Thursday, August 3, 2023

Creating Artificial Scarcity

Scarcity raises prices in a free market.  One way to raise prices is to create scarcity.

The pandemic was an eye-opener for American businesses - or indeed, businesses worldwide.  All it took was a rumor of shortage to create a panic, and resultant panic-buying and hoarding.

I noted early on at the start of the pandemic we were at an isolated campground in a remote part of Florida (yes, Florida still has remote parts!) and when we hit the "big city" and went to Wal-Mart, people were acting crazy, buying huge packages of toilet paper - piling them high in their grocery carts.  People were hollering and shouting.  A Wal-Mart employee bought out a pallet of bottled water and the customers stripped it bare in a matter of minutes, like hungry piranha fish.

It made no sense to me - what were these people going to do?  Go home, stay hydrated, and shit their guts out?  Why were they fixated on these two particular staples?  There was no rumor or indication that tap water was in any way "contaminated" by the virus.  I am sure scholars will be studying this event for years, (and already are, no doubt) as an example of mob behavior.

Of course, the joke was on the hoarders.  Once the "shortage" was over, the grocery stores put up signs saying, "we do not take returns on toilet paper and bottled water."  And you can guess why - some Karen had a garage full of the stuff, convinced she was going to "win" at this game.  The increase in price of these items also meant Karen would make a profit if she returned them for store credit.  So now Karen is stuck with a lifetime supply of toilet paper - no doubt damp and moldy in her basement.  Serves her right!

The problem with panic-buying and hoarding behavior is that is only shows a short, one-time profit for the manufacturer.  Once everyone has a hoard of toilet paper, they will stop buying.  So sales will actually plummet at that point, if our economic models are any good.  But of course, with a "shortage" you can raise prices - that is part of Adam Smith's "invisible hand" of the marketplace.  Higher prices will (in theory) force consumers to find alternative products and use existing products more efficiently -  and encourage entrepreneurs to enter the business, thus increasing supply and lowering prices.

In theory. In reality it doesn't always work that way.  For bottled water, there are plenty of other choices.  You can drink tap water, which in most places is perfectly safe (boil it, if you are that concerned).  Or use a Brita filter - we found a Brita Pitcher in the "free to a good home" bin at the campground (along with a bread machine and a cappuccino maker!).  Toilet paper?  Well, other than using your hands, a washcloth, or an old Sears catalog (or a corn cob, as they used to do in the outhouse) there are not many other products out there that were not already in short supply (napkins, paper towels).  And since Georgia-Pacific owns half the State of Georgia (and apparently Washington and Oregon as well) it is not like someone is going to buy up several thousands acres of pine forest and built a pulp plant overnight.  We have one in our town. It isn't a matter of just grinding up a few logs!

So there are barriers to entry or "moats" as Warren Buffett likes to call them.  This is why we have anti-Trust laws - so that there is more than one competitor in every marketplace.  Lately, it seems, we have devolved into monopolies, near-monopolies, or duopolies (acting in concert with one another) to limit competition and set prices.  And I think most of these companies didn't realize - until the pandemic - that they had such market powers to set prices and reap huge profits, until "supply chain" issues forced them to realize this.

One after another, every staple in America went through this "shortage" nonsense.  Cars and trucks were in short supply as assembly lines ground to a halt.  Flour and sugar disappeared from the grocery store shelves for a time.  Frozen fried potatoes shot up in price for no apparent reason.  The latest gag in this story is the lowly potato chip - going from a buck or two for a bag to a whopping six dollars, again, for no apparent reason.

What got me started thinking about this is a campground we are staying at.  It is nice and all and there is a lake nearby where we went kayaking twice.  We are going on an historic train ride later today and a 25-mile bike ride on a "rails to trails" path. Fun stuff.  But it is near the greater metro areas of New York, Philadelphia, and Washington, DC, so there are a lot of people (with a lot of money) who want to stay here.  I logged onto their reservation site back in March, when it "opened" for reservations.  The site opened at 12 Noon, and by 12:05, I could not get a reservation at all.

I managed to book five nights in one site, one night in an "overflow lot" (a field) and then six nights in another site.  No problem, but who was booking the entire campground for the entire season within minutes of the site going live?

It turns out it is the same problem we ran into a few years ago in the Adirondacks.  Any park within a two-hour drive of New York City was booked solid at $25 a night.  But many sites were empty nevertheless as wealthy New Yorkers would make reservations for a weekend and not even bother to cancel them if it turned out to be rainy or they changed their mind.  Even more mind-boggling was the trash problem created by wealthy New Yorkers who bought all brand-new camping gear and then just left it behind when they left, as it was wet or damp and they couldn't be bothered packing it up.  And we're talking expensive REI stuff, too!

