First we reported on the demise of Blockbuster, then the bankruptcy of Borders. Prior to those, Sam the Record Man and A&B Sound closed their doors. Yesterday, the Financial Post published an article claiming that HMV would be closing their Canadian stores.
All of these stores had one thing in common; they sold products from physical locations (bricks and mortar) that were easily digitized and delivered electronically over the web. Perhaps because of long term leasing agreements, they did not react fast enough to competition from such vendors as Amazon and the Apple Store. Revenues fell, but costs did not. Losses led to more debt, revenues did not recover. Business plans were changed many years too late and the inevitable happened.
There are other companies that will face similar challenges in the next few years. Any company that relies on selling entertainment products that are, or can be delivered in electronic format will disappear. It is far less expensive for consumers to shop online than it is to go to a store in person. With the pending releases of new and improved tablet computers, expect to see more books being delivered online.
We’ll go out on a limb here and make some bold predictions. Chapters/Indigo will scale back or abandon their Coles brand which occupies expensive locations in shopping malls. Rogers will begin closing their movie rental outlets. The remaining Virgin Megastores will close. Even large retailers are likely to scale back their offerings. We noticed that the Fred Meyer outlet we visited last week had removed their music/movie department. Walmart and Target can’t be far behind.
Thursday, February 24, 2011
Tuesday, February 22, 2011
Thomas Robert Malthus (1766-1834)
The world’s population is growing exponentially, and the world’s agricultural production is increasing arithmetically. At some point the amount of food required to feed the population will exceed our ability to produce it. When that happens there will be social unrest and an increase in deaths caused by wars, famines and disease. The way to prevent such a calamitous end is to reduce the birth rate through the postponement of marriage and restraint from the temptations of premarital sexual relations.
At least that’s what Malthus said in 1803. Fast forward a couple of hundred years and the same story is told. This time it’s the World Wildlife Fund, as reported in Newser.com.
The Malthusian predictions never came to fruition for several reasons, some social, some economic. When the demand for food increases, the price of food will increase. That makes land that was once unprofitable to farm more cost effective. The supply of food increases. In addition, existing farms can be used more intensively growing more food per acre. The increase in food prices makes the use of fertilizers more efficient. The increase in food prices also encourages research and development in agriculture. New technologies are developed and land becomes more productive.
A colleague of mine tells me that we need to study history so we don’t make the same mistakes again. At some point, researchers will heed this advice and we will stop seeing the same stories we saw 200 years ago. Until then, stock up on food and water because the world is coming to an end.
At least that’s what Malthus said in 1803. Fast forward a couple of hundred years and the same story is told. This time it’s the World Wildlife Fund, as reported in Newser.com.
The Malthusian predictions never came to fruition for several reasons, some social, some economic. When the demand for food increases, the price of food will increase. That makes land that was once unprofitable to farm more cost effective. The supply of food increases. In addition, existing farms can be used more intensively growing more food per acre. The increase in food prices makes the use of fertilizers more efficient. The increase in food prices also encourages research and development in agriculture. New technologies are developed and land becomes more productive.
A colleague of mine tells me that we need to study history so we don’t make the same mistakes again. At some point, researchers will heed this advice and we will stop seeing the same stories we saw 200 years ago. Until then, stock up on food and water because the world is coming to an end.
Saturday, February 12, 2011
Tuition Fees Debate
In recent years, there has been a huge change in the economic climate. We learn from first year principles that when our opportunity cost of time spent in the workforce is greater than that of pursuing higher education, rational people choose school. Thus, universities have been struggling to meet surging market demand for places during this economic downturn. An article in BBC news reported that Cambridge will be raising tuition fees to £9,000. This isn't all that surprising if you consider that the efficient way to reduce quantity demanded (number of students wanting to attend university rather than work for lower wages) is to raise the price. Interestingly, Oxford will be raising their fees to a mere £6,000. Those without the willingness to pay £9,000 will move from Cambridge to Oxford where it is relatively cheaper to get a degree. The bottom line is that raising prices makes sense from an economic perspective. A new efficient equilibrium will be reached.
