Search cost and price taker market

A while back, I was having an argument with a friend over how Walmart sells products cheaper than its competitors. Someone had told him that the quality of Tide that you buy from Kroger is better than what you'd buy from Walmart. I tried to convince him unsuccessfully, that something like this is impossible since companies like Consumer Reports thrive on this kind of news. If this was true, then somebody would have tested the difference in quality and reported it long ago. Besides, a company size of Walmart cannot tolerate that one of its supplier would give it an inferior product, because it will literally bring down the whole business. Imagine if you find out that the Tide you are getting from Walmart is lower quality. Are you going to buy Tropicana from Walmart anymore? How about M&M's? Doritos? Gillete shaving foam? Over the counter medicine? At the end of the day, it's not only Tide that's cheaper at Walmart but pretty much everything. Although, I have seen lately that Meijers and Target are catching up (competition always catches up) and for most of the similar items you can get prices similar to what you would pay at Walmart.

That being said how is it that Walmart is able to get lower costs from its suppliers. If you are running a small grocery store in your neighborhood (aka mom and pop store) then your cost of Tide or other products sold at Walmart is probably close to Walmart's prices. A simple answer that everyone knows is that this happens because of huge buying power that comes from buying in bulk quantitites. When Walmart buys products from its suppliers, it reduces bulk of their shipping and handling  costs, thereby reducing the cost of product for Walmart. But what else happens? There is something called search cost which is the cost of finding a buyer. I'll try to explain here what search cost is and how it affects the price you pay at the counter.

Imagine you are a farmer who grows corn. Now you have a harvest season and you started harvesting corn. You have ten thousand bushels of corn to sell (in real world its a lot more). Also assume that there are no commodity markets. Now you started selling your corn right outside your farm. You have distributed flyers in your neighborhood and people you know and posted flyers around the city that you are selling corn at $5 a bushel. Some customer came and bought two bushels. Another bought five and another one and so on. You estimate that at this speed you will sell your corn in 4 months. During this four month you will accrue  storage cost and your money will be tied up in that corn on which you can start earning interest (assuming you invest your savings) if you can get that cash today. Let's assume that a buyer stops by at your farm one day and offers to buy all remaining 8000 bushels of corn. But he says he is not going to pay you $5. Instead he will offer $3 per bushel and starting next year he will buy all your harvest.So you don't have to spend your money searching for a buyer. This reduces your search cost significantly. It will get you your money early, some of which you can use to buy bonds and earn interest. Commodity markets play the role of this person. A farmer does not decide the price of corn. He just takes his corn to the market and he has to take whatever the price is offered at the market, or he can just take his corn back. These markets are called price taker markets. These markets reduce his search cost significantly, however the price he is offered is not the same anymore.

This is exactly what happens when P&G sells its Tide to Walmart. Walmart has reduced P&G's cost of selling Tide. It has reduced the cost associated with finding a buyer. Yes P&G still has to market the product and run ad's on TV. But it has to do that even when Kroger or other mom and pop stores are selling it. But Walmart has reduced the cost of distribuing the product. Through Walmart, P&G can reach millions of customers. In the absence of Walmart, P&G will have to spend a significant amount of money to be able to reach all these customers and that will be reflected in the price you pay at the counter. So why can't P&G sell Tide to Kroger at the same price as Walmart? Well, first of all Kroger does not reduce the search cost for P&G as Walmart. And we don't know if Kroger is getting the same deal as Walmart. May be it is getting the same deal as Walmart but it may have other overheads that are higher than Walmart which increases the cost for you when you buy products from Kroger. May be you get better service at Kroger than Walmart which is reflected in higher prices than Walmart.

Search cost is one of the main reasons why we are able to buy cheap products at Walmart. Internet has redcued our search cost. Imagine what you'd have to do if there was no craigslist, no product reviews, no ebay and no amazon and of course no Google. By reducing our search cost, Internet has reduced the over all cost of the products for us. We can compare prices and reviews for products and services by just typing few words on Google. Imagine what you'd have to do for similar information if there was no Internet.

I don't need to give more examples but search cost is significant and it has a huge affect on the prices we pay. If a particular retailer can figure out a way to reduce search cost then it doesn't mean that the product he is selling with same labels is inferior.

How Technology Affects Business

Someone recently asked me this question. While the question seems relatively easy to answer, I was amazed by the vastness of the things that I could think of. And then I realized that based on personal experiences, the answer can vary considerably. Here I will list the technologies that I could think of, have changed the way we do business, technologies that have fostered new companies and drove some businesses out of the market place. I will also discuss two of my favorite companies glassdoor and linkedin which are changing the dynamics of skilled labor market.

