The Most Important Lesson I Learned In Business School
The most important lesson I learned In business school is that the best way to maximize profit is to do business in imperfect markets. When markets work perfectly, a zero profit condition occurs where competition pushes profits to zero.
How Markets Fail
The four ways markets fail are:
- Information Assymetry (i.e., see Rothschild example below). When one side of an exchange has more information than other.
- Monopoly/Monopsony (i.e., patents, copyrights, Wal*Mart). When there are many buyers but only one seller (monopoly). When there many sellers, but one buyer (monopsony).
- Network Externalities (i.e., fax machines, telephones). When the more people that use a product/service, the more valuable it becomes or when companies can externalize a cost
- Public Goods (i.e., radio waves, public space). Property of the government that certain companies can use.
Below is an example of information assymetry:
In the early 19th century Rothschild set up a Europe-wide network of messengers and carrier pigeon stations, gathering information that could affect his investments. He soon garnered a reputation for being first with the news. In June 1815, when the Battle of Waterloo was being fought, other speculators watched Rothschild's stocks in an attempt to guess who would win. Shortly after the battle ended, and long before anyone else knew who was the victor, he began selling stocks. Everyone assumed this meant Napoleon had won and Europe was lost. Panic selling ensued. When prices crashed, Rothschild bought everything in sight. [He made his fortune when news came that Napoleon had actually won and the stock market had risen!]. (Wikipedia)
Other examples are:
- Wal-Mart's ability to negotiate low prices from its suppliers because of its buying power (Monopsony).
- An invention being given a patent so nobody else can compete with it for 20 years (Monopoly).
- GE saving money by dumping PCBs into the Hudson River, making the river unfishable to this day. In so doing, it essentially pushed the costs outside of its network and to the local fishing indstustry (Network Externalities).
- Getting access to public goods such as radio waves and television waves (Public Goods).
Each market failure produces its own issue of ethics. In fact, I learned about this concepts from my corporate social responsibility class.
Plan English
All of this is to say, when choosing a career, I really think it is worth searching for the 'right' opportunities, that is market failures. While certain career paths are "hot", that just means you'll have more competition. From my experience, many of the 'real' opportunities in markets are not talked about by the people profiting from them, because they have an incentive to keep quiet and not let other people in.
I'm sure there are many ways to capitalize on market failures, but here are a few that have worked for me in my career:
- Find a mentor in the industry/profession you'd like to enter who trusts you, isn't threatened by you, and who is willing to give you the keys to the castle.
- Be willing to try new things others aren't trying and consequently be an early adopter/innovator.
- Explore opportunities that are uniquely suited to you, but where others have barriers to entry.
Posted at February 15, 2006 07:35 PM
