Market Mechanism 2

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This is in addition to the previous post on the market mechanism. Briefly, it’s the idea that competition erodes the value captured by the producer.

Barry Ritholtz asked Morgan Housel about what he wished he knew when he started. Housel responded, “One thing that sticks out is that good investing is not about being good at something but you have to find something that other people are bad at. The fact that you are good at modeling does not necessarily make a difference because a lot of people are good at that.”

This, said Fredrik DeBoer, is part of the myth of college. One way to avoid the squeeze of the market mechanism is to have a rare skill. In Housel’s words, to be good at something other people are bad at. People are compensated by what they know, proxied by a degree, then a graduate degree. More degrees more (proxied) competition.

Success is found, said Hamilton Helmer, in the durable. “If you do something better, the question is, ‘How can this be durable?’ There has to be something that prevents others from taking all of that away from you.” How can you avoid the market mechanism creating a commodity?

It probably will happen too. Rufus Peabody said about gambling: “I used to bet second halves in college and professional football. That used to drive my yearly earnings, it was an ATM machine basically. But the last three years I’ve basically broke even there and may not continue running the models because the inefficiencies that were there are no longer there.”

Profits attract competition, competition drives profits and prices down. The market mechanism is Santa for the consumer and saboteur to the producer.

There’s one way to avoid the market mechanism; attract less competition.

Movies, wine, investing, and sports all offer financial and psychic income. That’s a double dose of the market mechanism once someone sniffs out the potential rewards. A cooler choice might be digging pools.

What’s next to a cash register?

coffee lifestyle starbucks coffee shop
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Tyler Cowen is one of the most interesting and insightful thinkers sharing their wisdom today (and for the past decade-plus!). One of his ideas highlighted in our Twenty-Minute-Read on Cowen is to think of incentives and solving for the equilibrium.

To think like an economist, like Tyler Cowen, we should consider how things work within a market. Tim Ferriss asks Cowen what advice he would put up on a billboard? Tyler responds in an interesting, and quite different way, from what many of Tim’s other guests suggest.

Normally, this question tends to lead to something inspirational or tactical, something grand or granular. There’s also a bit of personal signaling in the answers where after an hour or so of talking to Tim, guests want to step off on the right foot.

Cowen flips the question and wonders: what works on billboards. Casinos advertise on billboards. So do lawyers and radio stations. Auto dealers advertise on the radio, which you listen to in your car, and notice how nice a new car might be. Cowen doesn’t answer Ferriss because there’s not a connection between that medium and his message, and mediums matter.

The same effect came up in the college admissions scandal book, Unacceptable. After dropping off kids, “moms in workout gear might pop into a local coffee shop, where the area near the straws and napkins was blanketed with ads for test prep services and tutoring companies.” If a college tutor, guide, or private counselor wanted to find upper-middle-class clients where better than a coffee shop?

Markets are dangerous for entrepreneurs because they lead to competition. However, markets are instructive for economists, or people who want to think like them, because they lead to understanding. During his lunch with the FT, Cowen said that he looks for Ethiopian restaurants located near other Ethiopian restaurants because “competition works.”

The biggest lesson from the short piece on Cowen is to think that through. Who is getting coffee at this kind of place at this time of day?

Zach Lowe and Kevin Arnovitz

Supported by Greenhaven Road Capital, finding value off the beaten path.

There are few basketball commenters more thoughtful than Zach Lowe and Kevin Arnovitz and they paired up for an episode of ‘most interesting’ NBA teams. We’ve looked at one of their conversations from 2017 that asked, ‘What if Jeff Bezos were a GM?

Making predictions is difficult when we extrapolate linearly. Lowe said, “With (Celtics’s) Brown and Tatum we do this thing where we expect linear development and it doesn’t happen and then we get down on them and one of those guys is going to pop this year.”

The same reason people get down on athletes for bad years is the same reason Jason Blum is in business. Blum says that he likes directors with good past movies despite their last. This is Blum’s version of Moneyball, he explained:

“My Moneyball approach is that this guy writes and directs Saw for $800,000. He does two movies for fifteen and twenty million dollars that aren’t good. He can’t get hired. He birthed Saw, a cultural phenom and he can’t get a job. My Moneyball approach is instead of looking at the sexy statistics to look at the work.”

People over-index on recent and optimistic data instead of the more accurate base rates. In his conversations with Lowe, Sam Hinkie explained this idea.

Metrics only matter if we measure the right stuff. Why, for example, Arnovitz wonders, do the Portland Trailblazers exceed their projected win total each year? Why is some data down on them this year? “What is it that these metrics are seeing about the Portland Trailblazers that I’m not seeing?… I still see a hyper-competent team that understands how to orchestrate a hundred possessions a game of offensive basketball.”

What the metrics might be missing is the culture.

The Patriots don’t measure sacks as much as they measure pocket size. Kawhi Leonard didn’t interview well before the draft, should that matter? Only the first four-thousand of your ten-thousand daily steps make big strides.

In much the same way we make predictions using the first (and easy) things that come to mind we tend to measure the first (and easy) things. Baseball’s Moneyball began with walks but teams don’t rely on those numbers anymore.

Numbers are ‘cut and dry’ but the world they describe is anything but.

Market mechanisms set prices, and evaporate good deals. Lowe said, “Someone asked me what I’d pay for DeMar DeRozan’s contract extension and that’s not a fair question for me because he will immediately reach a market value that I would never pay.”

Investors like to ‘fish’ by themselves and venture capitalists love to visit college campuses to talk to students. Fewer people means less bidding.

‘Peak Uber’ was in 2012, before they had to compete with Lyft. Moneyball was published in 2003 and now those same advantages don’t work.

Lowe and Arnovitz are thoughtful and these first three points demonstrate the holistic mindset required. It’s never just one thing. The Celtics had to make wise predictions, measure the right things, and avoid the market to trade down to draft Tatum.

Alpha erosion is the cousin to market mechanisms. Once a rival is familiar with your advantage they’ll work to reduce it. Lowe said, “Last year the sheer speed of how they (the Sacramento Kings) caught a lot of teams off-guard. Everybody knows that’s coming this year.”

Both Annie Duke and Nate Silver rode the poker wave before it got too competitive. Daryl Morey annually complains to Bill Simmons that their draft board looks more similar to the draft order. Venture capitalists pile into companies once they see something that works. It’s just the name of the game.

 

Thanks for reading.