So what about those who are against raising fees, and even believe that education should be free? The benefit-pay-principle means that as education is an investment and students gain from it financially, it is rational to borrow at this stage of their life to finance their education, forgoing current earnings in return for higher future earnings.
If we did not charge fees, placements would be allocated by the next best way, say by GPA. That means that those who slacked off in high school and got low grades (but who potentially could be brilliant) wouldn't get the chance to study. Society would loose out as a whole. Higher education is what we label a positive externality, or in this case a merit good. The idea is that the benefits to the individual can spill over to the rest of society, giving rise to macroeconomic advantages. A well-educated labour force will increase efficiency and productivity leading to lower unemployment rates and increased returns with benefits to the supply-side of the economy. Further, benefits of growth can stimulate capital investment in the physical sense and adoption of technological development.
Finally, in case some of you get confused, economists have a very precise definition of demand. Confusing quantity demanded with demand (and supply and quantity supplied) will inevitably lead to serious mistakes in the most simple of economic analysis.
The specific quantity desired for a good at a given price is known as the quantity demanded. For example, if Starbucks lowers their price of a tall coffee from £1.50 to £1.00, the quantity demanded will rise from 30 coffees an hour to 40 coffees an hour. (a movement along the demand curve)
A change in demand refers to an increase or decrease in demand brought about by a change in the conditions of non-price determinants. (a shift in the demand curve)
So what about those who are against raising fees, and even believe that education should be free? The benefit-pay-principle means that as education is an investment and students gain from it financially, it is rational to borrow at this stage of their life to finance their education, forgoing current earnings in return for higher future earnings.
If we did not charge fees, placements would be allocated by the next best way, say by GPA. That means that those who slacked off in high school and got low grades (but who potentially could be brilliant) wouldn't get the chance to study. Society would loose out as a whole. Higher education is what we label a positive externality, or in this case a merit good. The idea is that the benefits to the individual can spill over to the rest of society, giving rise to macroeconomic advantages. A well-educated labour force will increase efficiency and productivity leading to lower unemployment rates and increased returns with benefits to the supply-side of the economy. Further, benefits of growth can stimulate capital investment in the physical sense and adoption of technological development.
Finally, in case some of you get confused, economists have a very precise definition of demand. Confusing quantity demanded with demand (and supply and quantity supplied) will inevitably lead to serious mistakes in the most simple of economic analysis.
The specific quantity desired for a good at a given price is known as the quantity demanded. For example, if Starbucks lowers their price of a tall coffee from £1.50 to £1.00, the quantity demanded will rise from 30 coffees an hour to 40 coffees an hour. (a movement along the demand curve)
A change in demand refers to an increase or decrease in demand brought about by a change in the conditions of non-price determinants. (a shift in the demand curve)
Friday, February 11, 2011
Usage Based Billing
This is a first for us. We actually had a request for a comment on this topic.
Canadian internet service providers (ISPs) have requested permission of the regulatory authorities to begin billing customers on the basis of how much data they download. Their argument, it seems, is that the increased usage is beginning to slow down their networks and they need the increased revenue to be able to finance an upgrade to their infrastructure.
The economics of the internet are similar to the economics of any transportation system. The marginal cost of providing the service is low and constant up until demand reaches capacity. At that point congestion increases costs. A recent Financial Post article estimates that the cost of transmitting 1 gigabyte (GB) is currently less than one cent. Capital intensive industries, such as the internet, have high capital costs and low marginal costs, and marginal cost is almost always less than average cost. While marginal cost pricing would be efficient, it would not be sustainable. This said, Bell’s proposal to charge $1.12 per GB for usage above 60 GB and $1.87 per GB above 300 GB, as reported in a CBC article, seems to be a bit high.
Finance theory helps us evaluate the claim that the ISPs need the additional revenue to fund upgrades. Investment decisions are based primarily on net present values, a number that discounts future costs and revenues to determine the profitability of an investment. If the NPV is positive, the investment will add to profits. The key is that NPV looks at future cash flows, not historical cash flows. The interest rate used in the discounting is the risk adjusted weighted average cost of capital. A quick review of BCE’s annual report shows a mix of common and preferred equity, long term debt and retained earnings in descending order of magnitude. They do not rely heavily on past profits to fund infrastructure.
