Sunday, August 23, 2009

A Tale of Two Burgers

The state of California might as well have invented the Hamburger.

In truth, it was probably invented by a half a dozen people simultaneously throughout the Northeast & the Midwest, but let's be honest - the burger isn't just a sandwich... It's a whole experience of Americana. It's not some 1895 food-cart! It's drive-ins, roller skates, milk shakes and roadside diners.

Having lived all over the United States, I have to say... Nobody does that like Los Angeles.

We've got In & Out, Fatburger, Astroburger, Counterburger, Carl's Jr., A&W, and can even claim the very first McDonald's. We've got so many wonderful options out here that it's tempting to think that they just fall from the sky.

But alas, we live in the real world, not magic land where goods & services rain down on us from rainbows. The reality is, we don't have enough hamburgers to feed every single person in the United States (not to mention the whole world) at once. But fortunately, we do seem to have enough for people who want them... But all that gets me thinking, as things of this nature often do.

Why is it that I can saunter away from my house in any direction within 4 blocks and acquire a delicious cheeseburger which is not only of a quality that is quite to my liking and at a cost which is quite easy to bear? And more to the point, why don't certain other industries work that way?

As it turns out, when we apply just a little bit of sound reasoning coupled with a decent foundation in economic thinking - the answers to both questions are quite clear.

So let's start with why there's a seemingly endless supply of burger joints, all of which are accessible, perfectly safe and cater to a wide array of tastes. To do that, let's imagine that you've just opened a brand new burger stand.

(Pink's Hotdogs - about 1 mile from my house on La Brea... This is a small mid-day crowd - no kidding!)

Now that you've opened this burger stand, let's imagine 2 different worlds, based on 2 different sets of governing philosophies.


You make some great burgers, and you managed to find a little corner of the city that has hardly any competition and more than enough enthusiastic patrons to keep you going. In fact, once you've perfected the burger the way your customers like it - they start lining up out the door and down the block (see above).

If you're smart - this phenomenon isn't just an ego-boost, but it also tells you several incredibly valuable things about your business.
  1. People love what you're doing.
  2. So many people love what you're doing, in fact, that you cannot possibly serve all of them in a day - which tells you that you could easily sell even more burgers than you are currently.
  3. Your prices are quite possibly even below the maximum most people are willing to pay.
  4. You need to make more burgers!
These little pieces of information are great for any entrepreneur. They might very likely propel you to take action... Though specifically what actions you take may depend very much on your individual goals, there are a few obvious things you might want to do immediately.

For example: You might expand your existing location, this way you serve your customers more quickly, lines don't get backed up and your productive capacity increases. You might raise your prices - this may lower some of the customer volume, but if your burgers are so great 100s of people are lining the blocks and waiting in long lines just to get them, this seems unlikely. You might even consider simply opening a new location entirely.

Which of these things you do will be up to you, and largely a process of trial and error. If you raise your prices and you lose 100 customers a day, your loss in revenue will tell you quickly that changing the price was a bad choice. So instead of changing your prices, you might try hiring an extra cook and using some of your ample profits to buy a new grill. That in turn reduces your lines and encourages even more customers to show up each day... Your increase in revenue as a result lets you know that that was a good choice.

In either case, however - the great thing about your success is that customer demand and the bold profitability of your business has given you very specific signals to produce more burgers.

But, let's introduce a new player, me, to this little equation... After all, it's not only you who sees the writing on the wall! I am a lover of delicious burgers as well, and I am an investor looking for a new business opportunity to boot. Every day, I drive by your burger joint and see the long lines of hungry people waiting to buy some of what you're selling.

So I think to myself;
"I bet I could convince a few of those hungry souls to come eat my burgers instead!"
I have the money, the time and desire, so I open my very own burger joint just across the street from you. This is a game changer, to be sure... Especially if I do it before you have a chance to open a second location yourself.

Now. I know people love your burgers and merely copying you won't get anyone over to my side of the street - if I'm offering the exact same thing, why go to the new guy when they know how great the original is, right? So in an attempt to differentiate my own hamburger stand I offer some unique changes.

I start by selling my burgers just a few cents less than what you're charging, hoping that the price will entice a few of your customers across the street. Then, I add a few menu options that I know you don't have... I sell milkshakes and onion rings with my burgers when you're still only doing fries & soda. And it with a little luck, it works! I've managed to get some of your customers... and now there are TWO thriving hamburger stands..

