Category Archives: economics

Make less, make more!

Leave a reply

Many years ago my father advised me to avoid antenna design – “Too much black magic.” I took that advice; but I seem to have fallen into a similar trap, i.e. pricing.

Consider this pricing problem. You sell a product which two classes of people. One class, 10 people, would be willing to pay 100$ a unit. A second class with 90 people in it are willing to pay 10$ a unit. So if the vendor charges 100$ he will make $1,000; if he charges 10$ then he will also make a $1,000. If the the first class is willing pay a bit more or the second class is willing play a bit less then the vendor will profit if he makes only 10 units.

That story is a bit bloodless so let’s put some adjectives on these classes. The first class is desperate if they are willing to pay so much. We might say the first class is very loyal to the vendor’s product and nothing else will do. We might say the first class is locked in.

Early in the Bush administration a handful of electricity vendors in California realized they were in exactly this situation. They could make money if they sold less electricity. So they shut down some generating plants. They called it maintenance and complained about excess regulation. The first class of buyers, unable to switch, locked in, and addicted to electricity then drove up the price to amazing heights. At the time experts knew exactly what what was going on but the regulatory organization had been entirely cooped by the industry and so nothing was done. Amusingly the Bush folks talked about how we needed more supply which was true, and suggested we should open up new oil fields which was irrelevant.

There is a picture in my local paper of a long line in front of a pharmacy down the street from me. Long lines are a symptom of a group of folks in the first. They were queued up to get flu shots. The supply of flu shots has fallen sharply. The price is up. Clearly this market is just like the one in the model above. There is a core of desperate buyers willing to pay a lot; as demonstrated by their willingness to wait in extremely long lines. I’m suspicious that it’s also an example of the kind of story shown above.

What’s fascinating about some of these scenarios is how the trigger of the mode switch could come from anywhere. For example an investor in firm A might strive to get firm B shutdown; say by reporting safety violations to a regulator. Then when the firm B gets shutdown and the large class of low price buyers go looking for an explanation the regulator gets blamed.

The California electricity debacle shown how deeply the pro-business Republicans have undermined the regulatory systems in this country and sadly it makes me terribly suspicious about the current flu vaccine situation.

Meanwhile the Bush administration thinks scientific fact is a special interest group, and certainly not part of their base.

Industry Consolidation and Powerlaws

Leave a reply

Conventional wisdom holds that standardization is a means to create increased competition. This is not always the case. Conventional wisdom holds that deregulation is a means to increase competition. This is not always the case. Regulation and lack of standards are two ways that can frustrate the consolidation of small firms in an industry into larger firms.

This graph is an output of a simulation of an industry undergoing consolidation. The lines show the distributon of firm sizes in the industry. Each line on the log-log graph is one step toward a more consolidated industry. The line along the bottom shows the industry at the start of the simulation; a ten thousand firms all of size one. As the simulation proceeds firms merge; each merger creates a larger firm. Each line show the distribution of firm sizes after another hundred firms have been absorbed until there are only four thousand firms left; but notice that one of these firms has captured three thousand of the original firms in the market! Now that’s a way to concentrate wealth!

An Industry Consolidating

You can see the power-law distribution of firm sizes emerging spontaneously as the consolidation takes place. I.e. this is another means to create a power-law distribution.

Let’s peel back a bit more what’s going on here. This model is based on what graph mavens call a random graph. Each of the original firms is a node in this random graph. To start their are no links at all between them. The simulation proceeds by creating random linkages between these original firms. As links are introduced groups of firms are consolidated into now merged firms; or in graph theory terms you get connected components. Clearly if we do this long enough we will get one giant firm. That is often referred to a a phase transition; in which case we might say that the industry condensed or froze rather than consolidated.

Note that this model creates links between the original firms, so that a firm that is consolidated out of 100 of the original firms is a 100 times more likely to get a random link than one of the original firms is. That creates the usual rich get richer as well as the advantage to the early mover found in the power-law scenarios. The random nature of the linking also reminds us that there is no “merit” revealed by the distribution other than size and luck. Consider what that implies for the sleepy members of an industry the moment that the regulatory (or technological) barrier to consolidation is repealed and suddenly what was impossible before; mergers, are now key to the firm’s ongoing survival.

