The impact of finanicalization on retail

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Use the readings below and attached to answer the question below

Reading 1:

Reading  2:

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What are your thoughts on financialization and its impact on retail? Have we entered a new commercial age? Is this just another wrinkle in a constantly evolving marketplace for goods?

I thought it might help to provide a little context on the subject of financialization and its influence on retail. Let’s begin by defining our terms. When I talk about financialization here, I am referring to the idea that profit making increasingly occurs through financial channels rather than by making and selling things. Where Henry Ford made money by making and selling cars, today the Ford Motor Company makes a large share of its profit through Ford Credit by financing the sale of its products.

Certainly in recent decades the financial sector of the economy has grown relative to other sectors. To use the old economic pie analogy, the slice devoted to finance, insurance and real estate has gotten bigger while some of the other slices, like the one devoted to manufacturing have gotten smaller.

This all seems pretty innocuous, but it has a huge impact upon our daily life, including what we buy and where. Yet, we rarely stop to examine this phenomenon. If anything, we tend to see it as an inevitable fact of economic life, the result of some natural force of economic evolution. In reality it has been fostered by a series of laws, legal opinions and changes to the tax code.

That is not to say there was some kind of grand conspiracy to “financialize” America. I think it was more a matter of choices that at each point seemed to make sense but collectively had the effect of transforming our economic and social order. To be sure, people and organizations with a vested interest in those decisions tried to influence them in what they saw as a favorable direction – and sometimes their influence carried the day. However, I think the world is far too complex for any cabal to run things.

A bit of historical perspective

Corporations have been with us for a very long time – but not in the form we know them today. There was a time when most businesses were either sole proprietorships or partnerships. In America, corporations with the legal protections they offered investors and their potential to wield power were generally thought to be justifiable only in special cases that required exceedingly large amounts of capital, the most dramatic examples being things like the construction of the Erie Canal or later the transcontinental railroads.

That began to change in the late 19th century. Advances in transportation and communication made it possible for people to run businesses that were truly national in scope. Building those businesses required large amounts of capital, and corporations provided an ideal structure for attracting investors. The rush was on – but not without opposition in politics and in the courts.

In 1878, the California legislature passed a new state constitution that struck at the power of the railroads. Under this constitution, individuals were allowed to deduct their debts from the value of their property when computing their taxes. Corporations, however, were not allowed to do so because they were not individuals.

The railroads promptly refused to pay their taxes. Several California counties took the railroads to court to force them to pay. Not surprisingly the issue ultimately wound up before the U.S. Supreme Court which ruled against Santa Clara County. Essentially, the court said the equal protection clause of the 14th amendment (which had been passed to ensure the constitutional rights of newly freed slaves) also applied to corporations. The court, in effect, had granted a sort of legal personhood to corporations, a turn of logic that 130 years later would lead the U.S. Supreme Court to rule that limiting the amount of money a corporation could contribute to a political campaign was a violation of its first amendment freedoms.

Certainly, this one case in 1878 is not solely responsible for the new role corporations would play in our society. But it was an important first step – and it is a very clear signal of the changing nature of corporations in America.

Many politicians of the late 19th and early 20th centuries argued against these changes. In 1896 William Jennings Bryan electrified the national Democratic convention with his speech in which he blasted the financiers and corporations of his day. His speech won him the party’s presidential nomination. The Republican president Teddy Roosevelt (1901 – 1909) wanted to break up the big companies – or trusts as they were called. He feared they would lead to a concentration of wealth and power that would erode our democracy.

William Jennings Bryan “Cross of Gold” Speech (1896 / 1921) [AUDIO RESTORED] – YouTube

Over time, as corporations became more ingrained on the American scene, these issues would lose salience. In our post-modern age, national corporations have been replaced by multinational ones. Big business is old hat. Today, no major presidential candidate of either party speaks out against corporations with the same intensity as their predecessors did a century before.

Some might even argue the American entrepreneur’s dream is no longer to create a company, manufacture a better widget more efficiently than anyone else and get rich. Instead today’s Horatio Alger wants to create a company that manufactures or sells something that captures the imagination of investors and then get really rich by selling stock. The one is a dream dependent upon production, the other is a dream fueled by speculation. Fortunately for today’s Horatio an army of financiers stand by with an array of financial instruments to spin speculation into gold.

