Saturday, April 19, 2008

The Impossibility of Monopoly

Much is frequently written about how horrible so-called "big box" stores are for the American economy. The argument is essentially that these big box stores, with their loss leaders, "unconscionably" low wages and benefits, and huge economies of scale, drive out small businesses and thus reduce competition in the marketplace, effectively creating a monopoly. In the end, the argument goes, consumer choice is eliminated and we are all effectively "slaves" to the big, bad corporations. This in turn, also means lower wages, fewer jobs, and a devastated middle-class (or lower-class).

Ignore for a moment the actual benefits to the economy that result from the lower prices such stores are able to charge. The reality is that as these stores grow larger and larger, and become more dominant, they become less and less able to respond to their local customers' demands. In essence, as Hayek would have been all too happy to point out, they eventually get so large as to run into the same calculation problem as exists in socialism. As a result, markets open up for smaller business to develop again, and the cycle repeats itself.

There was an article on this a few months back in Reason*, available here.

In any event, this morning I saw an example of this phenomenon while shopping for seat cushions for Vienna (Ayn?Constance?)'s rocking chair at Bed Bath and Beyond. This was the first time I had been in BB&B in about a year. If you've been following the market, you'd know that Bed Bath and Beyond now has what is effectively a monopoly in the national bed and bath furnishings/accessories market (the real estate crash essentially destroyed its one national rival, Linens N' Things). Despite this monopoly, its same-store sales have been falling rapidly.

To be sure, Wall Street thinks things will improve for the company in the next year, despite its extremely conservative estimate for 2008 profitability. But what I saw this morning left me convinced that the company has fallen for the socialist fallacy.

Now that the company has an effective monopoly, there are only two ways for it to grow its profits: it can charge a monopoly price (which has its own long-term problems for the company), or it can try to encroach on the business of another, somewhat closely related market. My experience this morning shows that they chose the latter option.

As a result, I found the BB&B chock full of products I never would have found a year or two ago in this particular store: a huge section of personal hygiene products like toothpaste and shampoo, and a huge section of china and glassware for its bridal registry. And, most bizarrely, a pocket version of Guitar Hero.

So what? You ask. After all, aren't they just diversifying their business? Well, yes....except that in this case, that diversification comes at a heavy cost. In order to create the inventory for the china, glassware, and personal hygiene products, they had to remove space for the types of things they're most known for, including, amongst other things: bedding, kitchen gadgets, and, yes, my seat cushions. So, when my wife and I went to look for seat cushions, the only colors available were neutral or extremely dark. Since we were looking for a seat cushion for a baby girl's room that will be a bright green with pink accents, these options were pretty much worthless to us. So we figured we would try to find a simple girlie-colored pillow in the kids' bedding section. Much to our chagrin, though, they no longer had any individual throw pillows available in that section. So, we turned to the adult throw pillow section; again, we struck out, as the only throw pillows were in either neutral or extremely dark colors.

Simply put: in order to expand their market, they were forced to get rid of a lot of their niche products upon which they had built their company, keeping only the most popular of those niche products. This, of course, leaves a huge hole in the marketplace for smaller businesses to fill. Meanwhile, with the introduction of (especially) the personal hygiene products and (less so) the fine china, Bed Bath & Beyond is taking on pharmacies (and grocery stores), as well as high end department stores, respectively. While Bed, Bath & Beyond might be able to compete successfully with department store in the fine china market, it most certainly will not be able to compete with pharmacies and grocery stores in the personal hygiene market. (Not to mention video game stores in the Guitar Hero market).

This means that Bed Bath & Beyond has opened the door for competition in its core market (ie, bedding, kitchen gadgets, seat cushions, etc.) while at the same time jumping into a market where it is highly unlikely to have much success (ie, personal hygiene and, uh, video games).

At least in the US market, Bed Bath & Beyond had essentially reached its maximum profit; in an attempt to increase or maintain that profit, it is taking an unnecessary risk that most marketing majors could tell you is outright idiotic. Within the next five years, I am predicting either a resurgence in small local (but high end) bedding businesses or the emergence of niche bedding internet businesses.

Had Bed Bath & Beyond chosen the other route for maximizing profits (ie, charging monopoly prices), it would have created a host of other problems for itself. By charging a monopoly price, the market would become open for challenges by lower-priced competitors (Target and Wal-Mart, for instance, not to mention entrepreneurs willing to accept a lower profit margin to fill a much-needed niche in the market).

Anyone who has been involved in running a business, especially one that requires maintaining an inventory, understands that you can't make something out of nothing. You can't grow a business without spending something, whether it be effort or money. Unfortunately, there are a lot of times when spending more effort or money is counterproductive. Often this is because the business owner made a bad decision. But the more a business grows, the number of available growth-enhancing decisions decreases, eventually reaching zero. This is why we should not fear the big-box store.

*Totally off-topic, but this month was the first issue of Reason with Matt Welch at the helm of the print edition. I'll admit that I liked the magazine under Nick Gillespie, but this month's issue was easily the best in the last year or so. As always, Radley Balko's article is fantastic, but the article on the Iraq War funding process was relevant in a way that Reason often fails to be. The article on bottom-up power generation by Brian Doherty was both uniquely informative and filled with the free-wheeling joy that I love so much about most forms of libertarianism.

***UPDATE*** I apparently erred in saying that same-store sales for BB&B are dramatically down. The numbers upon which that statement was based were actually overall sales rather than same-store sales (which are slightly down I might add). This does not affect my overall argument, though, which is simply that BB&B's need to continue growing as a business must inherently create openings for smaller niche competitors. In other words: the idea that big box stores will kill small business and create a whole host of other permanent problems ignores economic realities.