More people get fed, more people have more options, there are more jobs available, cheaper burgers and more prosperity for all. Now pass the mustard!

* * * * *
Of course, you say - this is a silly example which we've seen thousands of times. We all already know that inevitably if you see a McDonald's, a Burger King isn't far away. And if not that, then a Jack in the Box, a Wendy's, a Carl's Jr. or an In and Out... Often across the block just like the hypothetical burger joints you and I opened. So why bring it up at all? Who cares?

Well... You should.

The real trick here is to dig a little deeper and realize what all this has meant to the broader economy in the first scenario:

  1. It was success - as defined by profits - that encouraged expansion and production of more hamburgers. The more money people were willing to spend, and the more people lining up each day signaled to both of us (as burger-stand owners/investors) that the demand for burgers was far greater than our current supply. As a result, we responded by boosting our productive abilities; you by hiring more staff and adding on another wing to your restaurant - and me by opening a brand new restaurant just across the street. The net result of course, is that:
  2. The world of Scenario A has more burgers! After you expanded and I opened a new restaurant, there were more burgers available for everyone. Price naturally went down some (we are now competing for people's patronage after all) in response to the increased supply, but more importantly more people are now getting fed more quickly, and much fewer have to wait in line to get their fix. This is the most important aspect to understand for the world at large - outside of these hypothetical situations.
  3. While less vitally important than the giant increase in the supply of available food, by my opening of a restaurant across the street and my desire to siphon off some of your customers by offering something different, people now have greater choices than they had before with just you. This means that more people for whom your burger wasn't quite what they were looking for (but no doubt still delicious), now have another option to get exactly what they want.

And so we continue making profits, we continue expanding our lovely little burger factories until eventually the average consumer will have been somewhat saturated with places to eat. At that point, economists would call this a market equilibrium. Prices come down, quality goes up, more people get served what they want. That's a big 3-way WIN for consumers!

It's also not a bad thing for you and me... In Scenario A, we've both been able to make quite a good living and expand our operations. Even while our respective profit margins have fallen some from the early days (especially yours before you had any competition), we're still making more money than ever before on the volume of our business.

That's the "theory" anyway... And surprise, surprise; the reality (in the field of hamburger joints) is identical. High prices and/or profitability encourages new entries into the market, and that competition results in higher levels of production, better quality & lower cost to the people who are buying the product... In this case, people who love a tasty burger, like me!

In short - and to paraphrase Ludwig von Mises - Consumers are king. (Side note: It's inconceivable that the phrase; "the customer is always right," could have developed outside a market economy... Ponder that one for a bit.)

That said, this reality assumes that transactions are voluntary. You were free to open your stand and sell your products, as was I, and no one was required to buy from either of us. If they didn't like burgers or didn't like our burgers, they were of course free to make other arrangements. People bought our food did so not because we required it, but because they freely chose to do so based on their own enjoyment.

Fortunately, in the restaurant industry in real life - transactions as such ARE voluntary. There are relatively few restrictions (though there are a few of course, like health codes, zoning & such) on who can join the market, so it's easy for me to start my own hamburger stand and compete with yours if I want. There are also no restrictions (that I'm aware of) on which restaurants people might choose to go eat at. That is to say, I've never heard of a situation where anyone was forced to go eat at McDonald's if they didn't want to. No one has been thrown in jail for failing to patronize TGI Fridays...

The voluntary nature of these transactions is crucially important to the signals provided in a market economy though - this way we know that if customers come and patronize our respective restaurants, we can be sure that their preferences are real and meaningful. If they were forced by some individual or some government, individual preference is necessarily being negated - and at that point, who knows what goods people really want? For governments and other criminals of course, the individual preference of the victim is hardly of any concern.

This is not true for many other industries in the real world, however!

As such, let's contemplate another world entirely, but still use the model of the burger-stand...


Imagine an alternate world where you've opened that same, incredibly popular, hamburger stand... But where instead of a free-enterprise system, we suddenly (and after the fact) implement a government-controlled system.

Imagine further that the government decides that it's such a shame not everyone can get your burgers, in fact, it's downright unfair(!) so to rectify this heinous crime against human rights, burgers should be made free to everyone. To have and consume a hamburgers is now an established "human right". Heck, let's even give them the benefit of the doubt and suggest that they were able to legitimately add the Right to a hamburger as a citizen of this city/state/nation as an amendment to the Constitution.