In the last step in the simulation graphed here you can see that the power-law distribution is on the verge of failing to provide a good fit; the industry is about to freeze up into one giant monopoly.

Both regulation and a lack of standards make it harder to create the random linkages that encourage this kind of consolidation. Something to keep in mind when chatting with the advocates of standards, deregulation, and free trade. Something to think about when large firms argue that deregulation and standards are good for small business. Something to think about when free trade advocates argue that free trade is an unalloyed good for small countries. It is more complex than that.

Continue reading →

Disintermediation

Leave a reply

By way of Making Light this marvelous essay on printing. In high school we took a field trip to the New York Times. The Linotype machines were in the next room. Hot, dangerous. In that room you were right at the narrow point in the bottleneck. The throat down which all that journalism flowed thru on it’s way to my parent’s breakfast table. The danger, the hot lead, the diversity of specialized crafts seemed entirely appropriate. Disintermediating these bottlenecks certainly triggered a mess of displacement.

I see that Comdex is dead. Another intermediary who’s time is passed. There was a time when Comdex was the hub of the computer industry; the place were buyer and seller would meet. The folks that ran Comdex used to be able to charge everybody. They would charge the sellers, the buyers, the hotels, the venues. Lots of power at the bottleneck.

When electronic type setting came along the unions negotiated a contract that assured jobs for their children. I wonder what the Comdex guys got; if anything.

Braudel’s marvelous History of Capitalism reports that in the middle ages seasonal fairs would emerge and grow huge and specialized. Villages in France would be entirely turned over to trading some good, horses for example, for a week or two a year. The entire of Europe’s horse industry would descend on the town. And then mysteriously one year or over a period of just a few years it would stop. Some other way for the buyers and sellers of horses to find each other would displace the market fair. I’ve watched that happen to MacWorld, Comdex, Sears. I wonder if it will ever happen to eBay?

Commuting as cost shifting

Leave a reply

Wonderful posting suggesting the idea that the time people spend driving is really part of the costs associated with shopping or working. That when employers or stores shift to models that increase the time employees or shoppers spend traveling they are actually just shifting costs. He then goes on to suggest that this explains a chunk of the difference of GDP between Australia and the US.

A nice example of using a blog as a way to engabe in “think in public“.

Friends of Moore’s Law

Leave a reply

Moore’s law isn’t the only rapidly growing technology curve. It has at least two peers. Disk space and communications. These stand on a rich substrate that is equally fecund. A soil of component parts: displays, batteries, memory, semiconductors and of social structures – firms, standards, technologists. These are not the only forces reshaping out future; because above all this the pool of talent that can be brought together to work on any given task is exploding.

This is the plate techtonics that pushes up (and down) continents of new applications and businesses. Meanwhile the differing rates that these elements progress helps to shape the topology of that future.

As we discover better schemes for coordinating the work of huge pools of talent the rate of displacement of which Wikipedia v.s. Britanica is one example will accelerate.

In another example if communications moves much faster than diskspace then we would rapidly reach a state where fetching information was a dominate strategy vs. local storage, caching or synchronization.

This paper: pdf from 2001 by Coffman and Odlyzko has a lot of interesting things to say about all this.

They conclude that: both disk space and network bandwidth are doubling ever year; realtime data (voice and video) won’t provide enough data to become the dominate form of data traffic. So we will continue to cache a lot of data locally. They say plenty of other other interesting things as well.

Russian Roulette

The death of a friend playing Russian Roulette shaped the life of the author of the fun eccentric little book Fooled by Randomness.  Nassim Nicholas Taleb is a mathematically inclined option trader who would like us all to realized that when you encounter a wildly successful individual you should pause and consider, was he lucky or was he skillful? He points out that the world is quick
to offer you bets in the form of Russian Roulette you get a 1 in 6 chance at a million dollars, but the sixth time you die. Assuming your life is worth more than million dollars then the house wins
these bets on average.

