Are we in a brave new world in which countries with developed financial markets produce nothing, have no physical capital, run permanent trade deficits, and pay for it all with perpetually over-valued financial assets? Yes indeed, according to Charles Gave, Louis Gave, and Anatole Kaletsky, as told in their book Our Brave New World. Austrian economics gives us reason to doubt their case. Permanent economic profits cannot be realized by a model. It takes superior entrepreneurial judgment to apply the right model at the right time. FULL ARTICLE
Source link: http://archive.mises.org/6865/the-myth-of-the-platform-company/
The Myth of the Platform Company
Previous post: Prices are up! Or Down! Depending…
Next post: New from Thomas Woods
{ 21 comments }
Their argument, which I encountered over a year ago in some of financial analyst John Mauldin’s dispatches, essentially boils down to this: We’ll make the lion’s share of the money, while you do the lion’s share of the work, now and forever, amen.
How absurd.
Yet More Tailors Outsourcing Clothes For Emperors
GaveKal is another classic troop of court jesters masquerading as the King’s advisors. But a fools must be parted from their gold somehow.
The problem with selling off your manufacturing and making money on branding is that you lose control of brand quality, which was what made the enterprise valuable. Even if you can maintain quality, you have lost the exclusive marketing control and anyone can undercut your brand. So platform companies will suffer death by decline of quality or rise of competition.
As the article points out, companies that actually do something get better at doing it. Companies that merely market will not improve what they have to offer. A perfect example is IBM selling their notebook computer division to Lenovo. Lenovo is going to get better at making notebooks and building their brand. Eventually no one will care about the IBM brand because IBM doesn’t make the notebooks.
And the Rothbardian thesis that all capital tends toward the same return is absolutely true. We can extend this further–those who produce ultimately tend to be able to consume. Those who do not produce ultimately tend not to get anything to consume.
In the short term, the developed world can take advantage of the developing world, but over time the overlords have to transfer title to the laborers in exchange for the goods. Fiat financing only works for a while. In the end, real property will be demanded as payment for services. The same will be true for China and other nations taking our IOUs at the moment.
A similar wealth transfer process is going to take place with aging baby boomers. The older generation owns and controls the means of production. When they retire and want to be served, they will have to transfer title to those who labor on their behalf. Like it or not, they will have to sell their birthright if they want the mess of pottage.
I love Austrian economics. It makes everyone accountable for their sins.
On average, firms will earn no profits; the profits of some are earned at the expense of losses made by others. The more firms that attempt to earn profits by adopting the platform model, the more competition among platform companies will eliminate those profits.
Yes, but what’s the cost to the firm of not adopting the absolute advantage of the platform model?
Answer: a relative disadvantage? no?
What a great article! Another comment I had is the ability of the companies and/or countries that have these capital intensive operations to pull the organizational and marketing talent from the developed countries and have both pieces, but now located in another country.
There are plenty of smart and well educated individuals in the developed countries who would love to move to one of these countries and offer these benefits to them. Because there isn’t a mass migration of individuals doing this yet those that do can earn great compensation and work in a market where they are highly regarded.
After all some countries such as the U.S. are known for our education so we draw students from all over the world to our schools. I would think someday in the future when the countries that ended up with all the factories have some of the best companies to work for in the world they will draw the management and marketing talent from the platform companies.
If a government makes a place so bad for manufacturing (by taxes, regulations and distorted tort law) that it goes other places, this will eventually lead to very bad consequences.
A large scale population can not live for ever by playing with the fiat money credit bubble (which is what is too often meant by “service industries” – the term does not have to mean this, but it normally does today).
The great mistake that many people make is to think that manufacturing goes to China (and other places) because of low wages and bad conditions.
Yes wages are low and conditions are bad – but the gap between Chinese wages and conditions and those of the West has never been SMALLER.
It is taxes, regualtions (such as union regulations), and distorted legal practices that is driving manufacturing away from the West.
And, yes, where things are made will eventually be the place where the companies that make them are also owned.
A major factor that enables current international economic relations to continue is that the $U.S. remains the world’s reserve currency. This situation increases the demand for the $U.S. above what it otherwise would be, thus enabling America to export some of its inflation. Should the status of the $U.S. as the world’s reserve currency materially change, a significant reorientation of international economic relations would occur.
The late Professor Sennholz has noted that the Euro could eventually challenge the $U.S. as the international reserve currency.
The US should adopt the euro on our terms before it is forced on us.
Why does a person with $10 billion work to get another $2billion? Because the only thing matters is power and money is the score card of power. A company needs power, not capitol.
Firms should put their capital to its most profitable use. By selling its assets, a firm isn’t destroying its capital. It’s transforming that capital from one state (physical property for instance) to another (such as cash). Whether or not this makes sense depends entierly upon the transactions in question.
On average, firms will earn no profits; the profits of some are earned at the expense of losses made by others.
On average, firms and individuals will produce profits. Otherwise we as a civilization would have the same average standard of living we had a few thousand years ago.
But didn’t we (europe) have the same standard of living, or should I say, per capita gnp, for thousands of years, until about the 1750s? If profit doesn’t account for the (conitnuing) rise in gnp, what does — productivity?
Now let me ask a really stupid question about this quotation: “On average, firms will earn no profits; the profits of some are earned at the expense of losses made by others.” How does this work exactly? If I allocate my capital in an investment that yields a profit (a return on capital above the basic rate), how is this a “loss” for another firm? From an opportunity cost standpoint? Maybe I’m confused but how is profit and loss on a macro level a zero sum game? TIA.
But didn’t we (europe) have the same standard of living, or should I say, per capita gnp, for thousands of years, until about the 1750s? If profit doesn’t account for the (conitnuing) rise in gnp, what does — productivity?
I think you may be a bit off if you claim that the 1740s were the same as the 4000s (BC).
Putting that claim aside, the transformation from a slow growth rate in average standard of living to a relatively quick one was, according to Mises, the development of capitalism:
“The characteristic feature of capitalism that distinguishes it from pre-capitalist methods of production was its new principle of marketing. Capitalism is not simply mass production, but mass production to satisfy the needs of the masses.” – Liberty and Property
Kevan: The quote you used was loose talk by the author of the article. What he meant (as he explained earlier in the article) is that business activities that are earning above normal risk-adjusted rates of return will attract other investment capital into the same activities, thereby tending to reduce the activities’ rates of return toward normal. Business activities that earn less than a normal rate of return on investment will see capital leaving such activities, thereby reducing competition and allowing remaining capital to see their rates of return driven up toward normal. Roughly speaking, such dynamics (without capital mobility barriers) see rates of return on average accross all business activities hovering around ‘normal’. At any given moment, some business activities will be earning above normal profits (rates of return) and some below normal profits.
I find it funny that the “Platform” folks claim that the most capital rich citizenry should invest in businesses that have gotten rid of their capital?
All this stuff about manufacturing leaving the Western World for the 3rd World is an expected given the demographic changes going on in the West. The Western population growth is lessening leaving people with lots of capital to invest while these other places have lots of people to work but no capital. And this process is good for both the West and 3rd World.
Now enter government at all levels. They only make the situation worse by regulating, restricting and taxing capital intensive business and literally force these business to either cease or allocate their capital out of the country.
Hi -
A couple of comments on the above discussion:
Mark: “Yes, but what’s the cost to the firm of not adopting the absolute advantage of the platform model?”
I don’t believe that the platform model is an absolute advantage, nor even an advantage. It may work in some cases while in other cases, it might cause the firm to lose what competitive advantage it has through lock-in to its capital structure.
Nelson: “On average, firms and individuals will produce profits. Otherwise we as a civilization would have the same average standard of living we had a few thousand years ago.”
Kevan Huston: “How does this work exactly? If I allocate my capital in an investment that yields a profit (a return on capital above the basic rate), how is this a “loss” for another firm? From an opportunity cost standpoint? Maybe I’m confused but how is profit and loss on a macro level a zero sum game? TIA.”
