Even More Things That Drive Us Crazy (Explained by Economics)

My MBA graduation

It’s finally official, I have an MBA! I just got my Master’s degree from Cal Poly and I am so happy that all of my hard work has paid off! I am so thankful to my family for supporting me, my friends and classmates for all the good times we had, and my professors for teaching me all about the many, many facets of business and economics.

I learned a great many things during my studies, and I wanted to celebrate by sharing some of them with you. It’s been quite a long time since I have done one of these posts on things businesses do we can’t stand but make perfect sense to them. Let’s take one more dive down that rabbit hole!

Stuff that was made in the old days was built to last, and often is still perfectly usable. Now when I go to the store to buy new things, I can guarantee it won’t last more than a few years, if that!

The pot on the left was made in the 1940s, the one on the right is a new one.

The pot on the left was made in the 1940s, the one on the right is a new one.

In the 1980’s and 1990’s, economist Michael Porter developed a series of models describing how the competitive forces that each business faces work and the different ways businesses respond to these forces. His work was hugely influential in shaping the way businesses behaved, and many of his ideas were taught to me in my classes as “the way things are”.

One of the ideas he developed was his “Generic Business Strategies” model – supposedly, every successful business model can fit into one of these categories:

Porter's Generic Competitive Strategies image from Slideshare

The basic idea is that every business is competing for either a broad target market (such as “people who buy board games”) or a narrow, focused target market (such as “people who are willing to devote hours of their day to a math-heavy, highly strategic tabletop game using custom-painted models”), and those businesses will then decide whether to compete with each other on cost or quality.

Businesses that compete on quality will pursue a “differentiation” strategy – they will compete to have the best product, because they know their customers will be willing to pay more to get the best. Luxury items, naturally, will fall into this category, but so will other companies that make their name on the promise that their products will last, like L.L. Bean. Differentiated products don’t have to be expensive; Coca-Cola bets its reputation on the promise that every Coke you buy anywhere in the world will have the same Coke flavor you know and love. It’s the attention to making one’s own product stand out from the pack that marks a differentiation strategy.

Businesses that compete on cost will pursue a “low-cost” strategy. Their goal is to increase their profit margins by cutting their costs as low as possible. They will be much more willing to buy lower-quality raw materials, cut corners whenever possible, and hand you a product or service that will do little more than simply serve its intended purpose. For many customers, that’s all they really need – something that will do. They are willing to sacrifice quality to pay a lower price. The proliferation of dollar stores across America shows just how many people will happily say with their wallets “I don’t really need the super-expensive good stuff, but I love a bargain.”

There is nothing inherently wrong with either strategy, but you can understand that it is very tempting for a business to pursue a low-cost strategy, as it will usually wring more profit out of each sale. That’s not to say companies with a differentiation strategy won’t try to cut costs, too; they will, but not at the expense of their quality. Then there are “Best-Cost Providers”, companies that decide to walk that fine line of being the “best for your money” brand. Best-Cost Providers will try to offer more features or services at a lower cost than their main rivals, meaning that they have to keep costs low while also providing “just enough” quality to look attractive.

The reason so many products have gone down in quality over the decades and don’t last as long as they used to is because so many companies today pursue a low-cost strategy. Porter’s model showed that companies needed to adopt one of these strategies to avoid floundering in wasted resources and muddled marketing. It is simply much easier to turn a large profit quickly by cutting costs than to try to make your product or service stand out with a higher-quality offering and hope customers will pay for it.

Why are there so many corporate mergers? Before long, there will be only one company left!

WALL-E Buy-N-Large image from Pixar Times

Actually, very few companies will buy others just because they feel like it. Berkshire Hathaway has made its success from owning a wide array of unrelated businesses, from GEICO to Dairy Queen to Fruit of the Loom, but that’s largely because of Warren Buffet’s incredible investing talent. Most CEOs are not Warren Buffet. To try to make multiple, unrelated businesses successful together is very, very hard and requires a tremendous amount of hard work.

No, most corporate mergers have a very clear logic to them that benefits both businesses involved. The goal is to capture either economies of scale or economies of scope, or in many cases, both.

“Economies of scale” is the idea that the larger your business operation, the more your costs are spread out and the lower your cost per sale. There are two ways this happens. If you buy your supplies in bulk, you can use the leverage of the immense size of your order to negotiate a lower price from your supplier, just like shopping at Costco can save you money buy buying in bulk. The larger your operation, the larger your order, the more you can pressure your suppliers to give you that extra savings.