Unlike Russian Roulette the terms of these bets are rarely so obviously presented. The house, or the Gods in this case, can offer you quite a spectrum of deals. First there is the subtlety of computing your chances in more complex games. If the Gods let you double your money, or die, on each bet and play with a gun that has 100 cylinders and one bullet how many rounds, on average, do you get to play? Second the Gods rarely give you terms that straight forward.

Taleb’s approach to this is to assume that people are way to optimistic and then use option trading to bet against them. Of course that requires a sufficiently mature and liquid market; one
that can support options trading. It’s unlikely you could use his approach to bet against the optimists that trade on eBay. Most forums that life is played out in lack the market mechanisms of Taleb’s scheme depend upon.

This is a great strategy to adopt when a Bull market transforms into a Bear market. So it’s not surprising that these days a publisher decided he ought to invite Taleb to write a book.

There is a story in Jane Jacob’s book about French Canadian separatism.  She argues that the reason that Toronto grew larger than Montreal was that the after the second world war Toronto was much more aggressive in taking risks. Meanwhile Montreal, an older wiser city, was more
conservative. Montreal had seen many a fad and so guarded it’s resources more carefully. Meanwhile the Gods arranged that for the 30 years following the second world war the games of Russian Roulette offered were very generous. Toronto thrived. Montreal fell to second rate and with it many of the hopes of French Canadians for independence.

Time to Market?

Leave a reply

Many years ago I was in one of those perennial meetings where the senior vice president stands up before the entire division and takes questions. These meetings often are nothing more than a study in power politics. Young turks with nothing to loose ask questions that bait the leader. Sycophants ask questions in support of what ever this weeks messaging seems to be.

Occationally someone naive about the stress in the room will ask one of those questions that goes right to the heart of the problem. In this meeting a young engineer asked “How important is time to market?” This was on all of our minds. The product we were working to release was more than a year behind schedule. We were all having a tough time making trade-offs between schedule and creating a virtuous product.

At that time in my life I was working with a very witty coworker who was full of very amusing one liners. For example he’d say “Here at YoYoDyne our leadership toggles betwix avuncular and asshole.” During this interval we were in an avuncular phase.

The senior VP tackled the question: time to market. He stated that he really didn’t know, but that in all his experience first to market was worth a substantial amount. I remember thinking, hm that’s not a very strong answer to what’s our #1 ethical issue around here, but I certainly respected that it was an honest answer.

Today I think we know the answer. It’s not a pretty picture. Capturing users is much more important than creating a virtuous product.

We know this because we know that power-law distributions will arise whenever the new users arriving in a marketplace exhibit a preference for the market leader. We also know this behavior is extremely likely in an emerging market. Consider this scenario. New users show up in the new marketplace. They thrash around trying to decide which vendor to hook up with. They thrash seeking some reasonably rational basis for making their decision. Now recall that this is an emerging market. Almost by definition that means that expertise is very thin on the ground. Users have a very hard time finding any source of expert advice. The user looking for some measure of product quality is left in a bit of bind. The market, because it is new, doesn’t have any mature sources of information about product quality.

At that point the user has to fall back on proxy measures of quality. That users then select the product to buy entirely on the basis of what other users already selected. It’s a fall-back onto almost the only information that user has available. The user is behaving rationally. Meanwhile, the market rapidly locks into a power-law distribution. The few early winners gain huge market share.

Hopefully, over time, markets will mature institutions, people, and collective knowledge to measure product quality in more accurate ways. At that point the early market leaders might start to be displaced. Of course how quickly that happens depends on how sticky the product offerings are. Software products are particularly sticky because of the training costs, and the way they capture the user’s data in ways that, by default, make it hard to switch.

Some markets never get the chance to mature. They evolve too fast. The entire stack of industries that stand on top of electronics revolution are like this. As the cost of computation, storage, and communications all fall, at large multiples each year, new markets keep emerging. Each time one of these markets emerges we get the same story repeated.

Large numbers of new users enter the new market, they thrash around for a measure of quality, they settle for using the behavior of others as a proxy for quality, and that assures the entire market grows up with a power-law distribution of vendors.

So the answer to the question? Time to market is everything when you are dealing with a newly emerging market that lacks matured ways to measure quality. This is doubly true if the customer relationships your capturing are highly sticky.