While it is always difficult to notice a change as it occurs gradually but an easier way to understand what has changed in our lives due to technology, just imagine how we did business ten years ago and how we do it today. Think about the percentage of online purchases you have done in last year and try to compare that with what you did back in 2002. Some great companies like Circuit city have gone bankrupt because they were not able to adapt to the changing market place. Best buy is in no better shape and I personally would not be surprised at all if Best Buy declares bankruptcy in next couple of years or even sooner. It is already closing several stores across US as part of restructuring its business. That being said, I think a failed business like Circuit City and Best buy has to do with more than just new technology. While Amazon definitely has grabbed a big chunk of Best buy customers, but there is more to the story than just online competition. Otherwise, how do you explain the continuous growth of Bed, Bath and Beyond? It has at least just as much competition as Best Buy. In my opinion the answer lies in customer service. I do not have any market surveys but in 2003 I decided I would never go back to Best Buy and I have not. Similarly sites like craigslist have faciliated a used goods market and reduced search costs to virtually zero, thereby eliminating some buyers who would have otherwise bought new products from brick and mortar stores. This not only has affected the retailers but also the manufacturers. Combine all this with review websites like Yelp and Google reviews who have significantly reduced information asymmetry, you have a consumer who is more informed and could make better decisions about the products or services he or she is in the market for. So, in case of Best Buy, what technology has done is that it has provided consumers an alternate reseller of the same products at not only a cheaper price but also good and reliable service. They not only pay lower prices for same products but also do not have to deal with an associate who is more interested in selling warranties and extra services that the buyer believes he does not want especially after reading reviews on websites like yelp. If it was only for technology and online competition that Best Buy was going down, then I would ask a simple question and that is "Explain Bed, Bath and Beyond to me?".

Now look at another aspect of how technology has affected the businesses. How we were getting our news ten or fifteen years ago and how do we get it today? This has literally drove some newspapers out of business. However, Wall St Journal while going through a difficult period has adjusted and its future still looks bright. Here we can give Wall St Journal the benefit of being a leading player in a niche market but I don't think excuses given by Chicago Tribune or similar companies have much weight. Tribune said that it needed to go into bankruptcy protection so it can adapt its marketing to the new technology. The question is, what took it so long? Why didn't they do it when they could have done it without going into bankruptcy protection. In the beginning of this paragraph I said, think about how we were getting our news ten or fifteen years ago and how we are getting it today. I didn't said think how we were getting our news last year because this change like all other changes has been gradual over a number of years. It is not an over night change. So, technology definitely drove newspapers out of business including some really big names but it was because of poor management and their failure to adjust when they could have rather than technology alone. Management of these news companies had an option to change and adapt to new technologies and they decided to do nothing.

Next I would like to talk about mobile computing. How smartphones have changed everything we do today. While Blackberry has been around for a longtime (it probably won't be for too long), love or hate, it was actually Apple that revolutnized the smartphone industry. Today we have two dominant players, Apple and Google, who have the biggest share of smartphone market. Thousands or probably millions of apps are downloaded everyday around the world. While developers have financially benefited from the smartphone revolution, smartphones, since still in growing phase are revolutionizing the way we do traditional business. Many people today deposit checks using their smartphones, they buy and sell shares and use their phones as GPS. There are several free apps which provide voice activated navigation including new social media GPS app called Waze. Going into the details of how waze works is out of the scope of this discussion but would you be surprised if Garmin or other GPS companies run into financial difficulties. What about paid apps like the one provided by your cellular service provider? Should your service provider make these apps free and make money in the same way as other apps are making? Well may be or may be not, because these big companies have higher cost and it may not worth it for them to get into advertising business using apps. But one thing is for sure, sooner than later, people will not be paying $10 monthly fee for their GPS app so they can either drop it altogether or try to market their service having a free mapping application. Verizon already does that. AT&T does not. Discussion about mobile technology would be incomplete if we don't talk about location based services. Today, many small businesses have grown because they show up on result when you are searching for certain type of business around you. Not only that they show up, their star ratings based on their reviews also shows up next to their names and if product or services are rated high by consumers then this further helps increase sales for the business. What this does is that it makes good businesses more profitable and bad businesses will eventually be driven out of business. Great thing for us consumers.

