Chapter 4: Fixing the market

By its nature, buying and selling is an interaction that takes place between two participants. Because most of us get involved in this activity when we go shopping, there is a tendency to differentiate these two roles, visualising the buyer as an individual customer, and the seller as a larger organisation such as a shop or a retail chain. However most of us are also aware that the shop is just one of the links in a ‘supply chain’ that can stretch across the world.

Take, for example, the mouthwash Listerine, one of the many thousands of products that you can buy at your local supermarket. Listerine is essentially a mixture of eucalyptus oil, alcohol and a sweetener called Sorbitol. According to an analysis carried out in 1999 (Kalakota & Robinson, 1999), the eucalyptus oil comes from trees grown in Australia from where they are packed and transported to a distributor in New Jersey. The alcohol is extracted by Union Carbide (now part of The Dow Chemical Company) from natural gas drilled in Saudi Arabia, while farmers in America’s mid-west grow the corn from which Sorbitol is made.

These ingredients are shipped to the Warner Lambert factory in Texas where the Listerine is made, bottled and boxed. The boxes are then transported either to wholesalers or direct to the warehouses of the larger retail chains, from where they are transported to chemist shops, supermarkets and other outlets. Getting that bottle of mouthwash to the shop where you or I might buy it involves a supply chain that encompassed three countries, numerous farmers, an oil company, a processing plant, plus various shipping and transport companies, wholesalers and retailers.

And this is only part of the picture because of course there are supply chains delivering the bottles that contain the Listerine, the tractors and other machinery that the farmers use to grow and harvest the eucalyptus, the ships and lorries in which the various ingredients are transported, and so on. Furthermore, those farmers in Australia are not only growing eucalyptus to make Listerine, but also to supply manufacturers of decongestants, deodorisers, insect repellents and various foodstuffs. For the natural gas supplier in Saudi Arabia, Listerine is only a small part of its market. Far more important is its supply for the generation of power, the production of ammonia for fertilizers and the manufacture of plastics, paint and many other products.

So the picture of the free market that we painted in Chapter 1 is misleading in a number of respects. For a start, the distinction between buyer and seller is far from clear cut. The reality is a mesh in which all involved are both buyers and sellers. The farmer growing eucalyptus in Australia may buy Listerine to keep his breathe fresh. The customer walking in to his local chemist may purchase a bottle of Listerine using money he earns as an employee of Union Carbide, which in turn is both purchasing natural gas from Saudi Arabia and selling alcohol to Warner Lambert.

Secondly, the majority of the transactions involved take place not within a free market but within large companies that are organised internally in a manner more reminiscent of the socialist dictatorships discussed in the previous chapter. At the time of the analysis, Union Carbide employed nearly 12,000 people at its manufacturing facilities, laboratories and offices across the world (Union Carbide Corporation, 1999). Within such companies, personnel are organised into a hierarchical bureaucracy headed by a chairman or president who presides over a board of directors. Reporting to the board are the division heads or vice-presidents, and so on down to the managers, the supervisors and finally the workers themselves. Activities are planned, procedures are in place and performance monitored against pre-defined targets. As Andrew Gamble put it recently: “Companies appear as little islands of socialism in the market sea.” (Gamble, 2004)

Furthermore, the transactions that do occur within the market are rarely determined solely by price. Trust and reputation are also important. A customer is more likely to buy from a greengrocer where the fruit and vegetables have proved consistently fresh and tasty, even if the price is a little higher. Conversely, he is unlikely to return to a greengrocer that has sold him stale or poor quality goods, even if it lowers its prices in an effort to entice him back. In other words reputation, good or bad, reduces the customer’s sensitivity to price.

This is why manufacturers are so concerned with branding. The ingredients that make up two shampoos, one branded and the other not, may be identical. However the trust that the customer has in the brand, built up as a result of previous experience with the product, allows its manufacturer to charge that little bit more.

This is particularly the case in the business world, where the outcome of many transactions is determined not only by the reputations of the parties involved, but also by the cost of actually conducting the transaction in the first place. As we saw in Chapter 2, the transaction costs involved in negotiating the reliable provision of raw materials or services vital to the operation of a business can be very high, which means repetition is to be avoided if at all possible. Once a reliable supplier is found, it may well make more sense to negotiate an on-going contract, so securing future supply, than to go through the costly business of re-negotiating with someone new, and risk being let down. Indeed many larger companies maintain a list of authorised suppliers, and employees are only allowed to use someone not on the list after a lengthy process of discovery.

Looked at in this way, a company can be seen as the crystallisation of a set of market transactions, or as D. H. Robertson put it nearly 80 years ago, “…islands of conscious power in this ocean of unconscious co-operation like lumps of butter coagulating in a pail of buttermilk.” (Robertson, 1930, p. 85) Perhaps the best example of this process is provided by its employees. Initially, a company may offer work on a piecemeal basis, negotiating a one-off fee for a particular job. Once the job is finished the agreement comes to an end and the relationship is terminated. This is a low-risk option as the company only has an obligation to the worker while it has work that needs to be done. On the other hand, if the worker proves particularly skilled, or fits in particularly well with the company ethos, there is the risk that he won’t be available next time a job comes up. This would mean going through the whole recruitment process again, which is both costly and time-consuming. Instead, the company can offer the worker a contract of employment. This is the more risky option, particularly in countries where the obligations of the employer are relatively stringent and reinforced by law, but on the other hand a well-trained and loyal workforce can give a company a decisive competitive edge.

Exactly which transactions become crystallised in this manner depends on a number of factors such as the importance of the product or service to the business; the regularity with which it is required; the reputation of the supplier; and the transaction costs involved in negotiating its supply. A publishing company, for example, may have negotiated long-term contracts with its more successful authors, and is likely to include a number of editors and designers on its payroll; but its basic stationary requirements can be met on a much less formal basis as there is little to distinguish one biro or paperclip from another, and plenty of suppliers to choose from. This is how companies grow, until eventually they are swallowing their competitors, suppliers and customers whole through mergers and takeovers.

Limiting liability →