A tale of two retailers

HMV stands on the brink of extinction with 4,500 jobs at risk. The shop is a fixture of High Streets up and down the country. It will have a sentimental value for many customers who fondly remember their first album purchase. But online retailers like Amazon and iTunes, able to undercut HMV due to lower staff, property, and inventory costs, have eviscerated HMV’s customer base. In 2010 HMV generated sales of over £2 billion. Last year that was down to £932 million.

This is an excellent example of how the market process enables individuals to work to increase the prosperity of society. To the consumer, the CD purchased from HMV for £7 yields no more satisfaction than the same CD which, thanks to a leaner business model made possible by advances in technology, Amazon can sell you for £3.99. The consumer’s enjoyment of the CD is exactly the same but he or she has money left over that they wouldn’t have had if they had bought the CD from HMV. With this they can buy something else they also enjoy, good or service X or Y. Their total utility, to use the jargon, is increased.

This is not the case for everyone. HMV’s creditors and employees will suffer from this. If the credits extended to HMV represent only a small part of a creditor’s portfolio then the losses will be bearable. For the employees, on the other hand, the loss will be more profound – the greater the share of their income comes from their employment with HMV.

This example shows the market process in action very clearly. It also shows how obstacles can arise. 

The utility gains from a new way of providing goods or services can be very large but, spread over society, the gain to each individual can be small (though, of course, if a number of such improvements are taking place at once the cumulative gains to each individual can be large). The losses, however, are concentrated among those who provided the goods or services the old way. 

There is an asymmetry here. If the gain to each individual consumer from buying CDs from Amazon rather than HMV is, say, £50 over a year (more accurately, whatever else could be bought with that £50), but the cost to each HMV employee is £5,000 in lost wages (assuming they believe there are other jobs available but paying £5,000 less) then the employees will be incentivised and concentrated and so could agitate for measures to prevent the market process by which the new method takes their market share. 

We see this in markets the world over. There are the vast subsidies to US farmers (usually big agribusiness who donate generously to political campaigns) which cost the average American family a few hundred dollars a year but form a large chunk of agricultural income. There are the associations of High Street shops who band together to prevent supermarkets opening nearby although, in that case as in others, the balance of lobbying power can lie with the new method.

Whichever side has the most power, entrenched producers or potential market entrants, doesn’t really matter, what is important is that this moves us from the market process to the political process. Producers try to win market share, not by providing a good or service at a price and quality that is more attractive than others, but by shutting others out of the market. As a rights based argument, we have moved from voluntary contracting to coercion.

As a practical argument, the non-market protection of existing producers at the expense of relatively more efficient new producers decreases the welfare of consumers which eventually decreases the welfare of producers too (insofar as they are  also consumers). The history of all human material progress is the history of increasing productivity; of getting the same output from reduced inputs or more output from the same inputs.

If Amazon or iTunes are able to put Bob Dylan on your turntable or Fritz Lang on your screen with fewer resources than HMV can – the buildings, the staff, and everything that went into producing them – then those resources are freed up to produce something else to increase our enjoyment beyond Blonde on Blonde and Metropolis; good or service X or Y.

This is how the market process enables us to live better and better. Joseph Schumpeter called the market process “creative destruction”. HMV was destroyed but Amazon was created.

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12 replies on “A tale of two retailers”
  1. says: Mr Ed

    Reports I have seen put HMV’s debt at around £220,000,000 or around £1,000,000 per store. This begs the question why so much debt was taken on by the company, which appears to have chosen to finance itself in part by taking on debt, which may well have been facilitated by low interest rates and central banking.

    It is almost as if HMV was in business to borrow money, rather than to make it.

    1. says: Robert Sadler

      Keep in mind that “debt” is a relative figure. What does it mean to say a company has £220m in debt? Not much if they have £1bn in cash and their equity is £2bn.

      Debt levels need to be compared to assets and equity before we decide if a company has a risky level of debt.

      I notice that both the banks lending to HMV were themselves bailed out some years ago. This would suggest HMV would have collapsed some years ago if not for the banking bail-out. As such I view this as good news. We are finally reaching the point where malinvestments are being liquidated, apparently at an accelerating rate. Losses will be taken and investment funds can be redirected to their best use.

      1. says: Mr Ed

        Indeed it is, but the financing appears to have been by taking on debt, not by equity. I understood the debt figure to be the liabilities of HMV, and if it had any cash pile, I cannot see why it would have gone into administration, which is presumably a possible means to stuff the creditors.

        That HMV was not liquidated (not to say that administration = liquidation) in, say 2008, is good news late in the long run. Indeed if the zombie companies are finally going, the economy may emerge from the post-boom quagmire of unrealised losses.

        If there were no redundancies, we (the few who actually existed) might almost all be farmers.

        1. says: Robert Sadler

          Understood (about the financing method). I was just pointing out that talking about the debt level without reference to assets/equity at the company doesn’t give us very much information about the riskiness of a company or its probability of bankruptcy.

  2. says: Paul Marks

    Mr Ed – agreed. And a part of the story totally ingored by the media (and by the leftist activists).

    The conflict is, in part, a classic “Public Choice” battle between a concentrated interest (HMV and its employees) and a wide spread interest (the public).

