Wednesday, July 9, 2014

"Principle, Price, or Creative Destruction?"

                                     Sydney M. Williams

Thought of the Day
“Principle, Price, or Creative Destruction?”
July 9, 2014

Years ago, probably in the mid to late 1950s, Grand Union opened a grocery store on the outskirts of Peterborough, New Hampshire, thereby ringing the death knell for the two or three small, independent grocery stores in the village. It was my first experience with Joseph Schumpeter’s dictum of creative destruction. For a few months, my mother hung to her principles and refused to enter what she called, the “grand onion.” But eventually, lower prices and dwindling products on the shelves of the financially-strapped independents forced her to change.

What prompted this subject was an article in the business section of Monday’s New York Times, headlined, “Principles Are No Match for Europe’s Love of U.S. Titans.” The article discusses how tech behemoths, like Amazon, Google and Facebook create a love-hate relationship, with consumers. Many feel principled when independent stores are placed in jeopardy or by the perceived ill-treatment by “Big-box” companies of warehouse employees. But for Guillaume Rosquin of Lyon, in the Times article, a $200 savings on a Blackberry was enough to put his “issues with working conditions aside.” Seven of the ten most visited websites in Europe are operated by American companies. Google has an 85% market share for search in Europe, compared to 65% in the U.S. Facebook, the target of several investigations for its tax practices in Europe, continues to add users – now numbering 150 million Europeans, or roughly one in three.

Amazon is the most visited website in Europe and the world. In June, they had a total of 282.2 million visitors, 35% of which were Americans and 31.8% were Europeans. Twenty years ago, the company did not exist. Principle versus price/convenience is an issue with which we all struggle. But it is also “creative destruction” that is at work. I have a brother who owns what some people claim is the best independent bookstore in the United States, the Toadstool in Peterborough, NH. In full disclosure, I own one share, or four percent of the business. Yet, on a Sunday morning, reading the New York Times book review section, I often – shamelessly – log onto Amazon.

Creative and aspirant individuals have always led innovation. When they live within a democratic capitalistic society they thrive. It is no surprise that American companies dominate web-based businesses in Europe rather than European, because America’s culture has allowed and encouraged the creative forces to be unleashed that provide for a dynamic society. However, a natural consequence of unleashing the creative spirit is inequality in terms of outcomes. For those who are bright, creative and aspirant will do best. However consumers benefit as well. Two principal benefits of creative destruction are reduced prices and greater availability of goods and services.

In business, as in life, time doesn’t stand still. In an interesting front page article in Tuesday’s Wall Street Journal, “Wal-Mart Looks to Grow by Getting Smaller,” the reporter Shelly Banjo writes of the new CEO, Doug McMillon, “…the problems of the past are forcing him headlong into the future.” Besides admiring the syntax of her sentence, the point Ms. Banjo makes is a good one: no matter one’s past successes, future success depends upon adapting to constantly changing circumstances. Wal-Mart, the world’s largest retailer with half a trillion dollars in revenues, is at risk because of companies like Amazon and dollar store chains, just as they (Wal-Mart) forced out of business, in its time, thousands of smaller department stores. So they must innovate. Conventional wisdom says that internet-based technology, like on-line shopping, is the future for retailing. Certainly it has been. In twenty years, Amazon has grown to become a $68 billion business, while Wal-Mart’s online sales are now $10 billion. But it is interesting that Mr. McMillon is experimenting with smaller, 10,000 to 40,000 square foot, stores – becoming a more integral part of the community, perhaps combining both principle and price? Perhaps recognizing that some consumers like to be coddled? As Mr. McMillon says, they must experiment.

The health of an economy, and in fact of a nation, can be measured by its friendliness toward innovation and is manifested in the number of business startups. I have been accused of spending too much time harping on the inhibiting nature of too much government, whether it is in excessive regulation, redistribution or in a tax code that penalizes investment and wealth creation. And I admit to that accusation. Inequality is a fact of life in capitalist societies, as intelligence, aspiration, creativity and diligence get rewarded. But, inequality is also a fact of life in socialist and authoritarian societies. Wealth in those societies accrues to those in government and their favored business cronies. The difference is that in democratic, capitalist societies innovation lifts the tide on which consumers float, raising everyone’s standard of living. Poverty in America today is very different than it was when I was young, a fact that often gets lost amid the heated political rhetoric in Washington.

The vast majority of Americans are employed in mid and large businesses, those employing more than 1500 workers. Yet, according to a study done by the Small Business Administration (SBA), businesses with fewer than 20 employees were responsible for 97% of all new jobs between 1988 and 2004. One of the more disturbing recent trends in the United States has been the decline – albeit modest – in the number of new start-ups. Besides, regulation and taxes, the two reasons most often mentioned are an excess of student loans and a paucity of visas for skilled workers. A Kaufman Foundation study noted that of the engineering and tech companies founded between 2006 and 2012, 24.3% had at least one founder who was foreign-born. As Adam Smith taught us many years ago, successful capitalist societies grow, at least in part, because people act in their own self interest. It is always been fascinating, when looking at villages, to note that people naturally fill roles that are needed – a lawyer, a pharmacist, a miller, a doctor, a green grocer and a cobbler. No government official told the village fathers what was needed. When a need appeared, someone arrived to satisfy the demand. This happened absent any government bureaucrats telling one man he should be a baker and another, a farmer. Entrepreneurs, like nature, abhor vacuums.  

The principle versus price conundrum is one we face every day, in different aspects of our lives. It has a lot to do with the ever-changing nature of commerce – of entrepreneurs discovering new ways to bring old products to market, and of discovering new products that render old ones worthless. It is the dynamism of a healthy society. Peter Drucker once wrote: “The entrepreneur upsets and disorganizes …his task is ‘creative disruption.’” While the Kindle threatens independent bookstores like my brother’s, he and other survivors like him innovate and fight back. The winner is the consumer, because he is every businessman’s ultimate customer. It is no surprise that four of the five largest companies by market capitalization today did not exist when I entered the brokerage business forty-seven years ago.       

Nevertheless, I still prefer to use local merchants in Old Lyme, versus big-box stores, and I admit to feeling good about what I have done – supporting someone I know, or at least someone with whom I am acquainted. We all want to live comfortably, and we love the idea of permanence. But to live is to be in constant motion. To stop is to die. We live in a world where price, convenience and even availability impact our purchase decisions. If my wife and I need to buy something that involves laying out a large sum at the hardware store, my wife whisks me to Home Depot, or to one of the warehouse clubs, BJ’s or Costco. I feel sorry for the local proprietor, but then she points out what we saved, and I recognize the necessity of adaption and understand that the owner of the local store must as well.

What gives me confidence for the future is the sense that the principles of innovation and entrepreneurship and the creative, but necessary, destruction they bring, are alive and well. I hope they remain so. Businesses better serve their customers under the threat of competition. Sad would be the day, were we to let concepts of equality and fairness, and politics of redistribution become so doctrinaire they overwhelm and inhibit our natural inclination to create, improve and grow. A nation that is rich serves all of its people far better than one that is poor.

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