War in my Wallet

1 Reply

In my wallet right now there is a little war going on. Representatives of various armies are fighting it out. Let me introduce them.

I have two kinds of Government currencies.

There is a nice 10 thousand yen note in there left over from a trip to Japan I took almost a year ago. I was forced to use Japanese currency when in Japan. They don’t use credit cards or checks much – in fact you could always tell that a restaurant was going to be amazingly expensive if they displayed the ‘flag’ of visa/master-card on their threshold.

There is some US legal tender – “This note is legal tender for all debts, public
and private”. It says “In God we trust” while Japanese note has a picture of the emperor on it and I’ve no idea what it says.

I have some private currency.

There’s a gift certificate from a huge bookstore in a distant part of town. It’s worth $10.33 cents.

I have a gift card that came via a rebate from the purchase of a cell phone.

I have quite a few forms of plastic based currency.

There is a credit card provided by my company that I’m coerced into using when I travel. That let’s them capture a number of benefits. They get the discount points on the transactions. The card allows them to prevent me from shopping in certain venues. It lowers their book keeping costs.

There is a credit card from from a small bank in the Midwest. I’m convinced to use this card because I’m bribed with a 1% cash back program. It’s very complex. I have to accumulate points, and then once over a certain threshold I get 1% back. If I remember to request it. Of course I run the risk they will change the terms or go out of business before I get my money back. They already changed the terms once, I used to get 2% back.

There is a credit card co-marketed by a major credit card processing bank and Beans. I was convinced to get that because it came with 2% cash back. They changed that to half a percent after six months. I’d get rid of it but the news paper subscription is tied to it.

There is a bank card. I had to ask them to send me one that didn’t have a debit card tied to the bank card. I sometimes use this card to buy groceries. They let me have cash back.

Then I have a bunch of cards that let me do transactions at semi-private clubs. All the places I can say one way or another “put it on my account”.

I have my health insurance ‘club’ card.

I have the health insurance ‘club’ card of my previous employer, since showing it gets me certain discounts.

I have my library ‘club’ card. It’s interesting because it gets me into two library networks and a few hundred individual libraries. They have linked all those accounts together.

I have the card that denotes my membership in the car driving club, aka my driver’s license. I need that to be allowed to take cars onto the highways. These days it’s the only card that let’s me fly on commercial airplanes. The phone company also demanded it when I got a cell phone.

I have three cards for gaining access to my job. One gets me onto the landlord’s premises. One let’s me get into various properties around the country my employer does business in. One let’s me get into the garage at work.

I have a card that let’s me enter the building were my son goes on Saturday mornings.

Then there are my charity club memberships, but I don’t carry those; except my ACLU membership card.

My absolutely favorite club card is the one that let’s me enter the Library of Congress.

All these things are there to let me do transactions. All of these are forms of currency, currency substitutes, or representatives of account relationships.

Currency has lots of network effects. Transactions are simpler if the parties have a currency they both agree to accept. Transactions are simpler if each party doesn’t have to include a phase in where they negotiate the means of payment. For example merchants are required by the credit card companies not to offer a discount for cash, but most will if you can deal with somebody in authority. Transactions are cheaper if we all don’t have to run different balance sheets for each kind of currency and then try to reconcile them once a month.

All these are competing forms of money are all trying to balance out transaction costs, bookkeeping costs, relationship stability, loyalties, trust, etc. etc.

Some are just trying to get a share of that market so they can take a bit of each transaction.

I was fascinated to learn recently that the reason that checks are used in the US more than many other nations is because the cost of check clearing is (or at least was) paid for by the Federal Reserve.

For example when you buy something on a credit card the card companies charge the merchants a fee. 1.5 to 6%. The print out from my taxes reports that my Federal tax rate was 17% this year (which doesn’t include the social security), presumably part of that goes to overhead to run the currency, banking, and check-clearing operations.

Maybe someday the Fed will be able to deploy a plastic currency that competes with current plastic currency. That certainly would disrupt a lot of people’s apple carts. It certainly could create some very substantial efficiencies in the economy.

On the other hand, right now my wallet is getting pretty crowded. The Fed might create single card that enables hundreds or thousands of virtual cards to be packed into my wallet. That could enable all kinds of confusion!