Dollars and Jens
Thursday, September 21, 2006
Sustaining profits
Imagine you're a sprinter, looking for an edge in your race. Imagine Nike designs a miracle shoe that can shave a full second off your 400-meter time. And it's a bargain at $150 a pair! How many races will you win next year owing to this great technological advance? Five? Ten? As many as you enter?

How about zero?

That's the correct answer, because if this shoe can shave a second off your time, it can do the same for your competitors. And you can bet that everyone will pony up the $150.
Worth noting is that this doesn't make buying the shoe optional; you have to buy it just to keep up.

Similarly, as Seth Jayson goes on to write about companies constantly improving their systems but,
with everyone generating similar cost savings and passing them onto the customers to try to boost sales, the only likely beneficiaries would be ... the customers!
that doesn't mean they can forego the improvements; they're mandatory, but won't lead to great new profits.

A lot of economic papers lean heavily and without much circumspection on the axiom that profits, in a competitive environment, get competed away. The first thing to note here is that economists don't count a fair rate of return on assets to be "profit", even though accountants (and the IRS) do — if a company can't produce enough in accounting profits to generate a fair return on capital, that capital hasn't been put to its best use, any more than workers are well deployed if a company couldn't afford to pay them what they could get elsewhere. The next big caveat is that markets aren't quite as competitive in the real world as they are in some of these papers (though, on a large scale, they're closer than most people think, and closer than they are on a small scale) — companies acquire loyal customers, or they create a brand, or they find some other way of preventing other companies from competing away their profits. Mostly, they find a way of doing something better (in some way) than anyone else can do it. In fact, this is almost exactly what the (economic) profit of a large company will end up being — it will be the extent to which that company is better at doing what it does than any potential competitor.

Along these lines, of thinking how competitors and other market participants will respond as the markets approach an equilibrium, here's an article on Saturn's no-haggle policy. I don't know much about the car industry per se, or whether this prediction is borne out, but it seems to me the natural thing to expect is that, if customers are required to pay MSRP at Saturn, while they will expect to pay less than MSRP somewhere else, then Saturn presumably has to make MSRP lower than they would if customers were going to haggle. There seems to be waste in terms of the customer's time and the salesman's time in haggling, so it seems it should be more efficient simply to post the actual price that a customer is expected to pay.

I have found it a general principle in economics, though, that things that look like waste — particularly when they look like rent-seeking — often serve some information-discovery purpose, and it may well be that haggling serves such a purpose. It may lead to customers to whom a particular car is more valuable paying more than a customer to whom it isn't quite worth what the average buyer would pay, but is still more than the unit cost of the car — if every car buyer were like that, it wouldn't be worth putting resources into building a factory and so on, but if you can get the gross profit from which to pay for the factory more readily by getting more of it from some customers than from others, then it may on the whole enhance overall economic efficiency for bargaining processes to tease that out. So I'm not too quick to jump to a clear conclusion that one system is always and definitely better than the other, though I have to say that Saturn's certainly appeals more to me as a potential customer.

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