Saturday, March 17, 2012

Frequency of Choice

I have talked about this earlier also, but the topic is so close to my heart that I wanted to have a dedicated post.

As far as I understand it, the crux of capitalism is choice. In economics the word choice is substituted by market. What is market? Market is where consumers exercise choice. If consumers don't have a choice it is not a market. The assumption is capitalism thrives on competition.  Competition creates choice. Consumers will choose the best products at lowest prices forcing companies to innovate and reduce prices. The best will survive.

This is all true and then not quite true. Two main problems:

  • Most people don't like to think. Even  if they can, the complexity of world is sufficiently high that figuring out what is best for them is close to impossible. Eventually it is either brands or price because they make the decision simple. 
  • Frequency of choice. Since this is all I want to talk about, I will use the next paragraph.
We are good at stuff we do often, the old practice makes the man perfect thing. We buy petrol, vegetables, groceries, etc almost every day. Prices changes are felt, drop in quality is noticed. But then their are things that we don't do often. Things like joining new job, getting married, buying car or home, taking a loan, choosing college, getting home painted, buying TV or refrigerator or AC, casting our vote, choosing a laptop or OS, choosing email client, signing up on a social network, etc.  Many of these choices are irreversible or if not irreversible then choosing the alter our choice is very expensive.  This is where capitalism fails miserably because it is no longer about choosing from alternatives but the choice of altering our choice. For products with short life spans like vegetables or toothpaste altering a choice is not expensive. Vegetables will last few days, toothpaste few weeks and you can choose better product next time, but with products that last years or decades or in some cases lifetimes, it is the altering of choice which is required not choice among products. 

Consider home loan business in India. Floating rates have been around for long time now.  What do they float on is unknown and once you take the loan you realize that the "unknown" is whim of the Bank. Usually your floating home loan interest rate will increase by 20%-40% within few months of taking the loan and now their is no choice.  Well their is a choice to switch to other home loan, but only if you pay 2%-4% of your home loan value as switching charges.  This is as monopolistic as it gets and we call it capitalism, the mecca of markets and choice.  Even banks don't know if they are giving a good/bad interest rate to the customer, then how can customer decide if he is getting a good deal and that deal is good enough for the next 20 years. No one can. The only way I can know if I getting a good deal is if I can switch my home loan any moment I desire to switch. That is what will make it a market.

The same happens when switching a job (notice period), casting a vote (5 years gap), buying a car (10% value drop when it get out of the showroom) and at many other places. In computers, the advent of SAAS based companies have started filling this gap by providing monthly choice to the customers to continue to use them which once was a difficult choice of finding the best product. Amazon EC2 gives choice to use machines by hour and OS by hour. I think governments which call themselves followers of capitalism have missed a point.  It is not the choice alone that matters, it is the frequency of the choice that is at the core of efficient markets.  


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