Why business is so difficult and unpredictable
younglingfeynman.com
younglingfeynman.com
From my own observation there are only a few markets that really seem to reach a Nash equilibrium and drive prices to the minimum sustainable value.
A great example is the mattresses business. You would think that there’s not much room for high margins there since it’s such a commodity technology. Good foam based mattresses for example can be mass-manufactured for around 30-50 $ according to industry sources. Shipping is also easy and cheap as they can be vacuum-packed and shipped as regular parcels. Yet, the top selling mattresses cost around 200-300 $. How can that be? I think there are multiple reasons for it but the gist is that price alone does not determine which product wins, psychological aspects play a central role as well. And while in the long run a Nash equilibrium can be reached in practice it’s often the case that the manufacturers in the market don’t compete too strongly on price since they understand the meta-game and know that they might ruin the market for everyone including themselves if they compete too strongly on price alone.
Indeed, that’s why many companies make Veblen goods and generate revenue from this.
I personally don't think there's that much room to move down in the mattress industry because lowering the price is usually the first thing marketers and SMB's try in order to grow market share (or when the business is struggling).
I don't know much about that particular industry but I suspect it was already in a Nash Eq. It would explain why the 'new player' was Casper. Someone who didn't participate in the game but created a new game instead.
I strongly agree with your comments about the psychological aspects (and general forms of psychological economic value creation). In the essay, I was referring more to businesses that are pretty much a commodity with very little distinction.
It doesn't seem likely to me that the people in the market would be working together to artificially keep the price stable at a particular point.
Such a system would be highly unstable since all it takes is 1 person to take advantage of it. If n is small enough, maybe but not if n is sufficiently big.
This is essentially what a Nash equilibrium describes; you have a system and then 1 person's greed results in them taking advantage and forcing the other party to respond until you have a stable situation that might be less ideal for the market than what you started with.
(You don't even see it as much in the tourist restaurant business anymore because of things like Tripadvisor.)
We already know from things like Yelp, Airbnb, Uber, eBay etc. that a minor drop (say 4 stars vs. 5 stars) translates into a huge drop off in clientele.
In a world where every Uber driver has 5 stars, having 4.5 practically means you're a maniac in the eyes of the consumer.
(Not entirely unjustified since 5 stars means 'average' for most people, and not 'outstanding'. So to give less than that is actually quite a hurdle for most people.)
young users will react to ads, feel they should spend money to feel they got something of value, get in the store on "super hot deal day" to get conned (like their parents were the first time?)
I'm exaggerating a bit, some cultures put a lot of pressure on being financially responsible. But for the rest I saw what I described with my eyes.
In the case of mattresses, while gross margin is higher than other industries, the volume is MUCH lower. So the overall profit is likely lower than you may guess.
That said I also think mattresses are not quite that rock bottom. because people shop so infrequently and the purchase is important, they’re likely to look to authority sources for guidance on which to get which can include friends, articles, and advertising. In advertising there’s an intuitive promise that if a company can afford to advertise than they must be doing well enough so the quality must be ok. Now we all rationally know that’s not necessarily true but it’s one reason imho why advertising works. So there’s room for branding and feature differentiation exhibit A Casper.
But I can imagine a case where the Nash Eq. doesn't settle at the absolute bottom price. Perhaps consumers don't care about price alone. Like you pointed out as well, if they interpret advertising as a trustworthy signal, then a business is forced to run ads.
Undercutting others with a low price, by not running ads would in that hypothetical situation signal low quality.
(Maybe a better example would be a bank in a trailer park vs. a bank in one of those beautifully designed buildings.)
But all those cost can be factored into things like CAC, COGS, SG&A etc.
Edit: There aren't that many studies on credibility and advertising but you might find this one interesting:
If you were a grocer, a butcher, a book binder, farmer or blacksmith from say, three hundred years ago, your business would have been established decades ago and would remain in a relatively steady state. If it made the same amount of money year on year (inflation adjusted), it would be considered a success. The current growth at all costs paradigm did not exist.
I see only monopolies.
Citizen science is cool, but doesn't extend outside of incremental value add domains. Fusion and more will almost certainly be from monopolies or monopolistic competitors.
At least that's how I interpreted that comment.
But Xerox PARC immediately came to mind, which was a breeding ground of innovation.