Thus politicians decide that government shall pay for all hamburgers hence-forth - no one should have to go without, and no one should be denied access based on ability to pay.

Of course, implementing a program like this is going to be costly and they definitely want to get their money's worth - the taxpayers will revolt if it seems like the program is just wasting their hard-earned income. So the politicians say the following to you - the only current supplier of hamburgers in your region;
"Because we're going to be the only one paying, and we're going to be buying up your product in bulk... You are going to give us a discount. It's your patriotic duty, and if you don't - we'll find some other maker of hamburgers who will and you won't have any business after that at all. So here's the "deal": We'll only pay 87% of what you were charging before, and in exchange we offer to write a law that makes you the only supplier of hamburgers in your district by law - no one will be allowed to compete with you. You will be the only one we deal with from now on and you'll get all the business you've ever imagined."
Well, as a result of this deal, I - the savvy investor/restaurateur who saw how busy & profitable your place was - have been disallowed from opening a competing stand across the street.

Government managers already have *you* to supply their estimated burger needs. I am now locked out of the picture... At least in your local area. (I might find a similar deal with government in the next town over and establish my own little local monopoly there... Of course, I also realize the deal with the devil you just made and think maybe now's the time for me to retire or consider another, less dangerous business opportunity anyway.)

So what happens next? Now that government has made your burgers free to anyone who wants them, and you're the only possible supplier suddenly your lines have doubled.

Not only that, but people who were once ordering only your standard cheeseburger are now demanding the double cheeseburger deluxe, with chili-fries and a drink. It's free now, so there's no reason for your customers not to get as much as they can on each visit. They no longer have to balance their financial position with their needs and prioritize what's really important to them.

Of course - with no competition, and a seemingly-endless pool of government money from which to draw, it doesn't matter to you all that much. In fact, at first, it's amazing! You have twice the customers you've ever had and by all appearances your business has never been better.

However, you haven't been reimbursed by the Treasury you send the bill over to the government and excitedly wait for the cash to roll in.

Finally (and just 3 weeks late!) the massive check for your services arrives... Only, it isn't quite as massive as you'd expected. Government isn't paying you quite enough per unit to really get ahead. Suddenly you remember that whole 87% rider in your deal. You aren't profiting very much anymore... Now the next time your fryalator breaks down you'll have to cut into your profit margin to pay for it when before you were maintaining a separate fund for repairs. Cutting into your profit margin is fine for now... It just means fewer nights out for you and the family - and maybe putting off that new car another year. Not the end of the world, right?

As things progress though, bigger problems arise. It started out just with you struggling to keep up your repairs and maintenance costs... As a result, you've not been able to really even consider much in the way of actual expansion. Now that your customer base has gone up quite a bit, but you are still just running the one little stand it's bit of a problem that you can't really afford to hire more employees, much less buy more grills for them to use.

As already established in this scenario; remember that I am not legally allowed to build my own place across the street, so my attempts at profit-seeking won't be alleviating any of the pressure of high demand from you. You haven't forgotten though... And so you start to realize that you may be in over your head.

Now, just as all this is coming to a boil, the same government who's beefed up demand and prevented any additional suppliers from joining the market also decide that they need to ensure the safety of the food you're selling, and if you want to offer any new products - a chocolate shake for example - it will need to undergo a rigorous testing process first.

Both you and your suppliers are suddenly faced with a large increase in costs. Now, before you made this deal with the government, if your costs increased, you were able to increase your prices as necessary to make sure that you were able to afford everything you needed to run your business properly, not to mention pay back your investors and actually take a vacation every now and again. But the price you get paid per burger is now fixed by law. You can lobby for an increase of course - but that only costs more money & time hiring lawyers, which may be necessary now but whichonly further cuts into your resources. Unfortunately - your attempts to get your per-unit payment increased fails anyway. You see, the politicians who created this program think it's too new to risk it looking like a mistake, and they certainly can't afford to be seen giving out more of the tax-payer's money... And it would be terribly bad PR if it seemed that you, the benevolent providor of the now-"public good", were seen as a greedy profit-seeker.

So you're out of options. You now make 0% profit on your business, and as a result are no longer able to even make basic repairs and maintain your existing facilities - much less expand to meet the immense demand for your business. Your business is running month-to-month, soon there-after, so are you.

