A postscript to Goddard on cost competitiveness

Jules Goddard puts not a word wrong in his damnation of cost competitiveness (Market Leader, March 2014). Solid research supports what many of us have long believed. But where does this cost nonsense stem from, and why does it command such credence?

The answer is the priesthood of our times: micro-economists.

They command as much respect today as the druids did two millennia ago and their teachings are just about as valid. A primary tenet of micro-economics is that the quantity sold is inversely proportionate to the price.

That is taught in every British university and is fundamental to the thinking of too many managers and directors, despite all the evidence to the contrary.

Brand leaders, for example, sell the most but, usually, are premium-priced. Another is that increasing market share leads to greater profits. So, following the first tenet, cutting prices below cost will maximise market share, but… The algebra was shown to be wrong long ago but the legend lives on.

In fact, higher perceived quality (and premium pricing is part of that) drives both market share and profit. The correlation was correct but the causality was wrong. Another is that buying decisions are rational, whether consciously or subconsciously.

This single-minded attention to Cartesian logic fails to observe that, as neuroscience has now confirmed, buying decisions are driven by habit, failing that (eg out-of-stocks) by social and other feelings of what seems right – and only failing that too, by reason. We post-rationalise our buying decisions, whether they are individual, corporate or governmental, which gives the illusion of reasoned choice.

The reality is that decisions are made using habit and, maybe, feelings. A fourth and equally invalid tenet is that buyers just seek value for money – the functionality at least cost.

The followers of St Thomas Aquinas understood marketing and consumers better in the 14th century than microeconomists do today. They distinguished three quite different kinds of benefits or values from purchases: virtuositas (function, ie the one micro-economists are fixated by); raritas (scarcity, eg of housing) and complacibilitas (emotion/satisfaction). When the 19th century economists could not make their sums work, they invented ‘utility’ as a vague concept to plug the gaps.

In other words, if the functional value is x but consumers spend y, and y>x, then the difference between the two is ‘utility’, which is invisible but is otherwise a functional benefit like any other. Victorian physicists came up with the equally spurious notion of ‘ether’ as the substance that filled space and permitted the transmission of light and gravity. ‘Utility’ doesn’t explain anything beyond economists justifying themselves. One could continue, but let us stop with the problem of quality.

Economists tend to measure that by price premia relative to similar commodities. Price being due to quality measured by price is circular and hard to justify when two boxes of corn flakes, say, have identical contents but different branding, packaging and pricing.

The truth is that micro-economists are just ignoring raritas and complacibilitas. Economics is a wide umbrella, sheltering geniuses such as Adam Smith, John Maynard Keynes and Friedrich von Hayek on the one hand and micro-economists on the other. They all share the same intellectual high ground, which gives micro-economists so much influence in boardrooms and government offices. They have done more to destroy British industry than any other factor. Burning witches has rather gone out of fashion but we can, and should, burn all micro-economic textbooks.

This article was taken from the June 2014 issue of Market Leader. Browse the archive here.