Another business affected due to new technology is TV and Video. Blockbuster, your neighborhood video store is history and Netflix, the company responsible to drive blockbuster into bankruptcy, itself is having a difficult time to grow its business. You can watch your favorite TV shows on hulu, while many people also spend a lot of time on youtube. You just have twenty four hours in a day. If you want to watch newly released movies, you can go to your nearest Walgreen's or a grocery store and get it from Redbox. Cable operators are another segment of business affected by this change but due to their monopoly and high barriers to entry into this business, they are still doing fine. However, I wouldn't be surprised if Comcast or some other cable provider is having problems in retaining customers due to internet and the rumored Apple TV.

If you work in technology and even if you don't, chances are you have heard the term cloud (computing). Many companies including Google, Amazon and Microsft are offering cloud services. It basically allows customers to let cloud providers host services including web services if they so desire. Cloud computing has enabled small businesses who cannot afford a technology infrastructure of their own to benefit from technology. For example, health care sector which has traditionally lagged in benefiting from technology can now use cloud services and improve its customer service and reduce cost by having online records, referrals, appointments, prescriptions and much more. And they can do all this without having any technology infrastruture and very few to no technical staff of their own. While still growing, it is well known that this is a very lucrative market which has tremendous potential for growth. In case you haven't already noticed, soon you'll start noticing changes in how your physicians and hospitals will be handling your prescriptions, appointments, referrals and other data inclduing billing. In case you don't know, Netflix runs on Amazon's EC2 cloud.

Finally I'll talk about my favorite topic and it is labor market. How is technology affecting labor market for skilled labor? We talked about how product reviews on websites like Yelp are affecting consumer's buying habits. Similarly company reviews on glassdoor are affecting labor market, though its affect may not be as visible today as it might be ten years from now. With company reviews on glassdoor, skilled labor has much more information about prospective employer. If companies have not already started noticing this, they'll soon realize how their employer brand is being affected by sites like glassdoor. We'll see exactly the same effects in labor market as what we are seeing in consumer market. Employers with good reviews and good reputation will be able to attract best talent and those with not so good reputation will get not so good talent. This in the long run will affect their products and services and ultimately their returns. Would you hire a consulting company if it has significantly higher number of unhappy employees? I can't speak for everyone but if I am submitting a resume for a position I am interested in, the first thing I do is look for its glassdoor reviews. And if a company is rated 2 star by its employees then I just tell myself that I can do better than this. Linkedin on the other hand has changed the way people search for jobs and recruiters search for talent. Connections on linkedin have facilitated networking enabling job market candidates to connect with recruiters who specialize in the area they are looking for a new job.

This is an amazing long list and no doubt quite incomplete. In conclusion I would only say that businesses that failed due to technology did so because of poor management. We are moving towards an economy where effecient and good businesses thrive and poorly managed businesses are driven out. Customer service has become more and more important and unless you have a monopoly and high barriers to entry for new competition, you want to make sure that your customers remain happy or word will get out much sooner than you think and it might be either too late or it may cost you a fortune to fix the issue and correct the image. Consumers are biggest winners of all this change and overall society has benefited from technological advances.

Microsoft's new tablet: Surface

Microsoft announced its new tablet computer on Monday, June 18th 2012. Tablet will be available in two different versions, basic and pro with one running an ARM processor and the other running an intel based processor.

I think it is safe to say that the purpose of this product is to offer competition to Apple's IPad or in general enter the fast growing tablet market. One of the things I studied in my Marketing class during my MBA was that, while good Marketing is important to launch a new product and help its adaption, but for long term success of a product, it should also be backed by a good product.

You can see the spec differences between iPad and Microsoft surface here. In this post, I'll just discuss the possibility of success of this product. But let me first share a small story.

In "The Art of Strategy", one of the authors Barry Nalebuff, describes a story from one of his Cambridge University's May Balls that he attended. There was a casino in the ball and each participant was given £20 worth of chips. The participant with most chips by the end of the night will be given tickets to the next year's ball. Barry led the ball with £700 and the next closest person had £300. The game was roulette. The lady running second bet all her money on a multiple of three. The chance of winning is 12/37 as the wheel is numbered from 0 to 36. If she wins, she'll triples her money to £900. Barry should have simply copied her bet and placed £300 on the same number. If she wins, then Barry also wins and will be ahead of her by £400. If she loses, Barry still wins by £400. Already knowing her bet, all Barry has to do is copy her bet. Barry does otherwise, she hits her number and wins the tickets to next years ball.