The capacitive touch screen was invented by Bent Stumpe at CERN [1]. The software technology that arguably made the iPhone possible, multi-touch, was developed by U of T, Bell Labs, and CMU. Steve Jobs visited CMU in 1985, though that obviously didn't translate into much back then.
The actual multi-touch software that went into the iPhone was developed by FingerWorks founders John Elias and Wayne Westerman at the University of Delaware [2]. Apple bought FingerWorks and incorporated the technology into the iPhone.
I had a product idea recently, researched it, and found a couple Chinese type products that did what my idea would do on paper...
One was priced at 6$, another, $15.99. The problem is, they'll all set your house on fire. No isolation, bad circuit design, globs solder everywhere, not rated for the right amperage.
A proper design would probably cost $75 for the consumer.
People assumed consumers wanted a cheap vacuum. (That's not an unreasonable assumption.) Dyson then showed that there are other dimensions consumers are willing to judge a vacuum on than just price alone.
One category (out of 4) in Pragmatic Behavioral Psychology (or Dutch School of Marketing) is context changing. By creating a $75 product, consumers have nothing to compare it too and might judge solely on price if they view it as a commodity.
Should you use context changing, you can shift the conversation from price to safety by educating them. Perhaps throwing it in the shape of a story about a couple who's house burned down, and why it's so important not to think you can skimp on this stuff.
In that context, you're no longer competing on price but on quality because you've messed with the context frame.
These are all things that will need to be tested. The only way to know for certain is by talking to users and seeing if you can sell the product.
But the vast majority of companies aren't of that disruptive kind. They're just normal mom and pop shops, and FBA/Shopify businesses.
Pretty much all those monopolies support small business. Think of Google, Facebook, YouTube, Etsy, Yelp, etc.
Also, I'd push back on the implication that cut-throat competition leads to innovation. I think that's rarely the case. It absolutely leads to incremental innovation but rarely to disruptive innovation.
That is almost always a function of an outsider, who's willing to challenge existing assumptions. (More often than not out of sheer ignorance of the existence of those assumptions. I can't even count the number of founders who've told me something along the lines of 'We didn't know we weren't supposed to do it this way.' Or, 'Had we known it would've been so hard, we'd have never even started.'
We need a fundamental rethink and "back to basics" to setup a simple interface between a Producer(including their Supply Chain) and a Consumer with absence of all unnecessary middlemen.
I don't believe it's ethical to externalize that responsibility in pursuit of more profit and growth.
That's why I included what Andrew Mason said about Groupon.
Is Groupon really a better company simply because it makes more revenue? I don't think so, but if you're only using 1 dimension to measure, then that's the conclusion you'll come to.
Did they ever go bankrupt, I tried to search groupon bankruptcy on DDG but there were so many stories about how they were going to go bankrupt I couldn't figure out if they ever did.
I wonder how it would've turned out had Andrew been able to stick to his guns. But that was never an option since it was structured to IPO from the very beginning because of all that crap with thepoint . com
Don't believe they ever went bankrupt. Those stories you found might be the result of the dealsites not living up to the hype.
There was a significant period of time where many investors believed those sites were gonna create the next Google.
Their market cap is still around a billion I believe.
Lots and lots and lots of grocers, butchers, book binders, farmers, and blacksmiths went out of business 300 years ago. And even the successful ones were all poor as were any employees in their employ.
We may need a historian to chime in here, but definitely not at the rate they go out of business today, is my thinking.
The well known narrative is that the Industrial Revolution at the start of the 1800's profoundly reformed society over the past 200 years. Events such as the Civil War, World War 1 and 2 accelerated that evolution.
At its heart, it's a very complex story though. Depending on the region, continent, culture, technological advances,... different areas and domains of the economy would experience changes. And it's not like one day people woke up thinking "Oh, we've entered the era of the Industrial Revolution, let's head to the factory now!"
Looking at larger timescales, economic change is above all a gradual change. For instance, some of the issues you'd see in urban centers - poverty, unemployment, sustenance living - did already exist long before modern industry established itself. What you do see is that industrialization - establishing factories, infrastructure,... - such as it happened in London or New York, exacerbated existing societal tensions, and created new ones. At the same time, society organically adapted to those challenges through the gradual adoption of technologies such as trains, metro/tram lines, bridges, sewers and so on. Organically, because at time nobody new how things would pan out, much like we don't know how modern technology is going to affect society in the next decades.
At the same time, none of that suddenly pushed existing industries out of business from one day to the next. Farmers, butchers and grocers were very much an intrinsic part of society and they didn't simply went out of business in a few short years.
