Transaction costs

Admin note: We're coming up on finals at Uni, so I'll only be posting every two weeks for the next little while. Sorry for the inconvenience, hopefully back to the usual schedule in early December. 

We’ve had a lot of economics lately and I had hoped to do a history post for today, but that one hasn’t panned out (yet). Instead, today I thought we could talk about transaction costs: the barriers in the market that get in the way of trade. I think these are a powerful force in our marketplace: the key driver of the revival in FPs, the reason we have an online community, and even the success of Goulet Pens. It is a topic that is well worth exploring. 

All of this falls within a branch of economics called Transaction Cost Economics (TCE), the area into which my research falls. TCE largely accepts the basic idea of supply and demand but we disagree with some of the assumptions. For instance, that model assumes everyone has perfect information: this certainly makes modelling easier but it’s hardly representative of the real world. 

In reality, people have to go out and search for information — try to find out what pens are available, what colours and nib sizes, whether it is high quality or not — and sometimes that search takes a lot of time and effort. If it takes too much effort, people stop searching (or they don’t bother in the first place). And that means some transactions that would have benefitted us — both buyers and sellers — don’t occur. So while actual demand for a product could be quite high, large information costs might mean that effective demand is much lower. (For those who know the basic supply and demand model, we’d represent this as a contraction in demand.)

Information costs can affect sellers as well. If a brand can’t get information to the buyers, it’s going to affect their ability to sell product. If they can’t get information that a group of buyers exist, businesses may not start up and they may not produce the kinds of products people want to buy. So transaction costs can have an effect on both supply and demand, and can have a sharply negative effect on the size of the market.  

Information costs are just one of the three main categories of transaction costs, the others being negotiation and enforcement costs. Negotiation costs are large in some markets but I don’t think they are significant for FPs — they certainly occur but they don’t take months and teams of people to conduct. So we’ll leave those aside for now. Enforcement costs are the effort of ensuring a sale or contract is fulfilled — that you get what you are paying for. I think this is an important consideration in the secondary market, but we’ll explore that more in a future post. For today, my focus is on information costs and how these costs have shaped the marketplace. 

If you imagine being an FP enthusiast in the late 1990s, it is a starkly different environment to today. There are no online stores, no online community and most brands don’t have websites. You really have only a few avenues by which you can experience the hobby: most cities would have had a store selling FPs, a handful of cities would have had social groups of FP users, and there were some mail-order services. I believe there were also one or two magazines floating around, but that was pretty much it. 

In other words, there wasn’t a whole lot of information available. Even if you were fortunate enough to live near a retailer, you still only had access to a limited product range. If you didn’t like the selection of pens (or prices) at that store, you were pretty much out of luck. They might be able to special-order some pens for you, but that would require you to know what sort of pens were available, and which would suit your preferences. 

This would have had some interesting effects: first, the market for FPs would have been quite small. Any potential buyers unhappy with their local retailer(s) would have just dropped out of the market. The small size of the market would mean that brands have smaller economies of scale — in other words, that pens would have been more expensive because the production costs could not have been spread across many units. In turn, that would mean higher inventory costs for retailers, who would respond by  carrying a smaller selection and only carrying models that were likely to sell. Nothing too exotic, nothing beyond the mainstream: lots of black pens, lots of gold trim, lots for the ‘average’ buyer, and none for an individual. 

Of course, once there’s a smaller selection at the retailers, then the market becomes smaller again, so costs go up even more — the whole thing keeps shrinking until it reaches some equilibrium where there are few buyers and most pens are quite expensive. I think this is an accurate reflection of pen stores in the 1990s. 

And remember: this is the market facing people who are already interested in FPs. For potential enthusiasts, there’s almost no way of breaking into the market: unless you have access to a mentor or a group, you’re not really going to be aware that FPs might suit you, let alone know how to access that market. The same applies for entrepreneurs who might have considered entering the market: there were not strong incentives for new firms to enter with low-cost products that are only profitable with a reasonably large volume. 

From my perspective, this is a world where retailers are willing to produce and sell a lot of product and a lot of buyers are out there, willing to buy a lot of product, but the supply and demand curves really aren’t marrying up as they should. It’s too hard for buyers to find out about the brands and the products and it’s too hard for the brands to find the buyers, so the entire market settles at a equilibrium which is well below its potential. And all of it is because information is too costly to acquire. 

