, this doesn’t hurt user experience too much. It does eventually lead to a sprawling mess, but by then a new kind of switching cost kicks in—the sunk cost of learning to use the system is so high that it feels wasteful to switch.
- This model also describes regulated industries that lack extraordinary returns on capital. It’s hard for a bank to become a monopoly because it takes so much capital to grow, and while even the largest banks have some regional skew to their branch networks, they tend to settle on a similar model. They also diversify in similar ways: issuing credit cards, getting into investment banking, having a capital markets business of some sort, etc…
Hotelling’s simplified model describes an iron law: under the right set of assumptions, sellers end up homogenizing their products, and niche interests end up under-served. In the real world, there are countervailing forces, and in practice the dimensions on which companies compete are messy enough that “adjacent” doesn’t really work. But Hotelling’s Law also illustrates why there’s relentless pressure for homogeneity: if some people like product A and some people prefer product B, something halfway between the two will capture part of that audience. And the producer of A or B is probably in a better position to make this new compromise product C…
One can observe that this dynamic often leads, beyond sameness, to steadily declining value/quality as well. So, one might wonder why, if all it takes is an innovative new entrant to stir up a market, that’s not going on all the time. The answer is, of course, complicated (and varies from sector to sector). But if there is a root cause, your correspondent would suggest, it’s the concentration of power and control in a market that yields oligopolies that can effectively preempt new competitors. (See, e.g., here, here, and here.)
The economics of every burger chain launching a chicken sandwich: “Hotelling’s Law,” from @ByrneHobart.
###
As we noodle on normalization, we might spare a thought for a man who innovated, then (for a time) enjoyed the benefits of an oligopolist, Thomas Crapper; he died on this date in 1910. Crapper popularized the one-piece pedestal flushing toilet that still bears his name in many parts of the English-speaking world.
The flushing toilet was invented by John Harrington in 1596; Joseph Bramah patented the first practical water closet in England in 1778; then in 1852, George Jennings received a patent for the flush-out toilet. Crapper’s contribution was promotional (though he did develop some important related inventions, such as the ballcock): in a time when bathroom fixtures were barely mentionable, Crapper, who was trained as a plumber, set himself up as a “sanitary engineer”; he heavily promoted “sanitary” plumbing and pioneered the concept of the bathroom fittings showroom. His efforts were hugely successful; he scored a series of Royal Warrants (providing lavatories for Prince, then King Edward, and for George V) and enjoyed huge commercial success. To this day, manhole covers with Crapper’s company’s name on them in Westminster Abbey are among London’s minor tourist attractions.
“The way we eat has changed more in the last 50 years than in the previous 10,000″*…
And that change is coming for China… Even as trade tension tighten between China and the U.S., foreign investment in China drops, and talk of decoupling grows (see, e.g., here and here), one sector of American business is doubling down on the Chinese market…
There’s been no shortage of tough news for China’s economy as some of the world’s biggest brands consider or take action to shift manufacturing to friendlier shores at a time of unease about security controls, protectionism and wobbly relations between Beijing and Washington.
Count Adidas, Apple and Samsung among those looking elsewhere.
But as a tumultuous 2023 for the Chinese economy comes to a close, there has been at least one bright spot for Beijing when it comes to foreign investment: American fast-food chains have decided a market of 1.4 billion people is simply too delicious to pass up.
KFC China’s parent company opened its 10,000th restaurant in China this month and aims to have stores within reach of half of China’s population by 2026. McDonald’s is planning to open 3,500 new stores in China over the next four years. And Starbucks invested $220 million in a manufacturing and distribution facility in eastern China, its biggest project outside the U.S.
This is surely not what Chinese President Xi Jinping had in mind as he made the case to American CEOs about the upside of China’s “super-large market” last month while he was in San Francisco for a summit of world leaders. The investments in fast food and other consumer goods, while Washington is curbing exports of computer chips and other advanced technology, don’t fit into China’s own blueprint for modernizing its economy…
Unlike manufacturing plants, fast-food franchises are relatively easy to set up and break down and don’t have to worry about IP security/theft. So, even as trade policy hardens and manufacturing/tech companies lean away, “American fast-food companies find China’s 1.4 billion population too delicious to resist,” from @BusinessInsider.
