Thursday, March 15, 2012

Economies of scale and the scourge of the middleman


You know me, I've got too much time on my hands these days so I chose to spend it keeping up with the tech pundits.  So I was watching Triangulation on TWIT this week (3-15-2012) and their guest was the co-founder of Kiva.org Matthew Flannery.

Kiva is a micro lending service that allows anyone to lend money to those in need around the world via a network of Microfinance Institutions (MFI's).  The first thing you have to understand is that it's not a bank and you don't get any interest on the money you lend.  In fact Kiva is the antithesis of a bank in that it exists not for its own profit motives but rather to offer access to needed  funding to those who'd be denied otherwise.  It's more like a personal loan that also scratches your humanitarian itch.

Make no mistake, these are loans not handouts.  In a move that should satisfy even the most staunch fiscal conservative, this is the ultimate expression of pulling one's self up by their bootstraps.  Most loans are for small businesses in need of a minimal amount of capital. Kiva facilitates the process by connecting would-be lenders to MFI's.  They take no  profit in the process and are funded by donations, grants, corporate sponsors and foundations.

Leo and Tom did a far better job  of shining a light on Kiva in their interview of Matthew Flannery on Triangulation than I can do here so I suggest you watch the episode if you want to know more. 
Kiva is the rare example of a middleman that contributes something tangible.  So it struck me how very wrong the so-called first world is in their handling of economies.

What it brought to mind was how much waste is caused by middlemen in the developed world.  For example, I have loans like everyone else.  A car loan, student loan, revolving credit card balances and the like.  Each one of those has an interest rate and somebody standing in the middle whose only purpose is to shuffle paper, for a fee.

I get the interest part of the equation, someone lets you use their money so it's only natural that they deserve some consideration for making it available to you. 

Here's the problem.

If you were to trace how many hands were on every dollar you ever borrowed or spent you'd soon understand why prices always seem to be going in the wrong direction of your bank balance.
Nobody just makes something and sells it for a small profit over their cost, there's always more to it than that.

 We always hear about "overhead"..  Overhead might as well be another name for middlemen.  Yes there's always a cost to make something but as business has evolved we've added layers of needless complexity creating a fertile environment for "facilitators". Everything you buy, use or see has an army of people between you and the producer.  All with waiting open palms contributing nothing to the process other than passing it from one hand to the next. 

Buy a new car and somewhere in the price you're going to pay the dealer's overhead.  He's got to pay for the land, inventory, utilities and property taxes just to offer that car to you.  Speaking of inventory he has to pay the car manufacturer for his inventory which introduces its own overhead.  The manufacturer has similar overhead for facilities as well as the overhead built into the price they pay their parts suppliers who in turn had their own overhead to produce the parts. 

The chain can go on forever with a middleman at every level standing between buyer and seller .  That cost ultimately  gets passed on to you in the form of a price that has little to do with the actual resources it took to produce the product.

Some might say that's just how the world works these days.  I say it's exactly why the world is in such dire financial straits.  There are far too many people whose living depends on doing little more than facilitating the movement of paper from one office to another. 

That's why there's so many layoffs in financial institutions.  When nobody's buying there's not enough paper to shuffle and the middlemen  start circling the wagons and reducing headcount.  Their fortunes are dependent on "servicing" accounts which in layman's terms means ensuring they get their fees for passing money from one entity to another.  They only thing they're actually concerned about servicing is their own profit margins.

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Whole economies are based on professions whose whole reason for existence is to "facilitate" a transaction.  Their names are common, Banks, Title companies, Loan Servicers, brokers, sales engineers and the like.  None of them produce anything tangible, they exist only as profiteers convinced of their own relevance.   Yet when they fail they jeopardize the financial stability of entire nations.

We hear a lot these days about poor working conditions in the third world.  That's because huge corporations seek to protect their profits by exploiting their workforces instead of cutting out the middlemen.  That includes the ones on their payroll by the way.

Of course PR departments and advertising firms swing into high gear whenever the public gets wind of an obvious injustice.  Realize that PR and advertising are just middlemen of a different color.  They too produce nothing of tangible value.  They are, in effect, the middlemen between customer and corporation and ultimately end up in the "overhead" reflected in the final price.

Which brings me back to Kiva.org.  In developing nations a few hundred dollars can have the same effect as a few million in other parts of the world.  That's because the resources provided match the need and nothing more.  The process is kept simple and the middleman isn't driven by a profit motive in Kiva's case.  Economies grow by making transactions between the buyer and the seller simple.   The more complex a transaction becomes the more waste gets introduced into the process .  Middlemen for the most part don't follow Kiva's example and exist only to complicate simple processes to their own advantage. 

Until economies recognize the threat of the profiteering middleman they will never be stable.  As such a vicious cycle continues to erode an already weak currency platform that's backed by little more than faith in the very institutions that created the problem.  Not enough money in the treasury? Just print more and dilute its value even further instead of dealing with the real problem.

The question that's never asked is what role do the middlemen play in all this?  They're right in front of you but only visible in their deeds.  When the news cycle is full of reports on deepening national debt,  failing banks and financial market corruption you see their handiwork.    

Economies are driven by markets.  Markets provide products to consumers.  Money is not a product even if the Wall Street currency traders  and economic strategists think it is.  It's simply a facilitator, a mechanism for exchange between parties.   If we apply the same criteria to it as we do a profiteering middleman, the reason for all this economic strife becomes obvious.   We've assigned a value to the worthless.