2011-10-28

Is Every Business Now a "Monopoly?"

Lately I have been thinking a lot about business models, profits, and so forth. There seems to be a significant difference between "the way things used to be" and "the way things are now."

As a simple illustration, we can look at the market for large home appliances or furniture. There was a time when durability, reliability, and longevity was the major selling point for such things. People would make their purchases based on what they thought would last the longest and provide the most reliable use. Such products often came with a lifetime warranty, or at least a twenty-year warranty. Companies became successful by producing the most preferred product, by earning good will with their consumers, and being the best. If a product failed early, that failure and how it was handled by the company impacted that company's reputation - for better, or for worse. The absolute best producer with the best warranty and best customer service made the most money.

And life was simple.

As certain means of production became much less expensive than the old way, businesses discovered the opportunity to make a profit in a slightly different manner. By manufacturing products of a lower quality and selling them for a much lower price, companies could expand their clientele to people who previously could not afford such products - or who could only afford them in limited quantities.

What companies discovered was that consumers seemed to prefer this approach. It offered consumers the ability to re-design their homes more often, experience the excitement of "new stuff" more frequently, and so forth. These days, most consumers have really warmed up to this approach. It is easy to decorate homes and have a well put-together house on virtually any budget. Companies have ditched the warranties and whittled prices down as low as they can go, even outsourcing manual labor to China or, as in the case of IKEA, to the consumers themselves.

Problem?
So life has changed and while we once used to pay a lot for a little bit of really high-quality stuff, we now have inexpensive, good-looking, disposable stuff in abundance. That this is a boon for society, there can be no question. Those of us who still want the really high-quality stuff have to be willing to pay for it. Very high-quality furniture and appliances are out there for a higher price. Everybody wins because everyone has access to the products that are consistent with their needs and budget. Life is great, right?

Well... Some of you may note that I have sort of cherry-picked my example. Virtually everyone loves IKEA, so no one would ever suggest that the market for furniture has deteriorated.

On the other hand, the market for guitars has changed radically. A few decades ago, every instrument was hand-made by an artisan using pretty much the same components. These days, even very expensive guitars are manufactured by laser-guided machines. But the quality of the materials used varies widely between low- and high-end instruments.

And guitarists don't like playing cheap guitars. So, while everyone has a guitar available at their preferred price-point, the only guitars anyone really wants to buy are the ones with high-quality components, and those are all expensive. Buying guitars can be frustrating because no one wants a cheap guitar. We only buy cheap guitars out of necessity, not out of demand.

Withholding Supply
These days, the most common business model seems to be one of withholding supply.

As our guitar example illustrates, the approach is not to offer the best of the best at the lowest price, but rather to use lower-priced items as incentives to spend more. Rather than offering existing levels of craftsmanship at the lowest possible price, guitar manufacturers simply compromise on build quality and offer the resulting compromise at a lower price than the "real" models. In fact, manufacturers are now offering guitar models with special name extensions, like "SE" or "MIM" to differentiate the lower-quality goods from the higher-quality ones.

Another example of how you might observe this phenomenon is in the "modularization" of software products. What used to be an upgrade to an existing product's functionality is now sold as a separate "module." So you might be able to purchase a cell phone that makes calls, but if you want to send pictures using the camera's built-in phone, you'll need to download a separate software module. At its worst, you will often purchase software that promises to do everything you want it to, only to discover that in order to make that happen, it involves purchasing numerous expensive add-ons.

As you can see, these kinds of business practices are much different than capturing production efficiencies as we described in the furniture examples. This is nothing more than the hallmark behavior of the monopolist: withholding supply in order to raise prices above marginal costs.

Let Me Be Perfectly Clear...
Now, unlike the average weirdo, I do not really have a legal or political problem with companies that choose to engage in business practices of this sort. I don't think "there ought to be a law," nor do I think it represents any major abuse of market power. I'm not saying that.

But as a consumer, I find this kind of behavior annoying to point that it is starting to impact my own market decisions. I no longer want to patronize businesses who engage in cheap tactics to squeeze more money out of me, withholding what they know I want with infuriating teasers to try to dupe me into over-spending for it.

Furthermore, as an economist, I find this behavior preposterous. There are a lot of people out there making far too much money while producing not nearly enough goods and services. A little aprioristic reasoning applied to these situations suggests that their days are numbered.

But perhaps more importantly, it also suggests that the modus operandi of most North American businesses is flawed, and these flaws result in a deadweight loss to society at large. When we stop to consider how far technology has come over the past one hundred years, and compares that to the cheap, brittle phones we carry in our pockets that shatter when dropped, or the fact that we must save up for years just to purchase a guitar that doesn't warp in expected weather conditions, it gets really obvious. We are getting hosed.

The Punchline
The reason I have been thinking about all of this is because I have been mulling over my own entrepreneurial prospects. My ethics are such that I would not feel comfortable engaging in supply games to squeeze my consumers.

What I want is to offer the best services I can at the most attractive price. I want to offer content and quality. I want to offer the best. I will never be able to offer "the best" by playing cheap games that take advantage of my consumers' ignorance or inability to strike a better bargain elsewhere.

Call it professional ethics, if you like. What is sad is that withholding supply seems to be the rule to me, not the exception.