So the holidays are behind us and if you were left disappointed by what you found under
your Christmas tree it might be because you weren’t in the spirit of things, or it might
have been because Santa couldn’t get any stock of anything.
The good little consumers of the world might have started to notice an increasingly common
trend where more and more products sell out the day they are released, or are never available
at all to ordinary consumers.
Everything from playstations, switches, Xboxes and graphics cards, to lego sets, handbags,
watches, and even toilet paper, it seems more and more like we are living in a world that
is out of stock.
But why?
Stock shortages from time to time happen, that’s just general supply chain management
but why has this become such a consistent issue.
All of these products are made by businesses with a profit motive, and those profits don’t
get made unless products get sold, so what gives?
Now I know what you might be thinking, “urr it’s the virus of course” and certainly
this has thrown a spanner into the works of global supply chains but it’s not the whole
story.
Limited supply is one thing, but if traditional economics is to be believed, businesses don’t
let themselves run out of stock, instead they just raise prices to match demand and maximise
their profits.
What’s more, is that the coronavirus is not exactly new news to companies. If they
were caught out in early 2020 then fair enough, but almost a year later you would think the
corporate executives responsible for multi-billion dollar product launches could account for
this new global paradigm, right?
But they haven’t, and you might ask why?
Well to understand this we as always need to look at a few key things.
How have global supply chains been affected, beyond just blaming everything on covid?
Are the companies involved actually making poor business decisions?
And why aren’t these products just doing what supply and demand would tell them to
do
and increase in price?
Intro Add
Now
of course it’s not the whole story, but it
would be foolish to assume that the fallout of the coronavirus has not had an impact on
the availability of products, but it might not be in the ways you would imagine.
Yes these days we are extremely reliant on global supply chains and yes these systems
have become far more complicated and difficult to manage with various restrictions popping
up and being eased every week in a very unpredictable way.
What’s more is that most of the products that are experiencing these shortages are
very complex and draw components from a vast array of suppliers in an equally vast array
of countries.
Even if one nation closes down factories or restricts shipping or does anything to halt
supply that means new products can’t be manufactured.
Now we can actually graph out the chance of a final product not been made with a really
simple function. The chance of supply being halted is equal to the inverse of the chance
of a components supplier being shut down, to the power of how many suppliers there are.
Even if we assume the chance of a factory getting shut down in a given month is extremely
low, let’s say 1% then this causes issues.
For simple products this is not a problem, but something like an iphone draws materials
and components from 43 countries, so using this little model there is a 35% chance that
this supply chain will be shut down in any given month.
If we look at it like this it’s honestly a miracle that manufacturing has managed to
stay as consistent as it has.
Of course, there are contingencies in place, and most modern supply chains have supply
buffers built into them, but with the world, like it is now the chance of a factory needing
to be shut down at some point in this process is incredibly high, much more so than we allowed
for in our simple little model here.
Now breath a sigh of relief because the maths is over, and so too is directing all the blame
at supply chains because of course there was the other side to this whole deal which was
demand.
One thing that has not been talked about a lot in recent months is that household incomes
have not really decreased.
This might come as a surprise to a lot of people that have been following the news of
record job losses and people hanging on by a thread until the next stimulus check comes
through, but total employee compensation has only fallen by 0.5 percent.
Now this statistic is for the US but it is a similar story for alot of countries, in
Australia for example total household compensation has actually gone up, and why?
Well that all has to do with the types of jobs that were lost, they were mostly customer-facing
low-income roles, whereas traditional white-collar workers have more or less sailed through unscathed
and top executives are being handsomely rewarded for guiding their companies through times
of economic turbulence.
If we take an extreme example like Elon Musks’ theoretical 55 billion dollar performance
bonus well then more than 1 million average Americans could lose their jobs entirely without
total household incomes being impacted. And when it is remembered that the people that
are loosing there jobs tend to be on the lower end of the pay scale than just this one pay
packed really does skew this statistic.
But the thing is, all of the products that we have been looking at so far are indeed
luxuries. $2,000 graphics cards tend to go in $5,000 computers and that’s just not
something that would ever be considered by the types of people that are unfortunately
being displaced from work, regardless of the global situation.
Of course things like toilet paper are just plain essentials but we will get to that later.
Video game consoles are a bit hit and miss, certainly they are affordable for average
workers but they tend to cater to younger demographics with fewer financial responsibilities
and maybe more of a propensity to put that stimulus check towards something a little
bit irresponsible.
This segues us nicely onto the second factor of demand, the various government stimulus
efforts from around the world.
Something like a $1,200 check could be a huge releif to a struggling family, but to a lot
of average households with no children and very few overheads it’s just some extra
cash that can be thrown towards buying a new toy.
There have also been less obvious boost to demand beyond just giving people money. Here
in Australia for example in an attempt to get businesses to spend more money the government
introduced the instant asset writeoff deduction.
Normally when a business buys an asset like a car or a machine or a computer it has to
set up a depreciation schedule. So let’s say an office spends $10,000 on chairs that
they predict will last 5 years then they would be allowed to deduct $2,000 per year in depreciation
expenses that the business will then not need to pay tax on.
The government’s new scheme allowed businesses to deduct the entire purchase price instantly
which meant any planned purchases were going to get done this financial year.