We suspect that the real motive behind the push for usage based billing is to make services such as Netflix more expensive. BCE has purchased CTV, Rogers owns Sportsnet, Shaw and Telus sell television delivery through cable or internet TV. Unlimited internet usage with lowcost Netflix makes their broadcast businesses less profitable.
Canadian internet service providers (ISPs) have requested permission of the regulatory authorities to begin billing customers on the basis of how much data they download. Their argument, it seems, is that the increased usage is beginning to slow down their networks and they need the increased revenue to be able to finance an upgrade to their infrastructure.
The economics of the internet are similar to the economics of any transportation system. The marginal cost of providing the service is low and constant up until demand reaches capacity. At that point congestion increases costs. A recent Financial Post article estimates that the cost of transmitting 1 gigabyte (GB) is currently less than one cent. Capital intensive industries, such as the internet, have high capital costs and low marginal costs, and marginal cost is almost always less than average cost. While marginal cost pricing would be efficient, it would not be sustainable. This said, Bell’s proposal to charge $1.12 per GB for usage above 60 GB and $1.87 per GB above 300 GB, as reported in a CBC article, seems to be a bit high.
Finance theory helps us evaluate the claim that the ISPs need the additional revenue to fund upgrades. Investment decisions are based primarily on net present values, a number that discounts future costs and revenues to determine the profitability of an investment. If the NPV is positive, the investment will add to profits. The key is that NPV looks at future cash flows, not historical cash flows. The interest rate used in the discounting is the risk adjusted weighted average cost of capital. A quick review of BCE’s annual report shows a mix of common and preferred equity, long term debt and retained earnings in descending order of magnitude. They do not rely heavily on past profits to fund infrastructure.
We suspect that the real motive behind the push for usage based billing is to make services such as Netflix more expensive. BCE has purchased CTV, Rogers owns Sportsnet, Shaw and Telus sell television delivery through cable or internet TV. Unlimited internet usage with lowcost Netflix makes their broadcast businesses less profitable.
Wednesday, February 9, 2011
Fighting Chinese Inflation
We have previously discussed the cause of the inflationary threat in China (click here for blog). This week, we have pulled together some news article showing some of the policy options that are available to countries that are trying to fight inflation. All of the articles apply to China.
The first line of defense is usually to increase interest rates. As rates rise, borrowing gets more expensive so construction costs rise, the demand for durable goods falls and the net present value of investment options decreases. All of these serve to reduce domestic demand and reduce inflationary pressure. A Reuters article dated Feb 8, 2011 explains that China has exercised this option raising their lending rate for the second time in the last seven weeks. Unfortunately the savings rate, at 3% is below the inflation rate of 5.3%. The real interest rate on savings is negative which creates a disincentive to save and an incentive to spend which is counterproductive to the policy goal. This effect is discussed in a Feb 9th Bloomberg article.
A second method that is available to some countries is to increase the reserve requirement. Reserves are funds that are held by banks against deposits and in some countries this rate is dictated by the regulatory authorities. Canada has no required reserves. China does, and a CNNMoney.com article indicates that that ratio has been increased to 19% for major banks. The effect of this is to reduce the supply of loanable funds in the market place, reducing liquidity and slowing the growth of credit.
China has adopted yet a third measure to try and control its inflation. A BusinessWeek article dated Jan 9, 2011 indicates that Chinese banks are being required to increase their capital ratios. (Capital divided by assets) An increase in capital ratios reduces the amount of funds that are available for lending, which gives the same results as increasing the interest rate or the reserve requirement.
China’s monetary authority is trying every tool available to it, except for one. The inflation in China is being caused largely by their policy of having the yuan pegged to the US dollar at a rate below its equilibrium value. The resulting capital inflows increase the domestic money supply and that is the root cause of the inflation. Let the yuan float and the inflationary pressure will dissipate.
The first line of defense is usually to increase interest rates. As rates rise, borrowing gets more expensive so construction costs rise, the demand for durable goods falls and the net present value of investment options decreases. All of these serve to reduce domestic demand and reduce inflationary pressure. A Reuters article dated Feb 8, 2011 explains that China has exercised this option raising their lending rate for the second time in the last seven weeks. Unfortunately the savings rate, at 3% is below the inflation rate of 5.3%. The real interest rate on savings is negative which creates a disincentive to save and an incentive to spend which is counterproductive to the policy goal. This effect is discussed in a Feb 9th Bloomberg article.
