Intermediaries

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Retail stores and wholesalers are examples of operations that cut transaction costs.

Intermediaries specialize in reducing uncertainty and cutting the transaction costs of conveying goods from original producers to the final users, often transforming the good to make it more compatible with ultimate users' demands.

Many people are surprised to learn that price swings are moderated by successful speculators, who are special types of intermediaries.

Intermediaries ("middlemen") are sometimes condemned as "profiteers"–villains who cause inflation, shortages, or other economic maladies. For example, people who trundled bottled water to the Midwest during the floods of 1997 were castigated by the media for charging “exorbitant” prices. But the real problem was the tiny supply of drinkable water. However, if more people had followed their example and tried to "profiteer," prices would have been lower. More recently, there has been much public distaste expressed towards companies like Halliburton which are pegged as “War profiteers” and “hurricane profiteers” for the hefty fees they are paid by the government for their efforts towards rebuilding Iraq and New Orleans. However, like all intermediaries, "profiteers" serve to absorb risks and help move prices towards equilibrium. This reduces transaction costs and conveys goods to those who desire them most while boosting the incomes of original suppliers. In fact, intermediaries reduce opportunity costs to consumers, and speculators tend to reduce both the volatility of prices and net costs of products.

Have you ever paid more than you had to for anything? Your answer must be NO if you behave rationally. You might object that, say, buying apples from a grocer costs more than buying from an apple grower. But if you bought from a store, it must have charged less than if you had bought apples at an orchard, after considering your time, information costs, travel, and potential spoilage. Otherwise, you would have bought directly from the apple grower.

Similarly, monetary prices at convenience stores exceed those at supermarkets. However, after we adjust for greater accessibility because of the longer hours typical of convenience stores and the frequent extended waits at supermarket checkouts, customers of convenience stores must be paying less (after considering all transaction costs) or they would buy elsewhere.

Absorption of risk is one important way intermediaries reduce transaction costs. Quality can vary. Apples, for example, range from prize-winners at county fairs to rotten. Consumers who bought a few apples to eat fresh, but wound up with mush unsuitable even for applesauce would be distraught. Orchard owners specialize in growing apples, but may not be geared to assure top quality to every consumer of every apple. Another problem is that a consumer may buy apples only sporadically, while orchards have tons of apples available at some times, and none at others. Timing between individual purchases and harvesting at a given orchard may not be synchronous.

Apple wholesalers and grocers, however, purchase such large quantities that they are accustomed to dealing with a mix of good and bad apples. They also sell to so many customers that no sale to any single final buyer is crucial. This assures apple eaters high quality and allows orchard owners to concentrate on production. Thus, those ultimate producers and consumers who want to reduce risk can shift it to intermediaries who are more willing to bear risk (perhaps because, by pooling numerous transactions, intermediaries may be able to reduce cost of risk.)

Transportation and information costs, time, and risk all contribute to transaction costs. No matter how hard you try, we doubt that you can come up with a single example where, after considering all transaction costs, at the time you bought something, you paid more than the lowest price possible for it. Even if in a supermarket, faced with apples from two different groves, you chose to purchase the more expensive kind you are then buying not simply an apple, but an apple of a perceived (or real) superior quality, and you bought that particular kind of superior apple at the cheapest available price to you.

It is because we act so rationally that it so difficult for many “responsible shopper” organizations to get common Americans to stop shopping at stores like Wal-Mart. Their arguments, such as the ones provided by Co-op America (www.coopamerica.org), are large-scale ones which discuss matters of labor standards and low wages and the destruction of “Mom & Pop” stores. Individual people recognize that when it comes to making their local Wal-Mart go out of business, they are “at the margin” and that their contribution or lack thereof is of minimal importance to any such movement’s success or failure (much the same rationale used by those who do not vote). Though it is difficult to find a person who will say they are opposed to higher standards of living for the poor and the survival of local commerce, it is nonetheless difficult to convince most of them that their participation at the margin is worth more than the money they would save shopping at these super centers.

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Author: Ralph Byrns

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