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Monday, March 20, 2017

The “Amazon Effect” Is Creative Destruction at Its Finest

The consumer is king in the market economy.

The chart below shows the phenomenal 127.5% rise in Amazon’s stock over the last two years, compared to a 18.5% increase in the NASDAQ Index (green line), an 11.3% increase in Apple shares (red line), and a nearly 15% decrease in Wal-Mart stock (purple line) over that same period.

That rise in Amazon’s stock price is from the “Amazon Effect” and the “Amazon Doctrine,” which are described below as they relate to an article in today’s Detroit Free Press titled “Gander Mountain latest sports retailer to fail.” Here’s an excerpt of that article (emphasis added):

Outdoor goods company Gander Mountain is the latest retailer to falter under competition from online sellers, announcing that it has filed for bankruptcy protection and will close dozens of stores. The St. Paul, Minn-based chain says that it will begin shuttering 32 stores over the next several weeks. It filed for Chapter 11 bankruptcy protection on Friday in the face of dwindling store traffic and shelves stocked with more goods than it was able to sell.

Throughout the retail sector, traditional stores, from big box chains to specialty shops, have struggled to entice shoppers through their doors as consumers increasingly do their buying online. Last month, roughly 14% of retailers monitored by Moody’s Investors Service could be deemed “distressed.’’ And several chains have sought bankruptcy protection, including American Apparel, Wet Seal, and The Limited.

But the sporting goods sector appears to be in particular peril, with e-commerce competitors often offering consumers more options for lower prices. There have been at least ten other bankruptcies among sports chains with over $10 million in liabilities in the last year and a half.

Prior to Gander’s announcement, MC Sports was the most recent sports retailer to seek bankruptcy protection, saying last month that it would close 68 locations. That move that will wipe out 1,300 jobs throughout the Midwest. Others shutting their doors include Sports Authority, once the second biggest sports retail company in the U.S., which shuttered more than 400 locations when it liquidated last year. Golf equipment giant Golfsmith filed for bankruptcy protection in September, and Sport Chalet, a southern California-based chain closed in 2016 after being in business for 57 years.

Here are some economic lessons from the demise of Gander Mountain:

Creative destruction are the consumer’s best friend, and ultimately the best friend of economic progress and job creation in the long run.

1. The forces of creative destruction, including the destruction of jobs, are unstoppable and beneficial to the economy. Economic progress and job destruction go hand in hand, as economist Richard McKenzie explained in the Wall Street Journal 25 years ago. This recent wave of job destruction in the retail sector is a good thing, and should not be impeded or stopped.  That is something that Team Trump should keep in mind as they pursue their  misguided public-policy philosophy of jobism, which mistakenly makes the count of jobs the key measure of a country’s economic success or failure. While Team Trump is quick to blame outsourcing and international trade for US job losses, it’s important to recognize that the domestic forces of innovation, disruption, technological advances, creative destruction, competition and changing consumer tastes are even more to blame for the loss of jobs in this country. But while bankruptcies and job losses are usually reported as bad news, there is an upside to these business closings – they release resources and labor to be re-deployed to other sectors of the economy that are growing and are doing a better job of operating efficiently and pleasing consumers. To quote Richard McKenzie, “Revitalized competitiveness mandates a willingness to replace much that is old with much that is new. It requires widespread (not wanton) job destruction.”

2. Consumer sovereignty – consumers are the ultimate rulers (kings and queens) in the market economy and they — not producers — “run the show.” Producers, sellers and retailers are constantly at the mercy of consumers’ changing tastes, behavior, and buying habits. As US consumers increasingly prefer doing their shopping online for more convenience, greater selection, and lower prices, traditional brick-and-mortar stores will continue to struggle and many more will disappear. This trend should be welcomed as a sign of economic progress and job creation. To help the economy grow to its full potential, we have to be willing to tolerate (and welcome) job losses and business closings.

3. Consumer greed. While the term “greed” is frequently used for CEOs, corporations and businesses, it’s almost never used to describe the behavior of consumers. Just do a Google search of “corporate greed” and “consumer greed” and you see that there’s a ratio of about 67-to-1 in favor of “corporate greed.” But I think the term “greed” describes pretty accurately the behavior of most of us consumers, who have a laser-like focus on low prices, high quality, large selection and speedy delivery. Therefore, Gander Mountain’s demise should be blamed on “consumer greed.” If “greed” is too strong of a description, substitute the term”enlightened self-interest” to describe consumer behavior. But either way, if US consumers weren’t so damned concerned about low prices and their own convenience, Grander Mountain wouldn’t have declared bankruptcy.

4. The Amazon Effect is a term used to describe the incredibly disruptive effects Amazon is having on the retail industry as it revolutionizes retailing, supply chain management and delivery, with a laser-like focus on creating value for consumers. Related to the Amazon Effect is Amazon’s official corporate version of consumer sovereignty known as The Amazon Doctrine (featured here), summarized here:

Above all else, align with customers.

Win when they win.

Win only when they win.

There may be no other large company operating today that better illustrates the economic concepts of creative destruction and consumer sovereignty than Amazon – to the significant benefit of consumers, who are the direct beneficiaries of Amazon’s success as an internet-based online retailer. The remarkable rise in Amazon’s share price (illustrated above) is a market measure of its success at fulfilling The Amazon Doctrine of aligning with customers – its stock is winning in the market only because its customers are winning daily with low prices, a wide selection of great products and the convenience of shopping online from home – or from anywhere with a Smartphone. More than any other factors, it’s likely the combination of the Amazon Effect and Amazon Doctrine that are most responsible for Gander Mountain’s demise.

Bottom Line: Here’s my economic forecast for the retail industry: Expect continued and very strong hurricane-strength Schumpeterian gales of innovation from the Amazon Effect, with a high likelihood of market disruption and creative destruction including more brick-and-mortar stores and jobs disappearing, accompanied by huge tsunami-level tidal waves of increased consumer surplus in the future. Hurricane Joseph (Schumpeter) and creative destruction are the consumer’s best friend, and ultimately the best friend of economic progress and job creation in the long run.

Republished from AEI.

  • Mark J. Perry is a scholar at the American Enterprise Institute and a professor of economics and finance at the University of Michigan’s Flint campus.