The other way economies of scale can save a business money is when they have large, fixed costs. For example, a factory is very, very expensive to build, and is filled with very, very expensive equipment. You can’t easily switch to a different, cheaper factory the way Starbucks could switch to a different, cheaper napkin supplier. Nor can the cost of building or maintaining a factory and all of its equipment be easily cut. For all practical intents and purposes, these costs are “fixed”. However, what a business can do is make that factory pump out as much product as it possibly can. The more units a factory produces, the lower its cost per unit. In this way, the business is getting the most for its money.

When two companies that are in the same industry decide to merge, it is usually a way for both businesses to capture economies of scale. You know how there have been a number of major airline mergers in the past few years? Airlines have immense fixed costs – those giant passenger jets are not cheap! Spreading that cost over more flights would be the smartest move for any airline, but there are only so many airports and only so many spaces at each airport. Thus, the incentive for airlines to merge is very strong.

As for economies of scope, we have covered that concept on this blog before. It basically means that when you have two or more related products or services, you can save money by sharing resources between them. For example, Anheuser-Busch InBev, the world’s largest brewer, owns 200 beer brands, including 16 that make more than $1 billion in sales per year. The company is able to save money by sharing brewing facilities, distribution networks, sales forces, and administrative staff between all of these brands.

I just wanted to make and sell a really cool Game of Thrones-themed iPhone dock that I made with my new 3-D printer, but I got a cease-and-desist letter from HBO threatening to sue me! What gives?

Game of Thrones iPhone dock image from Wired magazine

This is an actual example, by the way. There was also a recent case where somebody was trying to make a model of the viral “Left Shark” meme making fun of Katy Perry’s Super Bowl performance, only to get a cease-and-desist letter from Perry’s lawyers. Then there’s the ongoing legal battle between musician Deadmau5 and Disney over the former’s famous costume, which Disney claims infringes its Mickey Mouse logo. Why are all these big businesses so greedy that they act like they want to own everything?

All of these cases stem from U.S. trademark law. Trademarks are a business’s way of identifying itself to its customers, so said customers know what product or service they are getting and aren’t fooled by knock-offs. The Nike swoosh, the golden arches of McDonald’s, and the distinctive shape of a Coca-Cola bottle are all trademarks. So are the Iron Throne from Game of Thrones, Mickey Mouse’s ears, and apparently, “Left Shark”, which was trademarked by Katy Perry shortly after her famous/infamous performance.

The most important characteristic of U.S. trademark law, and the reason for all of these lawsuits, is that it has a strict “use it or lose it” policy. If a business stops using the trademark, they lose it. If a trademark gets adopted by the general public as a generic term for that type of product, the trademark is lost as well. Asprin, thermos, elevator, and granola are just a few of the product names that were once trademarked, but the trademark was lost when most people just started calling any old mechanical lift an “elevator”. As we speak, the Wham-O toy company is probably going to lose its trademark on the name “Frisbee” soon, as that name has become generic for most Americans in their everyday speech. On the other end of the spectrum, Nintendo successfully prevented people from using “Nintendo” as a generic term by popularizing the phrase “game console”.

Most importantly, there is the legal concept of “trademark dilution”. The idea here is that distinctive and unique trademarks can lose their value when other people or businesses use a similar one, even if they aren’t necessarily making a competing product.

For example, have you ever noticed that when the Super Bowl is approaching, many stores, bars, and restaurants will have football-related sales and specials but never actually refer to the Super Bowl by name? This is because the NFL (owner of the “Super Bowl” trademark) will sue them for calling their 40-buffalo-wings-for-$10 deal a “Super Bowl Special”. This isn’t because the NFL is greedy; I’m sure they don’t want to discourage people from being enthusiastic about their championship game. However, if they let these businesses dilute their “Super Bowl” trademark, then Major League Lacrosse can start calling their championship game the “Super Bowl of Lacrosse”! If the NFL tried to stop them, the lacrosse league could argue “You didn’t care when these other businesses used the ‘Super Bowl’ phrase, so it’s not really a distinctive and unique trademark anymore.”

In other words, businesses with famous trademarks HAVE TO sue anybody who could be seen as infringing on their trademarks, for if they don’t, they will lose that trademark. It’s just the way the law works.

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One Response to Even More Things That Drive Us Crazy (Explained by Economics)

  1. Pingback: Lessons I Learned Spending One Month Without A Vehicle | Cat Flag

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