###
As we supersize that, we might spare a thought for Fred Turner; he died on this date in 2013. One of the first employees hired by McDonald’s entrepreneur Ray Kroc, Turner rose quickly through the ranks, and succeeded Kroc as CEO in 1977.
Turner founded Hamburger University in 1961 and was a co-founder of Ronald McDonald House Charities.
“Humanity is actually much more cooperative and empathic than given credit for”*…
We looked earlier at the shrinking away of public companies in the U.S., both as a product of consolidation (of operations and of ownership) and of the (potentially dangerous) growth, in their stead, of private equity. University of Michigan professor Jerry Davis has a more optimistic take…
Public corporations have been dominant institutions in the American economy since the dawn of the 20th century. Whether due to their greater efficiency or power, listed corporations spread across nearly all industries. “Capitalism” in America was synonymous with “corporate capitalism,” and the number of exchange-listed companies grew with the size of the economy.
Yet since the late 1990s, the number of listed corporations has dropped by half in the US, underwritten by new technologies that lower the cost of assembling an enterprise. Meanwhile, neglected alternatives to the public corporation both old (e.g., mutuals, cooperatives) and new (e.g., open source, platform coops) have proven surprisingly durable. Given the manifest pathologies of shareholder capitalism, the combination of these two trends may suggest pathways out of our current dilemma…
[David explains how both consolidation among listed companies and the rise of private equity have contributed to this drop, but then raises a third, more general explanation…]
A more encompassing interpretation is that information and communication technologies (ICTs) have drastically changed the basic economic calculus of what an enterprise looks like and how it might be funded. In the US context, this has meant that companies prefer “buy” to “make,” as transaction cost enthusiasts might describe it. I coined the term Nikefication to describe the process of vertical dis-integration that reconfigured American industry during the 1990s and 2000s and the options it opens for alternative forms of enterprise, described in detail in previous books…
The vertical dis-integration of the American economy was driven by Wall Street and enabled by ICTs. Ironically, the result is that the capital requirements to create and scale a business can be much lower, reducing the rationale to go public in the first place. Indeed, IPO prospectuses routinely convey that the point of the IPO is not to raise capital, but to create a market for the company’s shares to enable VCs and employees to cash out – which is not the most persuasive pitch to potential buyers, and perhaps helps account for the disastrous post-IPO performance of most new listings.
The asset-lite model means fewer public companies, but it also suggests new possibilities for non-corporate forms that may be more human-scale and democratic. Nike’s profit-driven, asset- and employee-lite model is not the only option enabled by new technologies.
By “noncorporate” I mean forms of economic organization that are not owned by outside shareholders, although they may be legally organized as a corporation. These include mutuals (where consumers or members are also the owners); cooperatives (where workers, producers, or consumers are the owners); municipal enterprises (where citizens or governments own the enterprise); nonprofits; and open source projects. These forms are far more prevalent than one might expect, and in some cases they dominate their industry (e.g., property insurance, server software).
Noncorporate forms of enterprise have proven surprisingly resilient in the US. The Fortune 500 list for 2022 includes at least a dozen mutual insurance companies, including State Farm (#44), New York Life (#71), and Nationwide (#83). The single largest shareholder of over 350 of the 1000 largest American corporations is Vanguard—also a mutual. Land o’ Lakes (#213) is an agricultural cooperative owned by its producer-members, as are Ocean Spray and Blue Diamond. Ace Hardware is a retail cooperative in which local stores can be attuned to local needs and tastes yet gain the economies of scale of a large-scale brand. Jessica Gordon Nembhard’s brilliant book Collective Courage documents that cooperative forms thrived in African-American communities for generations – often overlooked by those who find data about the economy solely through online databases. And the US is home to nearly 5000 credit unions, which by law are not-for-profits, owned by their members.
Stanford Law professor Ron Gilson once quipped that if shareholders didn’t exist, they would have to be invented. That’s not quite true: plenty of American enterprises do quite well without shareholders. Indeed, civilization itself might be better without them. As I have written elsewhere, “nearly every major societal pathology in the West today – certainly in the USA – is caused or exacerbated by profit-oriented corporations,” including the opioid epidemic, the obesity crisis, the return of nicotine addiction among the young, democracy-undermining social media, and a climate catastrophe underwritten by the fossil fuel industry. Shareholder capitalism may be a suicide pact. Conversely, cooperatives are inherently democratic and accountable…
Institutional alternatives to public corporations are well-established in the US, and in some cases they lead their industry, such as mutuals in finance and insurance. But cooperatives have historically been thin on the ground here compared to Europe. According to the Democracy At Work Initiative, there were 612 worker cooperatives in 2021 –a 30% increase over 2019, but still a tiny number.