Although the situation that Microsoft faces here is different including the fact that Microsoft is the new entrant and no leader but one thing Microsoft could have done here was to copy Apple's marketing strategy. I think it miserably failed. The product they announced using Apple's marketing strategy of secrecy will not be available until October. What's the point of secret event again? We don't know what the price will be (I am talking about a number). Resolution is not even the same as the existing iPad, forget about the next year's version. Something we cannot blame Microsoft, albeit important is the number of apps and a developer's network like Apple. Combine all these things and I think, Microsoft Surface at best will provide reasonable alternative to competing Android tablets and at worst can face the same fate as Zune (although there will be fewer chances of that).

Facebook's recent IPO

I wrote about why I wouldn't buy facebook stock if it values the company at $100B. Friday's IPO did exactly the same and I stayed on the sideline. Shares of facebook traded between the offering price of $38 to $45 before settling down to $38 at the market close.

Today the shares closed 10 percent below Friday's closing price. The biggest question that comes to my mind right now is how much did the underwriters lost? I am guessing some people might lose their jobs. Additional 25% shares were offered just couple of days before the IPO and offering price increased from $36 to $38 (of course Morgan Stanley enjoyed additional fee). On the flip side, facebook investors and employees who dumped their shares in this IPO were the smartest ones and should have every reason to rejoice.

Future of Cable TV providers

Someone recently asked a good question.

• What’s the future of entertainment for a cable provider like Comcast?

Although Comcast also provides Internet and voice services, but for now I'll only focus on it content distribution service, aka cable TV. To analyze the future of Cable TV be it Comcast or AT&T, let's see the threats this business face. From a high level, I think there are following threats to Cable TV which all arise from internet (technology)

• Websites like hulu.com
• Netflix
• Rumored Apple TV
• Content creators who now also distribute content on internet, through their own websites
• youtube

Let's look at these threats in order. I am going to refer to the concept of long tail. If you are not familiar with it, then please read it here.

Hulu, founded in 2007, has support from NBCUniversal, News Corporation, The Walt Disney Company as they are its part owner. It has partnership with 350 content providers. Its user base is constantly expanding. Many providers who don't provide their shows on hulu, still have links available on hulu that will take you to their website where you can watch the show. One such example is "Unforgettable" from CBS. In this particular case we see that content provider is also distributing it through its own website, falling into our category 4 above.

Netflix which started as a movie subscription service in 1997, now offers online streaming of its movie service. It has also started streaming TV shows just like hulu. Although TV content currently provided by either hulu or Netflix nowhere nears what viwers get through Cable TV, but these providers are constantly increasing the content they provide, so although some years but it seems like it is now a matter of time when virtually everything provided by Cable TV would be available on hulu and Netflix combined.

Third on my list is the rumored Apple TV. This is definitely the one that Cable TV industry should be most frightened of. Apple changed the music industry forever with its famous iPod combined with iTunes library. If and when Apple comes with its TV which some people are already calling iScreen, chances are it will be a game changer for TV industry in General and Cable TV industry in particular. Imagine an equivalent of iTunes for TV.

Fourth on my list are the content providers who have also started to distribute their contents from their own websites. For example if I want to watch my favorite john stewart's daily show, I don't have to stay up late and watch it on TV anymore. I can watch it at my own convenience either on hulu or on dailyshow.com. Now, I don't exactly know the deal between hulu and comedy central for revenue sharing but I am assuming Comedy Central makes more money when I watch the show on their website, giving them an incentive that viewers watch their show on their own website rather than hulu. Then we have, other providers like CBS who stream several of their shows online on their own website.

Lastly, I mentioned youtube. Now this may not sound like a real competitor to Cable TV but youtube recently has made some pretty good changes with its advertising model. It has also started a movie streaming service which is rather expensive. I wouldn't be surprised if Google partners with content providers to provide shows and movies on youtube just like hulu.

For those who are familiar with the concept of Long Tail know that most people don't need what is provided by Cable providers. Every person has its own niche and hulu, youtube, Netflix and websites of particular TV shows, ESPN.com and its live streaming and similar services can now fill those several niches, leaving very little market for Cable TV providers. Only 6 years ago, Cable TV providers had mostly other providers as their competitors. That is not the case anymore. In fact competition from other providers is not as cut throat as it is from several of these players serving these niche areas. I mean how do you beat free?

One of the things that Comcast and other cable TV providers like AT&T are already doing is bundling their services. These providers provide internet, so they are using their advantage as Internet service provider to bundle these other services. But, how long can they sustain it? There are providers like dish network who don't bundle these services so a customer can only get TV from them and go to a different provider for internet.