    As the article explains – a few people with a concentrated interest have a bigger incentive to campaign politically, than a lot of people with a small (small each) interest. That is why such things as farm subsidies exist.

    However, there is also an unholy alliance between these commercially interested people and leftist (collectivist) activists – and it goes back a long way.

    Standard Oil (in the late 19th and early 20th century) did not cheat customers – on the contrary it offered them better quality products at lower prices. Yet there was a massive campaign of disinformation (i.e. LIES and SMEARS) against Standard Oil in the press and in books (the media of the day). Pushing for “Anti Trust” (what British people would call “Competition Policy”) government interventionism. Many of these lies and smears against Standard Oil remain in school and college text books to this day – due to the iron grip the left has on the education system.

    Part of this was the commerical interest of the competitors of Standard Oil – but that was not all of it. Allied with such interests were professional lefist activists – who hated “big business” ON PRINCIPLE and would tell any lie (and take part in any action) in order to undermine “big business”.

    At the heart of the “anti Amazon” campaign are the same sort of hard core leftist activists.

  3. The market should find the most efficient solution, yes, as long as efficiency is measured in money, and catastophes are externalised as ‘one off’ events. What we need is not ever greater efficiency, but a balance between efficiency and resilience. Resilience means building some slack into the system and adopting a variety of tactics. Then there would be less catastrophes and more ways of recovering from them.
    We also need to junk the assumption that more efficient markets are in any way associated to our wellbeing.

    1. says: Robert Sadler

      Matthew, you seem to be proposing government intervention here. I would suggest that the catastrophes are the result of prior government actions.

      If you want slack in the system, the best way is to get the government out of the economy. “Efficiency” in the market means yes, inefficient projects will be liquidated but it also means the process of finding another job will be more efficient.

  4. says: Paul Marks

    Mr Slater – “building resilience” means having reserves for bad times.

    HMV did the exact opposite – as Mr Ed shows.

    If a company piles on debt with nothing really to show for the debt it has piled on, it is going to go bankrupt.

    The only way that could be prevented is by CORPORATE WELFARE (in either regulations or subsdies) from the government.

    As for “junk the assumption that more effcient marktts are in any way associated to our wellbeing”.

    On the contrary, our well being is TOTTALLY DEPENDENT on markets being allowed to operate efficiently.

    If you have not already done so, I suggest you read Henry Hazlitt’s “Economics In One Lesson”.

  5. says: Paul Marks

    Yes Mr Sadler.

    Government intervention causes a mess, so the statists call for more government intervention – which causes an even bigger mess.

    A classic example is the boom and busts of the late 19th and early 20th centuries – caused by the expansion of credit money (i.e. the lending out of “money” that was never really saved) and the inevitable crash after such a boom.

    The National Banking Acts in the United States worked against market limitations on such activities – for example it was actually ILEGAL to “discount” the debt paper of the big New York “National Banks”.

    And, even before the Civil War, corrupt courts (such as New York court in, in memory serves, 1854) were declaring that banks did not have to honour cash-on-demand (gold) contracts i.e. would not be declared insolvant if they did not (thus greatly pushing credit money expansion).

    A problem was recongised – it was inpossible not to see the problem in the face of vast crashes. Yet the “solution” was worse than the sickness.

    The “solution” was, of course, the Federal Reserve system – which encouraged even MORE monetrary expansion (by standing behind the banks and backing them).

    The demented Benjamin Strong “boom” of the late 1920s and the (equally, if not more, demented) Alan Greenspan “boom” of recent times, are the result of this thinking – and even now the government stands behind such entities a the Federal Reserve, Fannie Mae, Freddie Mac (and on and on). All of which rest on the central fallacy that more money can be lent out than was ever really saved.

    “But we want to be free of thrift – of the gloomy curse that one must work before one can spend”.

    People can indeed defy basic economics (such as Say’s law), but they are only “free” in the sense that such a person is also free to throw themselves off a cliff.

    They are free to do it – but they are NOT free to escape the consequences.

    Bust must follow “boom”.

    And government intervention simply makes the problem worse – not better.

    Even today with an entirely fiat (government whim) monetary and financial system, and with government spending (in most Western nations) at close to 50% of the economy, and the rest of the economy saturated by thousands of pages of regulations that distort and twist everything they touch….. I have still heard people talk of the “failure of the free market” or even “the failure of lassire faire”.

    The collectivists are never satisfied – even in a state dominated society like this one, they still want MORE statism.

  6. says: Paul Marks

    On the point of the debts of HMV.

    Remember they sold Waterstones some time ago – so this debt was only backed by the assets of their own (HMV) shops.

    No other major assets – and certainly no mountain of cash.

    As for the liquidation of malinvestments…….

    Alas Mr Sadler!

    Most of the credit money has gone into to propping up property prices.

    Indeed the government is STILL pumping in money to keep up property prices (and, at the same time, compaining of the high cost of houses and flats – both to buy and to rent).

    Only when such prices CRASH will it be a sign that true “liquidation of the malinvestments” is occuring.

    1. says: Robert Sadler

      But there is a silver lining here Mr. Marks. When something cannot go on, it has a tendancy to stop! :-)

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