An example

What does all of this have to do with shopping? Well, let me illustrate with a hypothetical example.

Our story begins with a family owned department store. Members of the family had been merchants in Europe for generations before coming to America. They knew how to read and please their customers.

Once they are settled in America they opened a store. Thanks to the fact that they were such good merchants, the store is a success. It grows into a department store; then they open another location. The floors are staffed with knowledgeable salespeople; when people come to them they can offer advice about which products would be best for the customer. In turn, they build long term relationships with their customers. With their salary and commission these salespeople are able to build a middle-class life.

Grateful for their success in America, the owners are proud to contribute to charitable causes in the community. It is a way of giving back – and it builds goodwill for the store.

Running a business like this isn’t cheap. Good salespeople cost money. High quality goods, the kind customers won’t find at competing stores, often carry a narrower profit margin. Then there are promotion costs and the money given to charity. Nevertheless, the store provides a very nice lifestyle for the owners who are making a living doing something they like.

Of course, there are headaches. There always are with any business. And the local banker has to be paid back for the loans that financed their expansion. Still, they are the boss. They get to call the shots.

Now, let’s attach some completely fictitious numbers to that scenario just to help make my point. (The numbers are all expressed as 2020 dollars to avoid inflation adjustments.) Suppose the stores gross $5 million and expenses take up 90%. At the end of the year the owners are left with a $500,000 profit.

Over time their community grows and people begin moving to the suburbs. Thanks to changes in the tax codes, financiers are creating real estate investment trusts which are financing the construction of shopping malls. Their store is a highly sought after tenant for these properties. After all, the store is well known both for the quality of its goods, its excellent service and its reputation for community service. A company needs anchor tenants for the six malls it is building across the region, so they work financing packages to make the expansion possible.

The store goes public

The store has hit the big time. They work their same formula, providing more decent paying jobs for salespeople and expanding their charitable work into the new communities. Expenses rise dramatically. The six stores are grossing $12 million, but expenses are running $11 million. Still, profits have grown to $1 million and the family is happy.

Plus, with the increased volume the store can now draw designers to do special events at their locations. This boosts their visibility, and the store catches the eye of some investment bankers. They approach the owner’s with a proposal to take the store public, meaning they will sell shares of stock in the store. The money they offer is incredible.

The investment firm argues that malls all over America are willing to make the same sort of deal the store struck with the regional mall developer. Stylish stores with solid reputations are in demand. The owners will make more money than they ever thought possible, the investment bankers will make money putting the deal together, and the malls will make money by having a good tenant. It is win-win-win say the financiers.

Who can resist an offer like that? Soon the stores are sprouting like mushrooms. Only the people who are investing are not merchants. They are money managers and their mission is to achieve a certain rate of return on their investments. Makes no difference to them whether they invest in department stores or oil fields; it is all a matter of allocating risk and maximizing returns.

The problem is the family can’t run their stores they way they used to and achieve the rate of return the investors expect. To achieve those numbers the family must quit purchasing the highest quality goods and go for store brand items with bigger profit margins or reduce staff and take them off commission. The finance guys bring in consultants to boost profit. The exclusive merchandise goes – and slowly so do the customers. It’s just not as much fun to shop at the store anymore. To keep profits up, the store outsources their store brands to overseas suppliers. Customers still drift away. So, the store has to reduce its workforce, then take them off commission and finally end up with a skeleton crew earning substantially less than the employees once did.

From there, it’s a matter of scraping nickels and dimes to make the numbers the shareholders require. The original investment bankers are long gone, having pocketed the profits from putting the deal together. Customers are now turning to the Internet. The mall building boom has evaporated; there are no more sweetheart financial deals to open new stores.

The shareholders and the family are all unhappy. They suspect a new investment bank is considering a hostile takeover purchase with the idea of breaking up the chain into smaller regional companies.

Fortunately, not every financialization story has such an unhappy ending. Some stores will emerge as juggernauts. As you know from your readings, investors will also transform some of the designers and producers supplying these stores into billion dollar businesses.

The point of this long and labored example is to walk you through a scenario that illustrates how the financial markets can affect what you see in the stores, where those products are made, even the nature of your shopping experience.

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