March 10, 2006
From the desk of Winterspeak:Folly, consumption or investment?
Thomas Mahon is a tailor based in the UK who makes custom (bespoke) suits for about $3000 a pop. He started a very good weblog some months ago, got great press, and now has as much business as he can handle. Instead of expanding, he's decided to limit his output to 100 suits a year, with no change in price that I can discern.
Folks familiar with economics would instantly see that Thomas is leaving money on the table -- instead of limiting output (Q), why doesn't Thomas increase his prices (P) until demand naturally reaches 100 suits per year. This new price could be $3200 or it might be $6000. In either case, Thomas will make more money through raising P than limiting Q.
But Thomas has decided not to do this. There are three ways to interpret this decision:
1) The behavioral economics approach would say that Thomas is making various logical fallacies, that are common and represent general human behavior. Humans regularly commit follies.
2) Chicago-school economists would say that Thomas is maximizing something other than profit, and that this money left on the table is actually the price he's willing to pay for whatever "good feelings" he gets from keeping the price the same. What behaviorists call "irrationality", neoclassists call "consumption".
All of this is just a long-winded way of getting around to the current investment climate in Dubai.
Dubai is booming. The city has been growing for years now, but I have never seen as many skyscrapers being constructed than in my trip there last month. There are entirely new sections of towns being built, blocks and blocks of appartments, office towers, hotels and houses.
What's most remarkable about much of this new investment is the show-offy outlandishness of it. After Palm I and Palm II (palm tree shaped artificial islands in the Arabian Gulf, with houses on them), Dubai is building "the world" -- an archipeligo of individual islands shaped in a map of the world. The major draw is that you can buy, say, France, and have your address be "France, The World, Dubai, UAE". Dubai has also built the world's largest artificial ski slope, is building the world's tallest building, is constructing the world's first underwater hotel, which will kick into high gear just as soon as the world's largest submarine making factory pumps out the world's largest fleet of submarines to ferry guests to and from the hotel.
It's all a little mad.
The thing is, I cannot figure out if this spending is folly, consumption, or investment.
The projects seem ridiculous on their face, and the growth assumptions behind them are truly heroic, so maybe they are simply making a mistake and these pleasure palaces will be idle, and real estate prices will crater.
Much of Dubaii's financing comes from a small group of very wealth families, and they enjoy competing amongst themselves for prestige, so maybe all of this gilding is just them showing off and having fun. So the return on their projects may be lower but who cares -- they have plenty of money and they are spending it.
Perhaps this investment, overall, is real and correct. If you look at a map of the Middle East you will notice that it is utterly bereft of fun, with the exception of Dubai. High oil prices and political instability means there are lots of rich people in the area looking for a safe bolthole, somewhere secure to put their money, and an enjoyable, Arabic speaking holiday destination. They may be willing to trade off some return for a high probability that their money will not be blocked or confiscated by stroppy foreign governments, and given how the West is leery of Muslim Arabs these days, Muslim Arab investors may take a haircut and send their case to Dubai anyway. Dubai, given free money, is spending it freely.
Certainly, this sort of preference structure behind financing would go some way to explain the persistance of low interest rates in the US. Certainly they are difficult to defend on pure economic grounds. This excellent article details the effect Asian currency pegs have on keeping US interest rates low, and thus making it cheap for America to carry more debt. Perhaps non-financial preferences are driving activity in Dubai.
Posted by Winterspeak at March 10, 2006 8:53 PM | TrackBack | Technorati inbound linksChicago-school economists would say that Thomas is maximizing something other than profit, and that this money left on the table is actually the price he's willing to pay for whatever "good feelings" he gets from keeping the price the same. What behaviorists call "irrationality", neoclassists call "consumption".
Maybe he just wants to work less and have more time to go drinking with his Savile Row peers.
I would assume that by keeping the price the same and yet turning down offers he is increasing the value of his work. Now people have to sign up and get wait-listed in order to get their order. That has potential for business growth.
The tailor is rational. I don't have cite, but there was a wonderful explanation in the Economist back in the 90s. Here goes from my befuddled memory:
The question is usually posed in terms why don't "hot" restaraunts or clubs that persistently have long waits raise their prices or auction off seating priority?
The key aspect is to realize that the tailor/restaraunt is principally selling prestige or "buzz", not a suit or lasagne. Thus, they face a nasty non-linear pricing problem. They can raise prices precisely up to the point until that securing access no longers confers prestige on the buyer -- at which point demand collapses completely. However, it is all but impossible to know a priori where this "collapse point" is. Worse, that collapse point is a point of no return: no amount of price lowering will bring will bring back the "buzz" once everyone knows that the new refried sushi place or the guy who makes vintage leisure suits is now the place to be.