It may not sound like a big contributor, but I know I got my new editing PC this year for
exactly that reason.
Similar systems around the world have all had similar effects. Increasing demand…
if you increase demand and then pair that with a reduction in supply you get a very
predictable outcome, increased prices.
The market finds a new equilibrium at a higher price and only those that value the goods
enough to make a transaction at that new price get the goods.
It’s unfortunate for the people who are no longer willing or able to spend $800 on
a playstation or $3,000 on a graphics card or $40,000 on a rolex but that’s just economics,
it’s not necessarily less sad then someone no longer being willing or able to spend $400,000
on a Ferrari all other things being equal.
Businesses maximize their profits by selling all of their available stock at the highest
price point they can get, but the thing is they haven’t been?
In fact a lot of the marketing involved in these new products is how they are twice as
good as their predecessors at a fraction of the cost which just adds to the confusion.
Why would companies offer something better and cheaper when their customers are willing
to pay at least what the old price was? Why are they
Forgoing profits
To avoid confusion from here on out we are going to just be looking at 2 specific products
on the opposite end of the needs vs want spectrum. A roll of toilet paper, and the new RTX 3080
from Nvidia, which for the people that don’t know is an expensive computer chip that lets
your PC play games very well.
So there are two external forces making the market for these two items behave in ways
that we wouldn’t normally expect. Sticky pricing, and price gouging laws.
You see any time we draw market diagrams we make alot of assumptions about the world to
make it easy to work with but in reality, these lines are a lot fuzzier for a host of
reasons.
So sticky pricing is probably the biggest factor at play here, when Nvidia announced
their new graphics cards they couldn’t be totally sure of the demand that would exist
for them, remember the world was in a crazy place during the months leading up to the
release of this product.
Job losses could have got worse, the availability of complementary goods could have been a problem,
as in people aren’t going to buy that fancy new graphics card if they can’t buy any
of the other components that go into a shiny new gaming PC, and of course there were question
marks around competitor products from AMD as well.
With the benefit of hindsight, Nvidia could have announced prices 50% higher than what
they did and probably still sold out, but if household demand didn’t remain as strong
as it did, or AMD released a competitor card that way significantly better then they would
be stuck with an overpriced pile of computer chips nobody wants to buy.
Now you might ask, nowadays they know that isn’t going to be a problem, why don’t
they just raise prices now. Well now the issue is that the company has already spent tens
of millions of dollars on advertising and marketing on this new product at this price
point.
Announcing a new price point would involve going back and producing new marketing materials,
and negotiating new contracts with their development partners who were planning on selling products
at the given price.
This would also not go over well with the general public who were promised a new product
at an impressive price point.
In fact most of the hype surrounding this launch was about how cheap these products
were compared to the older lineup they were replacing, if you are getting similar price
to performance after a market guided price bump then most of this hype would fade pretty
quickly while also making consumers cranky at you for profiteering off shortages.
So yeah once prices are announced, they are hard to change, especially for big-ticket
items, they stick in place.
This leads us on to anti price gouging laws, which are technically part of what makes prices
sticky but does deserve to be mentioned separately.
In most advanced economies around the world, there are laws in place to prevent retailers
from raising the price of essentials during emergency situations.
Nobody want’s to see a gas station charging $100 for bottled water in the aftermath of
a hurricane so rules are in place to prevent this, seem fair enough right? Well yeah sortof..
Add
most economists agree that anti-price gouging laws are indeed necessary but that they are
kind of a form of necessary evil.
You see what this effectively makes is a price ceiling, above which prices are forbidden
to increase. The spike in demand that comes from these events means people desperately
try to buy up as much as they possibly can to makes sure their family is accommodated
for, but with no price measure in place this causes hoarding as people buy up everything
they possibly can, sometimes out of fear, sometimes out of greed and sometimes both.
However, if these laws weren’t in place then something like toilet paper would naturally
rise to a price level of let’s say $50 a packet, which might give these would-be hoarders
pause before they load 20 packets into their trolleys. Which means that there would be
enough left for everybody. Even if it was at a higher price.
A potential solution to this problem that didn’t involve raising prices was either
to arbitrarily limit the number of products and individual could purchase, or make the
sale of 1 item the regular price, but the sale of 2 or more and extremely high price.
Unfortunately, both of these strategies clash with similar consumer protection laws in a
lot of countries and states in the US, and even in places where they are legal they don’t
actually solve the underlying issue.
Now regular channel viewers may be able to see where this is going. These regulations
are effectively creating market failures where equilibrium cannot be achieved. Demand outpaces
supply at this price level and products inevitably go out of stock, this accelerates the problem
because cunning individuals see this as an opportunity profit.
Scalpers will buy up the limited supply and sell the products back to regular consumers
that missed out at inflated prices.
We have addressed this issue a few times on the channel, most notably in our video on
black market economics but the same thing that holds true for totally illegal items
that want to be sold at a fair price also holds true for legal items that want to be
sold at an illegal price.
So let us know what you think, would you be happy to pay the market-determined price if
it meant stock was always available? Or would you boycot buying a new product if the price
was increased far beyond what their press releases would have you believe? It really
is a very divisive issue with no perfect answer, unfortunately.
The good news is that you can purchase the other type of stock easily.
With acorns.