Wednesday, March 30, 2011

Disciples of the Free Market

We’ve all heard of the wonders of a free market. It regulates prices, produces superior products, and protects consumers from lousy products. In theory, I’m in agreement. In practice, I’m going to point something out using Michael Porter’s five forces.

imageLet’s consider an example. Restaurants in Eaton Rapids where you can sit down, eat, and get a beer or glass of wine with dinner. There is the English Inn north of town, however it’s very expensive and Evelyn isn’t quite ready to go there. We’ve got Abie’s, which is completely inappropriate for Evelyn. Then there’s Darb’s. That’s effectively the only local choice. This week we went in and sat for 20 minutes before anyone came to our table. Awesome. They are always full, even though their service frequently leaves something to be desired. They are conveniently located. They are also the only “family” restaurant left in town. As a result, there are few substitutes. It took Darb’s five years to turn a profit when they came to town, which is part of the reason that there aren’t more restaurants. They have to lose money for five years first. That locks out new entrants. There is very low rivalry. In this case, the bargaining power of customers is almost non-existent. We will probably continue to reward their poor service because we’re too lazy to drive to Lansing or Mason.

A second example is the Internet company we use at the office. They are reasonably reliable and offer co-location services that we use. Once again, their sales and service are terrible. We pay them $1100 per month for services, and their salesman returns my calls after three days. At that point, I’ll ask my question. He typically returns an answer after two weeks or so, once I’ve left him a half-dozen voicemails. More often than not, he answers a question completely unrelated to what I want to know.

In the past, they tried selling us a fiber-optic connection to their office. The value wasn’t quite right for us then, but we’re about to buy a new phone system. If we roll our phone, Internet, and co-location traffic onto the same piece of fiber, we may be in a position to get higher service levels at a lower cost. The only problem is that if we do that, I’m going to have to deal with our sales representative more. I refuse to encourage this company’s insistence on making us use a sales representative who is probably too overwhelmed to handle his territory.

Much like the restaurant situation, there are very few vendors in Lansing that can provide the array of services that our current vendor can provide. Barriers to entry are high. Switching costs are tremendous. There must be tremendous economies of scale in order for a competitor to make an entry into this market. In other words, the only companies which are likely to enter the market are ginormous, just the kind of companies that aren’t well known for their superior service.

Perhaps competition regulated markets in the past, but will it in the future? It seems likely to me that specialization, economies of scale, and available funding will regulate the markets of the future much more than customers will.

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