A less Machiavellian assumption is that he gets much of his business in repeat sales to the same individuals. Raising his prices suddenly could hurt customer loyalty, and might cost him later when a new competitor shows up. By waitlisting additional business and holding prices steady, he is choosing long-term stability serving a small group of customers over immediate profit. $300,000 gross every year isn't bad at all.
It's only businesses that sell to individuals that can afford to think this way. If you sell to corporations, don't expect loyalty, or even much memory - the executive you dealt with this time will likely have moved to another job next year. Or if you run a mass-market store like Walmart, reasonable customers know that it is impossible for you to remember them and so consider each sale as a transaction between strangers.
On further review, Mahon doesn't say that he's keeping his prices the same, at least not that I can see. And his pricing is not transparent (for good reasons, since the material, etc., will affect the price), so it would not be hard for him to limit supply and increase prices somewhat.
A 4th possibility is that he has found some other way to profit from the waiting lists without violating the restrictions he has placed on himself to generate the buzz.
I can speculate that if the number of suits are limited, he could increase sales of accessories such as belts, ties or socks that are largely made by a supplier and so not limited by his time.
Alternatively, he could be using access to his waiting lists to purchase non-monetary goods such as access to private clubs or restaurants for himself.
Lastly, (and I am not accusing him of this) he could sell more than the 100 suits, and nobody would know would they? By saying it is limited he increases demand.
Personally I've had exactly this conversation with a restaurant owner, and she was unable to articulate why she wouldn't raise prices despite a long queue. I think tylerh's comment above may be what she was trying to say.
Tyrone said:
"On further review, Mahon doesn't say that he's keeping his prices the same, at least not that I can see. And his pricing is not transparent (for good reasons, since the material, etc., will affect the price), so it would not be hard for him to limit supply and increase prices somewhat."
That is an excellent point. Although Mahon does list his prices here:
http://www.englishcut.com/archives/000006.html
No doubt customers can order various details to make the final price they pay higher.
Mahon can either raise his list price, or increase his "options" prices.
It could be that his current pricing is the "right" pricing, and a higher price would taint his product with being something akin to"bling", thus reducing desirability amongst the "right" customers.
I think the spending in dubai is investment. They seem to have learned the lesson "if you build it, they will come" when they built the jebel ali free trade zone. They marked off a patch of desert that borders the sea, and created a tax free zone that charges hefty rents. It seems like most of their projects are trying to recreate that same magic.
Not enough land, build an island, or 200.
Link to the Fed was interesting. Maybe my bias or naivete but seems like if you look around the world, the only place worth taking a chance on (ie.: financial risk) is the one willing to fight for securing everyone's future. Combine that with our economic history and apparent future (once again, relativly speaking) and it seems like assets accumulated in the U.S. will be safer than elsewhere and thus not carry the intrest adjusted risk factor. If the U.S. is going to clean up the Mid-East, let's spend all our U.S. profits on a play ground. If EVERYONE is willing to buy my suits at such a price, why...change...anything? Uncertainty has a VERY high price.
No public corporation would EVER except the situation of the tailor: highly profitable but zero growth. They would have to expand until they go bust.
He probably just has enough money and doesn't want to work so much.
There doesn't seem to be an economic theory which explains the concept of "enough money," but it surely exists in reality. I've met several successful people who decide to work less and relax more. Instead of spending 14 hours a day at the office/store/job site, they decide to work 9-4, and spend the rest of the day relaxing.
Sometimes these people come back to work becuase they get bored, sometimes they continue to take it easy. But once they have a lot of money, a not insignificant number of people decide to kick back.
Damn, I thought when I saw there were 13 comments, they would be about the Dubai construction question. I thought that was a great topic.
Winterspeak, I think you hit on the intention when you noted that Dubai is the fun place to be in the Middle East. They want to be a European and American holiday destination, and they already are a holiday destination for wealthy Arabs and Asians. And it is Sin City, Persian Gulf as far as American G.I.s are concerned. No place else in the area was even trying to compete in this niche when I was in the region, and I don't see when that will change.
Another thought is that when he says - "So I'm considering limiting my output to one hundred suits per year. One hundred. No more." - he is engaging in what we in the marketing trade call a "lie". I'm not sure what economists call this. :)
Quantities are limited. Act before midnight tonight.
Joe Schmoe: any decent labor economist would tell you that that's just the point where the marginal value of leisure time surpasses the marginal value of the money earned by extra work. Not that hard to deal with, once you move beyond the 'humans-are-motivated-solely-by-money' nonsense of lower-level econ classes. Now, if they decided to take less money and relax less, I might be a bit confused.
any decent labor economist would tell you that that's just the point where the marginal value of leisure time surpasses the marginal value of the money earned by extra work. Not that hard to deal with, once you move beyond the 'humans-are-motivated-solely-by-money' nonsense of lower-level econ classes.