This is a never ending discussion but at the end I think the real threat to cable TV business comes from specialty providers who are all serving their own niche. Comcast is adapting well by providing on demand features to its Cable customers. To keep up with this emerging competition, it will need to match services while not increasing prices at the same time. This can affect its bottom line and to maintain profits, it needs to find ways to either cut costs or find new areas to generate revenue. Looking at last 10 years of Comcast, it seems like the company has not grown at all and in my opinion it is the pressure from competition we discussed above that is eating its potential profits.

I think future for Comcast is not all that rosy. It will face challenges in growing and worse retaining its customer base. It should continue to increase its partnership with content providers to increase services to tablets and mobile devices. This would be similar to WatchESPN. But if rumored Apple TV is true then partnering with Apple, if Apple looks for a partner, can be a jackpot because the other option will increasingly look like RIMM or Nokia.

Novica.com

I was searching for a poncho for my wife when I found this website. Novica works with artisans around the world in developing countries to bring their products directly to the consumers. There is a network of people employed in each country Novica works, which helps connect and find these skilled individuals which adds to the cost of the products. But when you look at most products on this website, you'd see that the items are very unique and difficult to find else where and are very reasonably priced when you consider the fact how much work is done into bringing these products to the market. They'll look even cheaper when you compare them with what you'd pay at Nordstrom or Von Maur. Yes, that's the kind of quality products you get at Novica.

The site also works with people in developed countries to help the artists and artisans get loans at zero percent which can help these people grow their business. If you already don't know about it, I highly recommend you check their website.

What Amazon can do with Wish List

I think wish list is one of amazon's great feature. Most of the time, people use this feature to add items they intend to buy. While this helps increase sales, amazon has not done much to use this list.

Pricing is one of my favorite subjects and I think a lot about prices. In case of amazon's wish list, I think amazon should add an attribute in a user's wish list that says notify me when the item is price x or lower. And then amazon can analyze the list of all users for each item and find the price point where it can make the best profit. Then if it makes good business sense, then lower the price on that item for 24 to 48 hours and send an email to users notifying them of the new price on the product in their wish list for a limited period of time.

Calculation of the price point may be more complex. People will likely report lower prices than they are willing to pay so amazon might want to notify people when the price is x percent higher than they said they would buy an item for. But the idea remains the same. Amazon can use the wish list to increase its profits and its currently not doing so.

How China Undervalues its currency

Congress in last couple of years has stressed more and more to pressure China to ease restrictions on its currency. In my post about currency exchange, I explained how the value of currency affects exports and imports of a country. Based on that discussion, we know that when a currency is devalued, its exports increase. So when China undervalues its currency, it helps keeps Chinese products cheap and helps its exports.

In my post about currency exchange I explained how foreign exchange market determines the price of a currency. So how is it that the price of Chinese Yuan is not determined by the foreign exchange market. The answer is because Chinese government through People's bank of China controls how much Yuan is going to flow into the market, effectively controlling the price of Yuan.

Let's see this through an example. Assume there is a factory in China that supplies some product X which is sold to the US. Now the US buyer will make its payments in USD to this factory for the product X. But this factory needs Yuan to pay its employees, to buy raw material (if its not imported), pay for factory bills, taxes and other similar expenses. So the factory will go to People's bank of China and exchange its USD for Yuan. This is where Chinese government control comes in and it decides the price of Yuan. This USD, and similar hundreds of millions (billions per year) end up in Chinese reserves  and significant portion of this USD is used to buys US government bonds, making Chinese government the biggest, US lender.

Now that we know how Chinese government controls the price of Yuan, how does it affect (hurt/benefits) US. First of all, for no change in  income of American consumer they can buy more Chinese goods because they are getting more Yuan than they would in a freely traded Yuan in a foreign exchange market. So American consumer is better off. Then why does Congress and White house has an  issue? Because Congress or White house are not there to help american people. They are there to help those who fund their campaigns. While American people are better off when Chinese government undervalues its Yuan, the American business which is competing against a Chinese business is worse off. So these businesses combine together lobby the government and push for pressure on Chinese government to reevaluate its currency against dollar. This will hurt American consumer because Chinese goods will increase in price but will help American businesses as it would be easier for them to compete now.

This in a nut shell is how Chinese government undervalues its currency and how it affects its trading partners, the biggest of which is US. If you ask me, I'd say let them undervalue their currency as it helps me get cheap products from China.