Perhaps the digital revolution has finally created the conditions for cooperatives to thrive. Research from the pre-digital era suggests that one of the factors limiting cooperatives is, for want of a better term, the transaction costs of democracy. A lot of workers’ time spent in meetings to engage in dialogue, debate, and polling is a price that corporate dictatorships don’t have to bear. But newer tools have dramatically reduced the transaction costs of democracy: the same smartphones that enable pervasive corporate surveillance also allow worker voice at scale on a continuous basis.
It is not just transaction costs that have declined: the required assets to start a business are also much cheaper now to own or rent. Capital equipment such as Computer Numerical Control tools, powered by software, gets better and cheaper much the same way other software-powered tools do. (Compare the price of a color laser printer in 1990 to one today.) This is also true of the software required to run an enterprise. It is possible to buy a knockoff version of the enterprise software underlying the Uber app for under $10,000 – and the Drivers Coop in New York is creating a version to “franchise” the locavore driver-owned coop alternative to Uber. The ICTs that dis-integrated the corporate economy have opened space for noncorporate alternatives that might be more democratic and human-scaled.
There are reasons for optimism here. Platform cooperatives merge the benefits of coops with accessible technology, and have been especially effective in industries in which the required new capital investment is low (home cleaning, home health aides, transit). Trebor Scholz’s new book Own This! provides details on the opportunities here. Municipally- or cooperative-owned fabrication facilities can enable enterprises with limited capital to launch and thrive. If the required investment to start a business is low, then the range of alternative institutions, including coops, is correspondingly larger.
The technologies exist to create low-cost alternatives to public corporations. Maybe we are not stuck with the legacy of 20th century corporate capitalism after all…
An optimistic (and aspirational) take on what might follow the economic reign of the public company: “Is This the End of Corporate Capitalism?” from @vanishingcorp via @iftf.
###
As we ponder proprietorship, we might recall that, on this date in 1933 the hospitality industry got a boost as Congress ratified the 21st Amendment to the U.S. Constitution– repealing the 18th Amendment, which had prohibited the manufacture, transportation, and sale of alcohol. Prohibition had gone into effect in 1920 in an effort to reduce crime and improve public health, but it had backfired: despite massive public investment in enforcement, there was a sharp rise in organized crime (c.f.: bootleggers like Al Capone stepping in to supply black market booze) and the emergence of a “scofflaw” attitude on the part of a public that wanted its alcohol.
“Those of us who read because we love it more than anything, feel about bookstores the way some people feel about jewelers”*…
Your correspondent is certainly among that number; bookstores– and libraries– are at the center of my mental map of civilization. So imagine my surprise when Alex Leslie delivered data demoting book shops in the literary hierarchy…
A lot of ink has been spilled over the decline of the dedicated bookstore – stores dedicated “just” or primarily to selling books – amid the rise of online retailers and e-readers in the 21st century. Yet dedicated bookstores were often not the main source of books in the U.S. historically. In fact, that market role was highly contested over the last two centuries.
In the early 20th century, a consumer could buy books from many different types of retailer. The specific focus, stock, clientele, and consumer experience of these different retailer types varied significantly and did much to shape the relationship between consumers (or readers) and books. In this richly varied market, the dedicated bookstore was outplayed on multiple fronts…
[Leslie brings the receipts…]
… Perhaps the most striking aspect of their position in the book retail market is how unstriking it is. Dedicated Bookstores represented a significant 7.5% of Lippincott’s revenue, yet they trailed behind News companies and Department Stores (Fig. 1). They carried less purchasing power at the individual level, where they fell in the middle of the pack behind less-common yet higher-volume retailer types like Foreign, Medical, and even Religious (Fig. 2). And while Bookstores were easily the second-most-common retailer of books, only 9% bought directly from Lippincott’s—meaning that they weren’t especially consistent either (Fig. 3).