A second method that is available to some countries is to increase the reserve requirement. Reserves are funds that are held by banks against deposits and in some countries this rate is dictated by the regulatory authorities. Canada has no required reserves. China does, and a CNNMoney.com article indicates that that ratio has been increased to 19% for major banks. The effect of this is to reduce the supply of loanable funds in the market place, reducing liquidity and slowing the growth of credit.
China has adopted yet a third measure to try and control its inflation. A BusinessWeek article dated Jan 9, 2011 indicates that Chinese banks are being required to increase their capital ratios. (Capital divided by assets) An increase in capital ratios reduces the amount of funds that are available for lending, which gives the same results as increasing the interest rate or the reserve requirement.
China’s monetary authority is trying every tool available to it, except for one. The inflation in China is being caused largely by their policy of having the yuan pegged to the US dollar at a rate below its equilibrium value. The resulting capital inflows increase the domestic money supply and that is the root cause of the inflation. Let the yuan float and the inflationary pressure will dissipate.
Thursday, February 3, 2011
Substitutes and Complements
It is an exercise in mental gymnastics when we try and explain the relationships between substitute goods and complements in the class room. Typically it’s butter-margarine or blue ray players and disks. Students often don’t see why we bother.
The ongoing saga of the collapse of Borders illustrates the issue and also reinforces the need for an understanding of economics in the world of finance. An article from Bloomberg indicates that Borders in on the verge of a Chapter 11 filing, perhaps as early as next week. Borders still wants to undertake a merger with Barnes & Noble, but we can’t understand why B&N would want to take on the obligation of the additional real estate. (Click here for article)
A second article, from Venturebeat discusses Amazon.com’s latest earnings report. (Click here for article) While earnings were less than expected, the article does indicate that e-books outsold paperbacks by 15%. As we’ve been pointing out for the last little while, this is Border’s problem. Electronic delivery of books is a substitute for the printed version. In addition, the cost of shopping at Amazon is lower than at Borders making Amazon is a good substitute for Borders.
Our third article comes from Huffington Post and has to do with 4th quarter earnings at UPS. (Click here for article) As internet shopping continues to increase, the demand for shipping services also increases. They are complements. The following graph compares the relative stock price movement of the three companies over the past five years. Amazon and Borders have been moving in opposite direction, as our theory predicts. UPS has not been moving in the same direction as Amazon as we might expect. Reasons for this may include the general decline in the economy over the last 2 years and the increase in fuel costs over the time period in question. Another reason can be found by studying Amazon’s shipping policy which indicates that UPS is not the sole distributor of Amazon products.
Data was obtained from Yahoo! Finance. Stock prices are adjusted for dividends and normalized to February 2, 2006
The ongoing saga of the collapse of Borders illustrates the issue and also reinforces the need for an understanding of economics in the world of finance. An article from Bloomberg indicates that Borders in on the verge of a Chapter 11 filing, perhaps as early as next week. Borders still wants to undertake a merger with Barnes & Noble, but we can’t understand why B&N would want to take on the obligation of the additional real estate. (Click here for article)
A second article, from Venturebeat discusses Amazon.com’s latest earnings report. (Click here for article) While earnings were less than expected, the article does indicate that e-books outsold paperbacks by 15%. As we’ve been pointing out for the last little while, this is Border’s problem. Electronic delivery of books is a substitute for the printed version. In addition, the cost of shopping at Amazon is lower than at Borders making Amazon is a good substitute for Borders.
Our third article comes from Huffington Post and has to do with 4th quarter earnings at UPS. (Click here for article) As internet shopping continues to increase, the demand for shipping services also increases. They are complements. The following graph compares the relative stock price movement of the three companies over the past five years. Amazon and Borders have been moving in opposite direction, as our theory predicts. UPS has not been moving in the same direction as Amazon as we might expect. Reasons for this may include the general decline in the economy over the last 2 years and the increase in fuel costs over the time period in question. Another reason can be found by studying Amazon’s shipping policy which indicates that UPS is not the sole distributor of Amazon products.