Actually, I think it was Nelson Rockefeller who, when asked "How much money would it take to make a man happy?", responded with "A little bit more."
As for the rest, sure, you or any decent labor economist can explain the trade-off between income and leisure that way, but that's downright tautological. Generally speaking humans are motivated by gain, although what is gained may not always be monetary.
Somehow I don't think there can be an economic theory that explains "enough money," aside from tautology, because everyone's priorities differ. How would a theory predict, in advance of knowing the outcome, if/where a man will begin valuing relaxation more than labor?
Dubai is *not* a safe place in which to make massive investments. It's way too close to Saudi Arabia, and when - not if - the House of Saud falls, this closeness will present a major danger. It's only a matter of time before Saudi Arabia will be ruled by ultra-fundamentalists who will make the Taliban look like free-love libertines. They might just decide that "decadent" Dubai cannot be allowed to remain next door, with military conquest soon to follow. On a less extreme level, if the new fundamentalist Saudi government decides to close its borders, Dubai will suffer from the loss of Saudi travelers and investors.
Not everyone acts in a purely rational manner. Is this so surprising? It seems to me that that economic behavior is far better described by an eco-system than anything else. When you have an environment where food is plentiful and competition is low, you can end up with things like birds which have lost their ability to fly. They still manage to thrive and propogate, even though their evolutionary game plan will lead to extinction once aggressive predators manage to make their way to the island. You don't need to be totally rational to succeed, you just need to be good enough to get along in the environment where you live.
But things change, and new species and modes of economic behavior evolve. The inefficient die out, but this only applies in the long run. Why should you be rational when not being so incurs no immediate penalty?
On the Dubai front, I think that Wulf has half of it.
The other half, I think, comes from money flying out of the ground into the pockets of people who have done nothing to create or earn it. The world's largest artificial ski slope seems like a great accomplishment to people who have no frame of reference as to what accomplishment is.
The world's largest artificial ski slope seems like a great accomplishment to people who have no frame of reference as to what accomplishment is.
...except that the UAE, unlike most of the Middle Eastern oil kings, actually has reinvested large quantities of money into business and does well there at. So the above explanation isn't quite correct, either.
Could it just be that when you have so much stinking money that even a Swiss Bank Account looks small and petty, you might as well start sticking it into things you can enjoy, frivolous or otherwise?
I wonder what making 101 suits per year, or raising prices would do to his tax bracket?
Another alternate explanation might be that he's investing for the future, in a sense.
One thing he's remarked on, if I recall aright, is that the old Saville Row houses are losing business, turning to machine-made suits, and sometimes even closing up shop. He may be thinking that at the present, he needs to price in the same range as he has before, since that pricing comports with his peer producers, but by restricting his output, he ensures a higher quality which, for a bespoke suit, will continue to manifest itself years on down the line, when equivalently priced suits from tailors who use machines for some canvas construction, or do MTM or even (horrors! :P) fused construction are falling apart. At that point, his present restricted output and the uncompensated quality may enable him to capture a greater share of his particular elite market, and allow his business to continue, when even more of his competitors lose their prestige and are forced to shift downmarket or out of business.
This probably isn't actually what he's thinking, though, because he emphasises -- and I don't think there's any reason to doubt him in this -- that his fellow tailors aren't "competitors" so much as "community." But the above is one more gloss you can put on the decision to restrict output to 100 suits/year.
Mr Mahon is banking on the principle of scarcity having value. If he produces many thousands of his suits per year, they cease being exclusive, and they no longer have an elite appeal. There is also the consideration that there is more to life than expansion of production. He wants to have a life outside his work. Good luck to him.
I think triticale hit pretty close to the mark. After all, the suits are $3k each--how much more will people pay for a suit before feeling they are being played for chumps? When you have only a few hundred customers--the right people, of course--it doesn't take much word-of-mouth to alienate them in batches.
When you lose your core and become "bling", you may as well cash in your IRA because nothing's quite as whimsical as trends in bling. Ask Tommy Hilfiger.
There are also certain advantages to keeping the demandfor your suits artificially high by refusing to raise the price for them. For one thing, it lets you be picky as to which customers you choose to allow to buy your suits. A customer's being obnoxious? Get rid of him. Too demanding? Get rid of him. Wants a boring suit when you'd like to try something more daring? Get rid of him. Etc, etc.
The guy isn't trying to work less -- he's still making as many suits as he did before. He's just making the manufacture of those 100 suits more enjoyable for him. Plus, of course, he might be prolonging the appeal of the suits by making them all-but-impossible to get.
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