Dedicated Bookstores were a major player in the book ecosystem, but they did not define it. They competed in a tight market where other retailer types beat them on affordability, breadth of location, specialized subject matter, and high-margin editions. In this context, dedicated Bookstores could all too easily become jacks of all trades and masters of none. A majority of Americans got their books from other retailers, and this was not entirely due to a lack of dedicated Bookstores in many towns: it also stemmed from a lack in dedicated Bookstores’ business model, a lack which continued to plague them into the 21st century even as they became more ubiquitous. For all our platitudes about the power of books writ large or reading as a single hobby, books seem to be less of a unifying force in their own right than the subjects they concern or the experiences they complement…
Still, I love them: “The Dedicated Bookstore Predicament,” from @azleslie.
* Anna Quindlen
###
As we browse, we might spare a thought for Count Lev Nikolayevich Tolstoy (known in English as Leo Tolstoy); he died on this date in 1910. A writer whose works adorn most bookstores, he is considered one of the greatest authors of all time. (He received nominations for the Nobel Prize in Literature every year from 1902 to 1906 and for the Nobel Peace Prize in 1901, 1902, and 1909, but never won. After one slight, August Strindberg and dozens of other authors and artists issued a proclamation shaming the Nobel Committee.)
Tolstoy is best known for War and Peace (1869) and Anna Karenina (1878), widely regarded as pinnacles of realistic fiction. In the late 1870s, after a profound moral crisis, followed by what he regarded as an equally profound spiritual awakening, he became a fervent Christian anarchist and pacifist. His ideas on nonviolent resistance, expressed in such works as The Kingdom of God Is Within You (1894), had a profound impact on such pivotal 20th-century figures as Mahatma Gandhi, Martin Luther King Jr., and Ludwig Wittgenstein.
“We hear all this talk about integrating the world economically, but there is an argument to be made for not integrating the world economically”*…
… and indeed, those arguments seem to be holding increasing sway. Tyler Cowan ponders the possible economic implications of a future in which global economic interdependence recedes– a future in which globe’s economies, freer of each other, don’t rise and fall with each other (as they largely have for decades) to the same extent…
Will we see less co-movement in global economic growth?
That is the question behind my latest Bloomberg column (soft pay wall). China is now, and looking forward, less of a common growth driver around the world. Oil price shocks may not be less important for humanitarian outcomes, but they matter less for many of the largest economies. America is now an oil exporter, and the EU just made some major adjustments in response to the Russia shock. More renewable energy is coming on-line, most of all solar.
The column closes with this:
In this new world, with these major common shocks neutered, a country’s prosperity will be more dependent on national policies than on global trends. Culture and social trust will matter more too, as will openness to innovation — and, as fertility rates remain low or decline, so will a country’s ability to handle immigration. A country that cannot repopulate itself with peaceful and productive immigrants is going to see its economy shrink in relative terms, and probably experience a lot of bumps on the way down.
At the same time, excuses for a lack of prosperity will be harder to come by. The world will not be deglobalized, but it will be somewhat de-risked.
Dare we hope that these new arrangements will produce better results than the old?
Or perhaps a more general rising tide was the only way many countries were going to make progress?
Marginal Revolution
Byrne Hobart reflects further…
When economies were tightly linked, growth in the US led to more demand for manufactured goods from China, which created more demand for raw materials from other parts of the developing world. But if that link is weaker, it’s entirely possible for there to be a boom in some places and a bust elsewhere. That probably increases the personal returns from global macro investing while decreasing its social return: when the world is closely-linked, there are massive positive externalities in predicting recessions, because there are so few places to hide. It’s comparatively less essential for the world to know that German is slowing down but growth in Indonesia is picking up, but it also means that macro questions are more tractable.
The Diff
* Arundhati Roy
###
As we think tectonically, we might recall that it was on this date in 1865 that the U.S. first issued Gold Certificates.
Americans began to move out west in the first half of the 19th century. Banks started printing their own money to fund land purchases, and that quickly led to two problems: loose money-printing had a volatile effect on prices, and it became increasingly hard to tell what was counterfeit from what wasn’t.
To tackle these problems, the government decreed in the 1830s that it would only accept transactions in gold and silver. But of course, lugging metals around is nobody’s idea of fun. So in 1863, Congress paved the way for the first “gold certificates” to be printed two years later, in November 1865.
A gold certificate was, in effect, a form of paper currency backed by gold – although not entirely. The Treasury was allowed to issue $120 in gold certificates for every $100-worth of gold it held in its vaults…
MoneyWeek
You must be logged in to post a comment.