Chocolate and Gold Coins

Thursday, April 14, 2005

Magic in the Marketplace

Here is a link to the Forbes top 400 Americans. Here is a trick someone just taught me: just right click on the link and choose the “open in a new window” option. Now make the window small enough so you can continue reading this. Isn’t that cool, I’m glad I learn this.

Now looking at the list and seeing the many Waltons, Coxes, and Mars, it is clear that choosing your parents wisely is still the easiest way to become super-wealthy. Consider the Walton Family. Collectively they are worth nearly $100 billion – twice as wealthy as the Gates Family or the Buffet Family. Their wealth comes from Sam Walton, founder of Wal-Mart. Wal-Mart is a perfect example of what I call business magic: somehow they take the same workers and buy from the same wholesalers as other retailers, but their prices are lower. Like a magician’s trick, you see it happen but you can’t figure out how they did it.

The key to wealth is having a magic technology. Technology, in the sense that I’m using the word, is any means that you might use to take inputs (labor, capital) and turn it into a finished product or service that customers will buy. McDonald’s might be considered low-tech, but in reality that have sophisticated technology since it isn’t so easy to take high-school students and transform them into a force that produces a consistent quality product. Likewise, Wal-Mart is a very sophisticated technology. There are lots of people who would like to know how they do it.

Technology comes in two types: clone-able and magic. Clone-able technology can be duplicated by anyone simply be observing the end product. A chocolate-dipped frozen banana is clone-able. A really big paper clip is a clone-able. You don’t make any money from going into business by trying to create a new market with a clone-able technology. If you want to make money, you must have a magic technology – a technology that no one can figure out how you are doing it.

Looking at the list of wealthy Americans again, it is interesting to note who made the big money making computers: Michael Dell of Dell Computer. In the early 1980’s, you would have thought that IBM and Apple would make the big money. Well, they did okay for a while, but Dell, which wasn’t even around in the early 1980’s, took over in the late 1990s. I remember seeing one of the first Dell computers displayed in the late 1980’s in Austin Texas and thinking this computer is a piece of junk and the company will go under soon. I wish I had thought, “This guy is brilliant, I’ve got to buy Dell stock!”

What makes Dell special is nothing you can observe by looking at their product. Their “magic” is the ability to take your order, manufacture the computer to your specifications, and deliver it to your door in a week. That’s magic. It isn’t easy to clone that.

The IBM computer was the ultimate example the problem of having clone-able technology. Once the clones came in the market, it was all over for IBM. They thought their magic was their name, their network of service technicians, and a patent. Well, computers become obsolete before the break down, and as is often the case, the patent only proved to be a temporary obstacle. As for the name: “IBM compatible” worked wonders for Compaq and Dell.

The biggest mistake an entrepreneur can make is to try to open a new market with a technology that is clone-able. You do all the hard work (and use up a lot of money) doing market research for somebody else. You need to wonder, “Why did no one think of doing this before?” Maybe someone did, but they did not think there was a good market for the product, or if there were, then 10 other competitors would jump in a steal the market away. Think of the Sunshine Biscuit Company that invented the classic cream-filled cookie we call the “Oreo” cookie. You guessed it: Nabisco stole its cookie recipe and made a fortune off of someone else’s hard earned market research.

I read about a lady who lost a lot of money trying to market an oversized paperclip that had several patents on it. It was made of special steel so it wouldn’t deform. But it was too easy to clone. The patent didn’t help because the clone was made out of ordinary steel and did deform, but was made in China for one-twentieth the cost.

I saw on television once about a man who tried to market chocolate-covered frozen banana pieces. He did a lot of work trying to market his product. Then he tried to sell his company to a major company. He showed them all of the nice data he had collected showing how there was a profitable market for his product. In the category of “You need to have a good lawyer when you negotiate with a big company,” the company did not buy his company but just put it out of business by cloning his product.

There are some products that look extremely clone-able but haven’t been (yet). One example is Turbo-Tax. How can Intuit sell that for $50 apiece when all it does is calculate taxes? They cannot have a patent on that. Couldn’t any software company produce a clone for one or two million dollars and sell millions of copies for $2 apiece?

On the other hand, there are several products that haven’t been developed that many people want but manufactures are not brave enough to try to market. A good example is the self-cleaning toilet. There is definitely a market for it. Definitely, many companies could produce a workable prototype of a self-cleaning toilet. But if there is no magic associated with the technology, everyone will sit back, wait for the first entrant to do the hard marketing work of creating a market, and then a dozen clones will swoop in to take over the market.

Is there a market failure here? I am somewhat conflicted about this. It is clear the market prefers firms to cut costs than to create new products because cost savings go directly to the owners of the firm but new product releases create benefits to competitors who learn about the new market for free. On the other hand, if the entrepreneur is clever, he can often tie a clone-able technology with a magic technology and avoid being destroyed by the clones. For example, everyone thought Barnes and Noble would destroy Amazon when the on-line bookseller business took off. Selling books on-line looked very clone-able. But Amazon invented the best technology for processing credit card purchases. And they were able to develop software that magically knows what books you might like to buy from seeing your previous purchases. The moral of the story is that is can be really good to be the first to the market if able to spot opportunities to create some magic.

Nevertheless, I don’t think anyone will come out with a self-cleaning toilet in the next 10 years. A patent won’t protect anybody and there is little magic to be found in a toilet. Here’s one way to create the magic: we hold a contest for the best design for a self-cleaning toilet. The winner gets exclusive right to market self-cleaning toilets of any kind in the U.S. for 17 years. It probably won’t be the best technology after 17 years but, as it stands now, the only technology we will otherwise have is the do-it-yourself variety.

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