Data was obtained from Yahoo! Finance. Stock prices are adjusted for dividends and normalized to February 2, 2006
Tuesday, February 1, 2011
Correlation or Causation (lies, damn lies, and statistics)
Economics is a social science and, as such, follows the scientific method. We isolate a problem and try to solve it, or observe a particular behaviour and we attempt to explain it. That entails a series of definitions and assumptions, the construction of a model and the formulation of a postulate or hypothesis. Once this is complete, we then undertake a statistical analysis and see if the model supports or rejects our hypothesis.
Not all disciplines follow such a methodology. For example, Reuters published an article citing a University of Victoria study that suggests that the privatization of BC liquor stores is responsible for an increase in alcohol related deaths in that province. (Click here for article) According to the article, a statistician from George Mason University takes issue with the way the study was done and the interpretation of the data. If, as the UVIC study suggests, the decline in government liquor stores causes more alcohol related deaths, then opening more government run liquor stores should result in fewer deaths.
What the study apparently omitted was a hypothesis of causation. That is, did the privatization of liquor stores cause the increase in deaths or was there another factor that happened to be related to the timing of the privatization and also to the deaths? We did a quick and dirty survey of some literature to find out what may affect the demand for alcohol and the increase in alcohol abuse.
Most studies suggest that alcohol is a normal good. When income rises, alcohol consumption rises. (See the BBC article). Another study tests this hypothesis for causation and finds that increased alcohol consumption can lead to higher incomes due to social networking. (See report on San Jose State U study) However, during a recession, when many people lose their jobs, depression can lead to an increase in alcohol abuse. (See University of Maryland study) This would appear to be conflicting. However, the first case deals with alcohol consumption and the second with substance abuse which are entirely different. (See article in the Irish Medical Times) In addition to income and depression being factors, genetics may also play a role. An article from the Scotsman suggests that Scottish residents born in Scotland or Ireland are more likely to suffer from alcohol abuse than those born outside Scotland. Celts are more susceptible than Anglos, Saxons or Normans? (Click here for article)
We would suggest that the authors of this particular study redo their analysis correcting for the recession. Our suspicion is that the opening of the private liquor stores coincides with the recession and that the “cause” of the alcohol related deaths has more to do with depression, induces by job losses and falling income, than it does with privatization. This would show a correlation, not causation.
Not all disciplines follow such a methodology. For example, Reuters published an article citing a University of Victoria study that suggests that the privatization of BC liquor stores is responsible for an increase in alcohol related deaths in that province. (Click here for article) According to the article, a statistician from George Mason University takes issue with the way the study was done and the interpretation of the data. If, as the UVIC study suggests, the decline in government liquor stores causes more alcohol related deaths, then opening more government run liquor stores should result in fewer deaths.
What the study apparently omitted was a hypothesis of causation. That is, did the privatization of liquor stores cause the increase in deaths or was there another factor that happened to be related to the timing of the privatization and also to the deaths? We did a quick and dirty survey of some literature to find out what may affect the demand for alcohol and the increase in alcohol abuse.
Most studies suggest that alcohol is a normal good. When income rises, alcohol consumption rises. (See the BBC article). Another study tests this hypothesis for causation and finds that increased alcohol consumption can lead to higher incomes due to social networking. (See report on San Jose State U study) However, during a recession, when many people lose their jobs, depression can lead to an increase in alcohol abuse. (See University of Maryland study) This would appear to be conflicting. However, the first case deals with alcohol consumption and the second with substance abuse which are entirely different. (See article in the Irish Medical Times) In addition to income and depression being factors, genetics may also play a role. An article from the Scotsman suggests that Scottish residents born in Scotland or Ireland are more likely to suffer from alcohol abuse than those born outside Scotland. Celts are more susceptible than Anglos, Saxons or Normans? (Click here for article)
We would suggest that the authors of this particular study redo their analysis correcting for the recession. Our suspicion is that the opening of the private liquor stores coincides with the recession and that the “cause” of the alcohol related deaths has more to do with depression, induces by job losses and falling income, than it does with privatization. This would show a correlation, not causation.
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