Over the past 200 years, as - among other things - mobility increased, you do see a change in how an entire economy evolves from local activity towards regional interconnected networks of trade and exchange. And that created increasing pressure on traditional modes of living up to the point where they were no longer viable.
We should be aware that the modern concept of a small business doesn't necessarily apply to historic professions and trades, and how those tie in societies that were very much different 200 years ago from where we are today.
The trades and professions back in the day weren't so much "jobs", they were specialists who learned the trade from father to son. That ties into the fact that local economies were heavily based on how families were connected. Social connections pretty defined with whom you'd trade. The people that came to you to get their horse new shoes, or with whom you'd trade a few hats of grain, well, your families very likely knew each other going back several generations. Trust was essential in order to make this all work.
Let's also not forget that people avoided travel if possible. It was simply a proposition which was too expensive and too risky, given that modes of transportation were extremely limited. Mass migration never happened because people wanted to, but because they were forced too. (Irish Potato Famine of the 1840's is a great example). Most people lived their entire lives within the same 20 to 25 mile radius. Hence why local communities at the time were close knit.
When a local community - village, hamlet,... - lost a blacksmith or a master carpenter, that wasn't just a loss of a worker, it had a profound impact on that community. So, that then ties into the fact why people were so adamant on their kids to follow in their trail and were apprehensive towards newcomers who hoped to compete.
World War 1 and - certainly - World War 2 with the advent of modern transportation as cars, trains, airplanes, boats, mass production and so on changed all of that.
In fact, it's an evolution that happened in subsequent waves where parts of the economy and society altered in a snowball like fashion. Supermarkets and retail chains, for instance, didn't exist in the 19th century. The earliest forms date back to the 1910's. And they only started to pick up in the 1930's. But the real change happened after World War II when suburban development boomed and automobile ownership saw a sharp increase.
Smaller and larger communities had already evolved massively between 1800 - 1945. But 1945, that's the point where the modern changes we still enjoy start to fundamentally alter them: television, telephone, modern media, roads & freeways,... became essential parts of society as a whole, even though those were already established in urban centers by a couple of decades already.
So, we are talking about changes that happen at different speeds depending on where you lived and who'd you talk to.
I think that still rings very much true today. The problems we see today in smaller, rural communities today - unemployment, emigration, downturn - still tie into an evolution that started in the 19th century and still is fully underway. A historian 300 years from now will likely look at our era and interpret that as a continuation rooted in dynamics that originated further in the past.
If I have to make an apt analogy, then the coal mine industry of Appalachia would be a great one. It's a poster child of how an industry first established itself as a front runner and supported entire local communities as it tied into a regional and national economy, and then began a decline as that same larger economy moved on. That's the point where you see a domino / chain effect. As the industry that supported the majority of a community through salaried jobs declined, unemployed inevitably stalls local business for local traders: washers, grocers, bars, woodwork, car repair,... Meanwhile, retail chains survive because of network effects and distribution.
Don't let the title fool you but this video does a great job at showing the impact of that dynamic: https://www.youtube.com/watch?v=EJZmr7E2M_U
If butchers, farmers, book binders and grocers didn't survive, that's mostly because society has fundamentally altered over the past 70 years and moved from communities where close connections and traditions were essential for survival of the community, into groups with a far greater social and geographical mobility.
In a way, it's still possible to open a butcher or book binder business and be successful at it (If you know how to diversify), but your trade wouldn't be essential to the functioning a close knit local community such as it was even 100 years ago.
Thoroughly enjoyed that. Thanks for sharing.
E.g. How companies used to be a crucial part of the local culture. If you know all your customers by name, and your son goes to school with the son of some other customer, you have skin in the game in a way certain companies don't anymore. You're incentivized to do a terrific job.
Not only this, but it baffles my mind that most (high-) schools put (interesting but almost completely irrelevant) subjects such as literature, comparative studies, dead languages etc. above skillsets with massive real-life relevancy such as financial literacy, programming, psychology and leadership.
The world's school system is completely and utterly broken but everyone's just too busy with their own BS to change it. It's heart-breaking.
Some people argue that there are 2nd order effects one needs to take into account, e.g. abolishing grades; what would be the impact on the hiring market, where grades often are a proxy for discipline, work ethic, etc.?
I think Sal Khan was on to something when he hypothesized that we should do homework at school, and the lectures at home. Essentially flipping the model.
