Confessions of a Serial Entrepreneur: From hot dogs to Rolls Royces: How economics ignites the imagination

 
Richard Farleigh
KIDS just don’t know how to say “thank you”. As a child who grew up in a foster home, I was lucky to have had some wonderful teachers who looked out for me and made getting an education enjoyable. But when I finished high school, I just walked out of the school yard one last time without so much as a “good-bye,” let alone expressing any gratitude.

Years later, I looked back and felt awful; I just hoped my selfishness hadn’t affected my teachers’ enthusiasm and willingness to give time to the pupils who followed me. So I was thrilled when one of my favourite teachers, Peter Rolfe, contacted me on his way through London, and I could treat him to dinner at a good restaurant. It had been over 30 years since I’d seen Peter, and hearing about the rest of his career reminded me that some people have a wonderful ability to just keep giving, no matter what they get back. And I could remind him that it was he who had first ingrained my love of economics.

Whoever said economics is the “dismal science” was wickedly wrong. Economics draws from many fields; it’s like a melting pot for things like psychology, logic, the scientific method, statistics, and mathematics. That’s why it can be so fascinating. This week and next, I want to mention a few that Peter used to ignite my imagination.

“Giffen Goods.” Normally if something goes up in price, people buy less. Giffen goods, however, behave in a strange way. They sell more because they are expensive. The example Peter gave was Rolls Royce cars, a luxury good that gives the buyer prestige as well as a product. And the reverse can be true – when Giffen goods don’t sell despite their low price. I was reminded of this when I tried, but basically failed, to sell high-quality cheap tennis racquets online. People assumed they were rubbish, even though they were every bit as good as the expensive models.

“Hotelier’s theorem.” On a one-mile beach packed with sunbathers, there are two competing hot dog stands. Where’s the best place for them to be positioned? Answer: a quarter of a mile from each end. That way the furthest distance any buyer has to walk is a quarter mile. The trouble is, the sellers will move towards the middle, almost to the point where they are next to each other, and some unlucky sunbathers will have to walk nearly half a mile. The hot dog sellers know that on each side of them there is a “captive market” who have no choice – the competition is even further away.

We see this move to the middle in many walks of life. Areas of competition start out offering a real choice but end up being very similar. Political parties, for example, used to offer a choice between near socialism or elitist capitalism; now they are all basically in the middle, offering market-oriented policies with a social conscience. Consumer products also converge; look at PCs and try to find any real differences. It makes me wonder how similar the iPhone and Samsung Galaxy will be in a few years time.

“Substitution.” When incomes go up, people can buy more sausages, because they can afford to. But they might also buy fewer sausages, if they substitute-in more expensive meats such as steaks. Whether the “income effect” or “substitution effect” dominates will determine whether sausage sales rise or fall.

There was a lot to reminisce with Peter about. More next week.

Richard Farleigh has operated as a business angel for many years, backing more early-stage companies than anyone else in the UK.
www.farleigh.com