Turns out at the campground we are at, the same problem exists.  People literally abandon tents and gear at their site - they don't even bother to take the tents down!  One resident rescues these, along with "shade tents" (broken or otherwise) and makes necessary repairs (if needed) and donates them to Boy Scouts or sells them and donates the money to charity.  The idea of just throwing away camping gear after one use is just alien to me.

I talked with some people who worked here, as well as other campers and residents, and found out that many people from the Big City go online at 12 Noon exactly and reserve blocks of weeks, sometimes for multiple sites.  No wonder the place sells out so quickly.  We could not get the site we are in this week for last week as some idiot reserved it and then never used it.  They actually have a Facebook page dedicated to re-selling these reservations.  You are not allowed (in theory) to "scalp" the sites and make a profit, but since the owners of the campground allow this and do not monitor it, there is no way to police this.

The site we are now in was finally occupied at the end of last week by a guy who only wanted it for three days.  He paid for the full week, plus the $15 reservation transfer fee.  It made no sense to us at all.  What was weirder is that when you asked the front desk whether there were any cancellations, they never even looked at the computer but instead said, "No, all full!" and suggested we check out the Facebook page where people re-sell reservations.

How weird!

In a way, it is like how farmers sell crop futures and investors buy them.  The farmer, before he even plants his corn, has a fixed price per bushel he will get when he harvests it.  He is incentivized to harvest as much as possible.  If the market is flat when harvest time comes around, he is not penalized by the drop in prices as he has a guaranteed buy-out price.   On the other hand, the investor who buys the option can make a lot of money if the price of corn doubles between now and harvest time.  The farmer ameliorates risk this way - hedges his bet - by using futures markets to stabilize his business.

For the campground, selling out in March means they have a lot less hassles making reservations during the year.  If people want to re-sell or buy an existing reservation, that is not their problem, and in fact, they make $15 every time someone does.   By selling out they also create artificial scarcity. Word gets around that the place sells out quickly, and thus people covet more the opportunity to come here.  And let's face it - you have to sell the sizzle to get people to leave their comfy loft apartments in SoHo to go out into the woods in shower in an open shed amid the dirt and bugs and dust and gravel.  If they looked at it that way, no one would come.

It is the same effect as the velvet rope at the hip nightclub.  The fact people are lined up to get in makes it seem like what they are selling is desirable.  What they are selling is a $20 cover charge for the privilege to buy watered-down drinks and dance on a sticky floor under blinding flashing lights listening to music at (literally) deafening sound levels.  If you looked at it that way, no one would ever come.

Creating artificial scarcity increases demand, particularly if people don't perceive there to be any alternatives or no one jumps in to fill the void. But someone has. We leave Friday for a new campground not far down the road, even closer to New York City, that is trying to tap into the same demographic of young, hip, urban youth.  The owners of the present campground are not pleased.  How can you sell the sizzle when there is more than one sizzle?  You can't.

Of course, one way to maintain scarcity is to maintain exclusivity.  While you could have opened up a "Studio 55" next door to "Studio 54" back in the 1970s, unless the "in" crowd went there, you'd go bust.  People would perceive you were doing a "me too!" move and it wouldn't sell.

And I guess that is another weird aspect of scarcity - selling scarcity as a feature.  Every car maker has "Limited Edition" and "Special Edition" models that they will claim are exclusive and in limited supply.  People covet what they cannot have and when you obtain the coveted item, you want everyone else to know you scored.  So the de-luxe model of the '52 Chevy has a chrome spear on the side of the fender with the word "Deluxe" on it - just so you can rub in the face of your poor neighbors who could only afford the "Standard" model!  They will never know the obscene luxury of having door arm rests and sun visors on both sides and a dome light that turns on when you open the driver's door!  Such luxury!

And so profitable, too.  Because these few trinkets cost little in terms of materials and labor, but add much to the sales price. You can easily double the price of a vehicle with "options" and option packages as well as trim levels.  Yes, you are selling hardware and features, but you are also selling the prestige of having the limited or special edition that only the few (million) are privileged to.

Of course, this artificial scarcity game is short-lived. Companies are showing record profits based on these artificial shortages - and are creating artificial inflation at the same time.   But eventually people notice that potato chips cost more than a meal and they start to cut back on spending.  The one-time profits disappear, but the money from them stays in the bank.

We are already seeing inflation subside and I suspect we will see prices actually drop this time next year.  As people run out of credit and money to spend, we could be right back in 2008, if we are not already there (recall back then there was also a "labor shortage" and "record profits" right before the fall).

Just in time for the 2024 election, too.  Funny how that works!