This may be a question of terminology. Austrians believe that on average all firms will earn a positive ACCOUNTING profit, which is due to the natural rate of interest. Austrians call this component interest rather than profit. Austrians reserve the term “profit” (“loss”) for a return above (below) the rate of interest. It’s just a matter of definitions. As Nelson points out, firms are not all losing money in an absolute sense.
As far as the zero-sum aspect, if you accept that due to arbitrage, the return on investment tends to equal out somewhere, if a firm earns an Austrian-profit, that means either that the factor s it purchased were priced below the equilibrium level (and the firm that sold them left some money on the table, i.e. suffered an Austrian-loss) or their outputs were sold at a higher than equilibrium price, meaning the people who purchased the outputs suffered an Austrian-loss.
Mr Blumen, thanks for this good article!
Though, I would like to say that some Austrians would claim that there is no equilibrium on market. Professor Lachmann would have said that it’s natural for entrepreneurial action to disrupt the existing state of the world.
Professor Kirzner is too much mainstream in his analysis of economic consequences of entrepreneurial action.
It is absurd to think that platform companies would have sustainable high returns. High returns attract competitors and the lack of barriers to entry such aslarge capitalization makes it that much easier for new entrants to enter the market. The net result is to lower returns. Many entrepreneurs want to own the manufacturing and the marketing because being separate, each is at the mercy of the other and the uncertainty that can be created by such a structure. This platform economy is just another gimmick to sell a book but not a real viable business model to be taken seriously by entrepreneurs and business owners and their managers.
Got it. Thank you.
Mr. Blumen,
Why didn’t you approach this article from the perspective that the transformation to a platform company is an instance of “creative destruction?” This seems to make more sense than arguing that a platform company is not sustainable.
Even if the platforming operations are not sustainable over the long term, the investors are not necessarily worse off from this transformation as the freed up capital can be used for other (potentially more profitable) endeavours.
I’ve read Our Brave New World and read Gavekal’s research for six months. After that time, I passed on their very expensive subscription price (over $20,000 per year). While some of their research is interesting, I think they are reaching with the platform company business. Investing is always a business of finding companies that are maximizing the use of their capital. The platform company model is merely a way to increase the return on capital in the short term. That will benefit short term holders of the stock, but is not a long term business plan.
Mr. Blumen:
Just because some enterprise earns economic profits (an above normal return on investment) does not necessarily mean that others must have earned economic losses. Tiger Woods clearly earns an above normal rate of return on his human capital. Who earns below normal rates of return because of this?
A golf course has the perfect location for a given population such that it can garner higher than otherwise golf fees and rate of return on investment. Anyone who golfs there receives an greater benefit than the cost of their fee. Just because they would receive a greater net benefit if they could golf at a lower price doesn’t mean they suffered an economic loss because the golf course earns economic profits. If the golf course with the ideal location did not exist, those who would have golfed at this course would then suffer a loss by having to play at a location and for a fee that in total are less desirable.
Alex MacMillan:
The idea that economic profits and economic losses are zero-sum comes from the middle chapters of Rothbard’s Man, Economy, and State. It’s a bit much to try to condense it to a sentence or two but you can read it on-line at Mises.org.
Regarding golf, there are hundreds of athletes who have spent thousands of hours of their lives trying to master gold to the point where they can make money on the tour. Many of them never made any money, and some of them made negligible amounts, less than they would have made working at some other job.
We can’t exactly calculate this because no one knows what other job they would have taken. And in some cases the person might regard it as worthwhile to have practiced all of that golf instead of working at some other job.
But I’m not sure that Tiger Woods is the best example because there is only one of him. With the work out of the theory, the examples tend to use goods for which there are many so there are identifiable alternative uses.
Regarding the golf course that has the perfect location, whether they earn a greater return than other golf courses or not depends on what their costs are. Over time the land rent would adjust to reflect the value of the revenue that the golf course derives until land rent was bid up to the point where the return of the course ownership was average. If they were able to buy the land at a lower price, the person who sold it to them took an economic loss on the sale of the land.
Comments on this entry are closed.