In the early-1990’s Arthur Andersen Consulting visited our company and put on a small demonstration of the power of the internet. This was at the beginning of the browser era. Netscape had simplified the ability to go online and Yahoo had started its search engine. For demonstration purposes, Arthur Andersen created a search program to find the lowest price for the Top 50 compact discs. Brick and mortar stores and Tower Records, one of my favorite locations for music shopping, were selling the Top 50 CDs for about $14. As I remember we searched online for a 1993 Mariah Carey Album, Music Box, and the search engine came back with prices ranging from $8.95 to $16. CDs are the ultimate commodity; that is, they are uniform, shrink wrapped and need little service (just return the CD for an exact replica if it arrives damaged). The winning bidder on the search was a no-name distributor in Nevada who was cheapest, even including shipping.
The Internet as a Deflationary Force
I had an “Aha!” moment. The internet was the ultimate force of deflation. In economics, price is a function of information. The internet made price information available to everyone simultaneously and in real time. Why would I spend more than $8.95 for the CD? Do I care who sells me this CD? Am I going to need a lot of after care for the CD? Do I care if the seller is in Nevada or India? All I want is the CD at the lowest price.
On the retailing side, the game changed as well. I don’t want a large brick and mortar store, too expensive. How do I win the new retailing game? I need to buy in bulk from the record company to obtain the lowest wholesale price. I need the lowest cost warehouse space, the cheapest packing and shipping and little or no returned merchandise.
If this model works for CDs, it works for all standardized manufactured goods from cars, televisions and home goods to running shoes and clothing. This puts enormous pressure on the entire supply chain to produce the lowest price goods. FedEx and UPS and high speed telecommunications via the internet enable manufacturing and shipping from anywhere in the world. Labor and capital are now squeezed in totally new ways.
This natural evolution of the internet unmasked true price information in services, as well. With the click of a mouse, consumers can now see the real and hidden pricing on everything from travel (Priceline, Travelocity, Expedia) to mortgages (Quicken Loans, Lending Tree) to insurance (IntelliQuote, Insure.com). The consumer can also utilize online professional or customized services such as law, medicine and tax preparation.
Deflation is Inevitable
The Federal Reserve and Treasury’s attempts to offset the deflationary effects of massive credit destruction are sailing straight into the headwinds of the new internet driven deflationary force. Despite the cheerleading on CNBC, many consumers and retailers are suffering their own personal Great Depression. Every consumer dollar counts and consumers now must avoid impulse purchases and become savers. Inevitably, they need to migrate from the pleasant surroundings of the local shopping center to lower cost, no frills internet commerce. Judging by the growth in Amazon sales and the decline in traditional shopping centered retailers’ sales this trend is well under way.
Implications
Do you want to hold a 30 year mortgage on the Mall of America or the Garden State Plaza? Do you want your law or medical practice in an expensive office building in mid-town Manhattan? Do you want to be a pension fund holding signature shopping malls and expensive office space? The specter of declining real estate values and lower profit margins for traditional retailers does not bode well for the equity markets or the chimerical economic recovery.
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