As all this is happening, you've only been able to save costs by buying the lowest grade, cheapest beef & cheese allowable, by reducing the size of each of your burgers and even buying discount bread. Worse, you've fired your chef and instead promoted the 22-year old fry-cook to his position, because he costs you half as much. The once beloved quality of your burgers has been ruined.

Now imagine this situation persists unchanged for a few years. Try as you might, you've never been able to keep up with demand. Even though burgers are free and "everyone" is supposed to be able to get one whenever they want, you are completely incapable of providing as many burgers as everyone wants. So some people will wait in line for hours and hours, and even still some of those get turned away each day. Your machinery is deteriorating, the quality has declined, and your once-proud little hamburger stand has become a laughing-stock of the town.

People who used to say, "Go there if you want the best burgers in the state!", now lament; "Go there if you want to wait in line an hour for a tasteless lump of meat... but hey, it's free!"

* * * * *

Of course, you say - this is all silly too, right?

No government would stop people from opening a competing hamburger stand! And of course, no one thinks that hamburgers are so important to humanity that it should be a basic human "right" to have them whenever you need one for free (paid by the government via taxation).

Naturally... We rightly see them as a luxury item... A juicy double cheeseburger is one of life's great pleasures, assuming you're a carnivore and a Real American. They bring us back to our youth, they remind us of barbecuing outdoors and dad standing over a charcoal grill. For some they even remind us of the halcyon days of 1950's suburbia and cross country road trips with the family. And perhaps if you're ancient enough they might remind you of a World's Fair (or even a county fair at this point). But they aren't a necessity.

Of course not.

And as a result - we let freedom work. We let markets work. And virtually no one who ever wants a burger has to go without. They are abundant, they are cheap, and yet most of them are delicious.

Even better, there's a dozen different price points on which you are free to decide based on your own values, financial situation and needs. Sure you can get the $40.00 Kobe Steak-burger from the fancy steakhouse prepared by a trained chef or the $20.00 one with sides from Applebee's. Or you can get the $12.00 double cheeseburger from the nostalgic 50's dining car all decked out in neon & aluminum with waitresses on roller skates. Or if you don't care for nostalgia and service, but still want a decent meal you've got $5-10 burgers from any number of local joints... And if you just want to stuff your face with something greasy, cheap and tasty - you've got In & Out or one of it's myriad competitors. And if even that is too expensive for you... National chains like Burger King & McDonald's still offer cheeseburgers for $1.00.

But you get to decide.

You have almost endless option, and that lets you balance the hundreds of values going on in your mind whenever you sit down to eat. Are you really hungry? Do you want something that tastes amazing? Do you want great service or to be left alone? Do you have an hour to eat or only a few minutes? What can you afford?

That's such a tiny spectrum of the factors influencing your decisions on a daily basis, and with something as trivial as the hamburger Governments and most people (except the disturbing surge in fat-hating food nannies of course) don't care what you choose. So they don't set up special 3rd-party payer systems. They don't assert some magical "right" to have a burger for free anytime you want, and they certainly don't often limit the number of suppliers allowed to join the market place. As a result... We see the wide array of ubiquitous choices in food everywhere we go. It doesn't matter what city you're in, not only in the United States, but just about anywhere in the world!

But in other industries - health care & education being the prime examples - in which Scenario B is the norm, this is hardly the case! Those resources are getting more scarce, not less - and the demand for them continually increases.

In both Scenario A & B, I used rhetoric to explain the theory... As silly as it seems to center it around burger stands, the truth is - both theories are in play in reality... Just in different industries. In both cases, the theory does describe reality (which is good, as they'd be pretty awful theories if they didn't). It may seem counter intuitive, though I assure you in truth it is not, but the more people use the force of government to provide services - the less available, and poorer quality those services will be.

It is no less ironic, however, that it's only the trivial industries that are left alone and thus which market forces are allowed to work free from much of any coercion - and so provide us with completely adequate supply of just about anything you might never really need. And yet, the things that are so crucially important, like health care and (quality) education are distorted beyond all recognition and wind up being incredibly expensive and inaccessible to much of the population. If government's are going to meddle endlessly in the voluntary affairs of normal people, I often think it would be best just to restrict them to things that don't really matter at all, like burger stands and baseball games.

On that note... It's time for lunch!

No comments: