Wednesday, February 22, 2017

Big Box Stores

Here is a paper Nathan Conroy and I will be presenting at the Eastern Economic Association conference this week.

16 comments:

  1. I was curious why your model leads to an outcome contrary to what one would predict market forces alone would lead to using standard Austrian economic theory.

    If I understand it correctly:

    - The model leads to total spending being distributed between M and B
    - M and B are both price takers (I think?)
    - If the volume of sales is below costs they lose money and this reduces their cash balances
    - If their cash balance falls below zero they exit the market.

    The key variables therefore appear to be the relative preference to shop at M versus B and the initial cash endowments. For a given combination of preferences between M and B, if M is given a sufficiently large cash endowment over B it will prevail and not B.

    (I hope haven't over-simplified and missed other important factors)

    I think if one introduced some other stuff into the model that is assumed in standard economic thinking about this kind of problem (such as the ability of M and B to set prices and to attract outside investment) the outcome would change. If consumers prefer M over B even during the "volume war" stage their margins would be better (if they can set prices?) and this would mean it would be irrational for B to run sown its cash reserves , and rational for other investors to back M, and these 2 things combines would lead to the "normal" market outcome.

    BTW: I did like the model and it might be the catalysts that finally makes me take a look at python.

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    1. "I was curious why your model leads to an outcome contrary to what one would predict market forces alone would lead to using standard Austrian economic theory."

      It does not to a contrary outcome. The model is right in the code, for all to see, and contains ONLY:
      1) market forces; and
      2) standard (Austrian? not sure why you put that in) economic theory.

      So what we have shown is that is what we *should* expect, given standard economic theory.

      Thanks for your kind words on the model.

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    2. What constitutes a "market force"? I have the vague idea of "supply and demand", but that isn't satisfactory. Is property law part of it?

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  2. My specific concern was the assumption that as B has a bigger initial endowment than M it will be able to withstand losses for longer and prevail even though consumers prefer M over B.

    If (in a variation of your model) one looks as M and B as businesses seeking to attract investment funds based on expected profitability then (if consumers prefer M over B) a business plan that involves backers of B building a sufficiently large cash fund to drive M out of business will ultimately fail as M (having the competitive edge because they have a product consumers prefer at a given price and therefor greater expected profitability) will be able to thwart these plans. I would argue this variation would be amore realistic version.


    Also: Your model (I think) assumes high fixed costs and low (or zero) variable costs while total sales in stay constant. Is that correct ?

    If so then as the model plays out individual surviving M and B increase their sales as the total number of businesses decreases. Eventually the model reaches an equilibrium where all remaining businesses are likely to remain profitable (sales are greater than rent). Is there a reason (beyond the way the parameter values are chosen) why this equilibrium would not be a combination of M and B rather than always being either all M or all B ?

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    1. rob, having a product people prefer more in general does not make you profitable! Hamburgers are not "more profitable" than veggie burgers, at least not because more people like them. That is an extremely non-Austrian understanding of profit ya got there, son.

      In fact, in equilibrium, exactly 0 products are profitable. (See Mises on the ERE, Human Action.)

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  3. You list three choices for the preference ordering. But doesn't that leave out a key factor? I think it does. I am quite happy with that ordering, providing the monetary impact is zero. Otherwise I deny it is my, or anyone's actual preference order. Here for example is my preference ordering for a certain setting of another parameter

    1. Just box stores and I keep $5000
    2. Box and local stores and I keep $2
    3. Just local stores and I keep $3

    Here it is with different values for that odd parameter
    1. Both stores and I keep $4000
    2. Just locals and I keep $300
    3. Just boxes and I keep $1

    More orderings are possible. Hence it is wrong to say I, or anyone, has a unique preference as in the start of the article.

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    1. But we always take these things ceteris paribus. Cause otherwise, we'd have to add:
      1) Both stores and the Mafia kill my children
      2) Just locals and I'm forced to house Keanu Reeves
      3) Just boxes and I can do nothing but answer blog comments.
      Etc. etc. etc.

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    2. But we are just assuming *at the current prices, whatever they happen to be* these are the comsumer's preferences. What we show is that the small stores can go out of business even if consumers prefer to do 70 or 80% of their shopping in them.

      I'll let you know if any economists object to this aspect of our model this weekend.

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    3. Well price and money are pretty clearly instrumental variables in any model of shopping though right, whereas Keanu Reeves probably isn't.

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    4. Ken based on your comment I added:

      "(We can further assume they know the costs of achieving 1, 2, or 3: they want 1 even if they sometimes pay higher prices to achieve it compared to 3, i.e., we could add a monthly shopping bill to each of the above.)"

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  4. well, I decided to install python and Indra and it was quite easy to get it to work.

    I'm just getting my head around Indra but I can see its quite a powerful tool.

    Having said that, I still suspect the BigBox model is stacking the deck in favor of BigBox dominance - but need to dig deeper on that.

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    1. Just to be clear, rob, we're not trying to prove that big boxes are always evil, or anything like that: we're just showing a theoretical possibility!

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  5. Having spent some time playing with the model I came back to my original concern. Why would a rational investor use some of their resources investing in gaining market share for what is (based on your assumptions) a regressive technology?

    I conclude its a regressive technology based on the statement that consumers prefer M-only to B-only. I take this to mean that if one takes all the resources that were initially invested in M and invest them instead in B (or B+other stuff) then consumers gain greater utility from M-only to the alternative. This is another way of saying that moving investment from M to B reduces productivity. Less output (measured in utility) is produced for the same inputs. Is that reasonable interpretation ? If not, what does it mean that consumers prefer M-only to B-only ?

    While I suppose it fine that its an assumption in your model that this is what investors in B do, I am not convinced that a business model based on
    1) promoting a lower productivity model
    2) having large start up costs as more productive competitors are driven out of business
    3) even when they have succeeded in the initial phase of the plan may find it hard to compete with sectors other than than M who are more productive
    is going to find many takers in the real economy.


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    1. You are literally hallucinating Rob. The model You are looking at does not contain technology, let alone regressive technology, nor does it contain investors or startup costs.

      I think you're laboring under the miss apprehensions that the goal of bottles is to be "realistic", and that they are made better by including more factors of reality. So since you think these factors are to be included, you have simply hallucinated them into the model.

      Realism in a model as first of all impossible, because it ceases to be a model and just is the reality it is supposed to model. Moreover, trying for realism is to be distracted from what models actually can achieve in pursuit of a Chimera. The virtues of model should strive for our simplicity, comprehensibility, and manipulability.

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    2. "The model You are looking at does not contain technology, let alone regressive technology, nor does it contain investors or startup costs. "

      Taking these things one-at-a-time:

      technology: I think all new business processes and entities such as the introduction of things such as new retail outlets can be reasonably described as "new technology". Your whole model is explicitly about this.

      regressive technology: The new retail outlets by your assumptions lead to lower utility. I explain clearly in my comment why this means (in my opinion) that the box-stores are "regressive technology".

      Investors: What would you call the retailers in your model who start-up the box-stores ?

      start-up costs: Your model largely depends upon the retailers who start up the box-stores having sufficient large endowments to withstand initial losses. I cannot think of what to call them apart from start-up costs.

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    3. I am at a loss for words. It is like talking to someone who says my model is missing cat food. When I respond Ha? The person says "well if you don't have cat food, all the cats will die !"

      " what cats? "

      "Well you have to have cats, because what else is holding down the mouse population? "

      "Mouse population?"

      " there are food stores in the model! If you don't have cats, they will be completely filled with mice!"

      The person clearly has no idea what a model is, and there just isn't anything more to say.

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Why is it "irrational"...

to not want to work with someone who smells bad? I have the unfortunate job of telling someone whom I am mentoring that when they return ...