The Cheat of Structural Profits

Companies and industries enjoying protected profits stifle innovation and take your money. Can you recognize these parasites all around you?

Links: FIOS; DirectTV; Comcast; RCN; Verizon; Microsoft; Ticketmaster; RIAA; MPAA

Generally, business models develop like so:

  • Uber Inc. invents Widget A. Widget A is the first of its kind and/or does something unique
  • To bring Widget A to market, Uber Inc. spends money on research, development, etc.
  • Uber Inc generally tries to patent or otherwise protect their investment in Widget A
  • Uber Inc. starts sells Widget A at a very high profit margin (a high retail price), meaning Uber Inc. makes a lot of money on each widget sold. They can do this because there is nothing like Widget A on the market; people are willing to pay for it because it provides a needed solution. Uber Inc. makes lots of money.
  • Over time, Uber Inc. starts to drop the price of Widget A. They have a known brand, but they are starting to get some competition.
  • Over more time, Uber Inc. really shaves the price down, still making money, but now they have to compete for each customer on value, because many other companies are selling things that perform like Widget A, some at a lower price.
  • At this point, the Widget A market is relatively mature, with nobody making really high profit margins, but good solid competition with a range of choices for consumers.

Now, this isn’t meant to be an economics lesson, and the above is highly simplified, but for our purposes it suffices.

Most people in a capitalist economy can look around themselves and recognize the above progression in every day objects. TV’s, radios, cars, DVD’s, shoes, you name it and you can find at least an echo of the above progression.

This description of a business model is meant to show that no business gets a guaranteed high profit margin forever; competition and choice combine to put downward pressure on a company’s profit margin.

Except when they don’t.

I use the term Structural Profits to describe a business model that has a built-in profit margin, where external forces are prevented from squeezing profit margin downward. Some of the industries we interact with on a day-to-day basis have managed to get themselves into the position of having Structural Profits. You can bet they are happy. You and I, not so much.

For Example:

Health Insurance
In the health insurance industry, several elements conspire to keep profits high. A solid geographical monopoly allows one or two insurers to dominate any given region (60%+ of all coverage). Then, the disconnect between the knowledge the doctor has vs. the patient means patients can make little meaningful judgment about the worth of tests and treatments. Finally, fixed-price co-pays and byzantine billing mean consumers aren’t often even aware of the true cost of care.

Cable Industry
Cable operators enjoy a large monopolistic advantage, since they are generally ceded territory by government agencies. The advent of DirectTV has helped a bit, as has the recent FIOS product, but let’s be fair: DirectTV, Comcast, RCN, and Verizon have more in common with each other than you. And again, because of bundling, consumers have no true idea of the cost of a particular channel, of VOIP, of internet bandwidth.

A Few more:

  • Wireless - monopoly, barrier to entry for competition is astronomical
  • Microsoft in the 90′s – software “tieing”, predatory bundling
  • High Finance/Wall Street – government protection, asymmetric marketplace
  • Ticketmaster – near-total monopoly on event ticket sales

I could go on and on, and so could you.

In certain industries, you can make an argument that protections are in the public interest. Certainly we like having firefighters, ambulance drivers, and telephones.

But it is a sad state of affairs when industries have a protected guarantee to large profits.

In fact, no industry fights against innovation as hard as an industry with built-in high profit margins. Witness the RIAA and MPAA’s fight against digital distribution, the health insurance industry’s fight in Washington against any sort of reform, and the cell phone industry’s contortions regarding the high cost of wireless service in the U.S.

Anywhere you find an industry or business model with Structural Profits, you can be sure to find a barrier to innovation. Look around and see how many such industries you can spot.

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