Thursday, April 19, 2007

An Experiment in Capitalism

Great news! Capitalism works and I've got proof. Better yet, the proof is in the pudding, or in this case, in the soda.

Until a few months ago, my company was one of the few in Silicon Valley that did not offer free snacks to its employees. We had some subsidized vending machines in the cafeteria, where 35 cents would buy you a soda or a snack. A few months ago, my company got generous and started offering free soft drinks and snacks. Here are my conclusions and observations regarding this natural experiment in market economics:

Observation: In the vending machine age, product shortages were very rare. In the age of the free for all cafeteria, shortages are a weekly phenomenon. The cafeteria is stocked every Monday, and by Thursday pretty much everything is gone. Friday is a good day to be on a diet. Vending machines were also stocked on Monday of each week, yet rarely ran out of stock.

Conclusion: Vending machines are the equivalent of capitalism. Goods (snacks) have a market rate and are allocated only to those customers who value them most and are willing to pay the appropriate price. Since the vendor has a financial incentive to maintain a stock of product to sell, if the machines run low, they are quickly re-stocked (although in practice, that was rarely necessary).

The free-for-all cafeteria is the equivalent of communism. Everyone collectively owns a fixed stock of goods (a ration). Even if you place little or no value on a product, there is no incentive for you to hold back. The worst case scenario for grabbing a snack is that you leave it uneaten on your desk. Goods are allocated on a first come, first served basis, which is an added incentive for over-consumption, waste and probably hoarding.

Observation: In the vending machine age, products were offered based on user demand. If a product did not sell, it was quickly removed and replaced by something more popular. In the free for all cafeteria no inventory management or product management of any type is performed. For example, the cafeteria offers several types of soda, Diet Coke being the most popular & Doctor Pepper being the Jiggly of the soda world. Even though all the Diet Coke is gone by Tuesday afternoon, and some Doctor Pepper cans still lingering until late Thursday, the same levels of stock are ordered on a weekly basis and user preferences are not considered.

Conclusion: Because there is no penalty for getting the wrong product mix, nor is there an incentive for actively managing supply, the program is allowed to run on auto-pilot, with little prospects for improvement. Once again, its all about financial incentives. It strikes me that our free-soda program is run as a cost center (and costs are managed down), while the vending machine was run as someones profit center (and profits are managed up). This is the root cause of the striking difference between the two programs.

The bottom line is that the switch to free sodas ended up as an expensive bargain, at least for me. Where before I could get a drink for 35 cents at any time of day or night, now I get my favorite drink on Monday and Tuesday for free, but have to drive to the supermarket to get $1 soda on Thursday and Friday, and settle for second best on Wednesday. If I happen to work late and want a drink late on a Thursday evening, I am often out of luck.

Did you really need proof? Capitalism works. Let's stick with it. In the large scheme of things, I think that our little natural experiment also shows that sometimes supposedly free benefits end up being more expensive for the very group that they are supposed to help. A real world example of this phenomenon that immediately comes to mind is rent control.


plonkee said...

This is a very interesting description of economic systems, I like it.

The market is indeed a natural system for many commodities. It does not necessarily apply to everything. Some things - like healthcare - are not best suited to a true capitalist market if we have aims other than keeping cost down. Not using the market does mean that it will be more expensive though, there's always a trade-off.

Shadox said...

Thanks for a very valid comment. Of course, I completely agree with your statement.

There are many examples of market failures. These tend to involve lack of information, asymetrical information, or phenomena such as monopolies. In each of these, the markets do not work on their own and government (or other) external intervention is required to get a reasonable outcome.

Anonymous said...

Totally off the wall observation - at our office, the Dr. Pepper is the premium drink and the Diet Coke is the last choice.

Our snacks are on the honor system, so we have a middle ground - socialism maybe?

Shadox said...

It strikes me that there is a market opportunity. All we have to do is get the excess Dr. Pepper from my company and the excess Diet Coke from yours, ship 'em UPS ground and solve this inventory imbalance...