Most of these big problems haven't been solved in 1 fell swoop but by many people nibbling on the edges. I suspect this will be no different. In large part due to the inertia of culture.
I think that works better for at least some people. I'm pretty sure that it works worse for some people, too. What it does is change which group is more successful. That might be nice, in promote-equality kind of way, but it isn't necessarily progress.
Actual progress would be figuring out which people do better in which kind of educational approach, and putting each person in the environment where they do best.
Anytime we try to force a sufficiently large group of people into one system, we're bound to create artificial distortions as a result of sanding down the rough parts, i.e. the outliers.
Part of the solution will have to be the offering of multiple paths toward becoming a productive/successful citizen.
There's a second problem here as well, the status quo problem. When a sufficiently high percentage goes through university (and all in the same age bracket as well.), you create a signal that if you don't go through traditional education, you're somehow defective. Thereby, removing the option of choosing a different path because of the stigma (e.g. starting university at 36 instead of 18).
You just have to analyze the data for the long term, not just the short term. If your unsubscribe rate increases, but purchase rate increases more to compensate, that makes sense for the short term but not the long term. Long term, churn is going to cost more and more, since it persists, and you will eventually run out of new subscribers to add. Retention matters more in the long term, and that is not 'art', it is science.
But I can't help but feel like it's cheating a little bit. Because you can call anything rational (including irrationality) in hindsight, provided you simply expand what you deem to be rational post-facto.
For example, increasing price to increase demand would seem irrational and receive a lot of push back in most companies. If you pull it off and it actually works, people can claim it was rational all along.
(This has been my experience with mathematics vs. psychology too. In psychology, people always claim what you say is obvious even though it isn't. Probably because the problems can be stated in plain English. In math, it's the opposite. People find everything incredibly difficult, even though it's super obvious. Probably because mathematical symbols are a little intimidating at first.)
But I get your point of view and I agree. Maybe some day we'll have enough data, or the right kind of models such that we can pretty much always know what the right thing to do is with absolute certainty.
Every other field involving manipulation of people is difficult, because people.
If you want answers, fund and study the brain.
In some weird sense, I feel like mathematics is way easier. I often half-jokingly say that but there's an element of truth in it.
All your definitions are painfully clear. (How often do you see people disagreeing, only to, later on, find out they actually mostly agree but were operating under different definitions.)
You control every single variable. If I want to create a 'lab' to constrain a variable, you just write down 'Let n be an element of Z' or something like that. Tada, now you're only working in Z. Try controlling variables in business haha.
I'm glad to see behavioral economics and psychology are slowly starting to take off more in business.
Thanks for reading btw.
Imagine trying to predict who's going to be relevant on YouTube in 5 years. In my eyes the problem is creators dynamically adjust their content based on their viewers and what other creators are doing. Then the recommendation algorithm introduces randomness. And finally any growth that does happen rapidly compounds. As a result it's a chaotic system and trying to predict it on any longer timeframe becomes impossible. Similar concept applies to modern tech businesses.
I wrote this essay about that specifcally: https://www.younglingfeynman.com/essays/physicsenvy
No connection to the physicist.
Not sure what about the site was "unbearable". It's just text. There weren't any banner ads or taboola chum. I guess I have low standards for what constitutes a decent site.
The writing was a little growth hackery, one weird trick to supercharge your business, with a dusting of math theory. It was definitely an ad, but in the sense of "write compelling content and they will come to your site", as opposed to spray-and-pray low rent banner ads.
How many business domains end in a Nash equilibrium? How many end up with a monopoly or a small number of cartel players? How many businesses really only compete on price? How many try to inflate perceived value with branding and narrative management? What does "invent" mean in the context of a company like PayPal, which essentially just copied and repurposed one part of the banking system?
"Business is hard" has nothing to do with the replication crisis. If your business is succeeding, you're reading the market correctly by definition. If it isn't, there may be other reasons besides not reading the market correctly.
It's hard because the number of failure modes is bigger than the number of success paths. And the success paths are culturally disguised and non-obvious. (E.g. hard work, VC finance and advice, a good company culture, and so on are not a success path. Ferociously trying to monopolise a market while paying your employees as little as you can get away with and producing minimally competent products boosted by PR, ads, branding, and aggressive sales tactics is far more likely to lead to "success.")
What is the point of this article? It's certainly not to offer actionable strategic intelligence.