When I visit B&M stores, I’m struck by how many of them are still stuck in the mindset of the 1990s. The days when buyers had no alternatives and retailers could slap on a huge markup are long gone. Some of them don’t realise it and still think they are serving a tiny, elite clientele — that they can afford to be dismissive of buyers who are younger or don’t fit the store’s idea of elite. Many with this mindset have been forced to close their doors, many others are likely to fail if they don’t adapt. I won’t shed any tears for them. 

It’s easy to say that this business model has been undermined by the internet, but it’s more accurate to say that it has been undermined by the availability of information. It still requires time and effort to access information about brands, products, retailers, etc — but it is available. As enthusiasts found each other online, they shared what they knew, and began pooling it and building up valuable resources like FPN. All of it with the intention of making the experience of buying and enjoying FPs easier — or, in technical terms, economising on the costs of information. 

Today, blogs and social media are central in this. I think for almost every blogger out there, part of their motivation in blogging is to share information that they have come across. Whether it is information they have researched or just the result of their experiences, there is an absolute treasure trove of details available. Questions about product quality and suitability can be answered without needing to order something and experience it directly. And for any information which can’t be found, there are invaluable resources like FPN and reddit where experts reside and are willing to share their knowledge. 

Nowadays, most of us who have come into the hobby have benefitted by the work done by many others who went before us. And we all feel some amount of gratitude for that, and reciprocate by trying to share what we’ve learned with others who are searching it out. That is why we start blogs, that is why we participate on forums and social media. This is the driver of our participation, and the wonderful sense of community is a happy consequence. 

All of this activity has effectively increased the demand for FPs but arguably supply has benefitted just as much. Brands have far greater ability to ‘see’ their customers nowadays: to know who is buying, and where, and why, and are increasingly able to communicate with those customers and incorporate their preferences into product design. Retailers, too, have been able to recognise that FP demand is not concentrated in urban niches but is spread out throughout the world, and have adapted to that. Most online retailers are able to ship to most countries around the world, enabling buyers to enter the hobby who were once prevented from doing so. 

Perhaps the biggest driver and beneficiary of this process has been Goulet Pens. I can’t think of anyone who has invested as much time into educating  newbies and building a repository of knowledge as the Goulets and their team, nor any other business that has grown so much on the back of it. Brian’s videos have reduced the information costs faced by new enthusiasts and increased demand for FPs; they have also reduced the information costs faced by brands, by helping them to find buyers and facilitating the entry and success of new supply (particularly Noodlers and Twsbi). 

(I know Brian credits a lot of his success to the ideas of Gary Veynerchuk, but I think TCE offers an alternative explanation for the success of Goulet Pens. Veynerchuk’s view would be that success was built on the back of social media and the creation of a passion-based community; TCE would say economising on information costs created a market for the Goulet business. The Veynerchuk view essentially claims that this could work for most businesses; TCE’s view says that this only works in an environment where information costs are large. It might not seem important why a business was successful in the past, but it certainly matters when it comes to making decisions about sustaining success.)

The gap between actual demand and effective demand has grown narrower. We have moved from one equilibrium to another, where there are many more enthusiasts included in the market and many more opportunities for retailers like the Goulets and brands like Twsbi. The industry has gone from a niche serving a wealthy, elite clientele to one that is far more egalitarian and democratic. 

Economising on information costs has been the fundamental factor behind these improvements, but I don’t believe these costs are fully reduced yet. Even though the information is now available online, in most cases it is not well organised and certainly not as accessible as it could be. This is why I am such a big fan of Pennaquod, an FP-specific search engine created by Ian Hedley of Pens! Paper! Pencils! It was the first big step towards improving accessibility, but ironically I think the search engine is not well-known (particularly amongst beginners). We need to do better at organising everything that is available online. 

I also think we can do better at providing specialist information about brands, retailers, and geographies. If you want specific information about Montblanc, you can go to the MB forum on FPN. For vintage Esterbrook, you can hit up Brian Anderson or the Esterbrook forum he moderates. But if you want information about Visconti, Sailor, Twsbi, or dozens of other brands, it is not centrally located and there are opportunities for people who are passionate about particular brands to get involved with this. Every week, I get questions from bloggers who want advice on getting started or becoming popular, and my main piece of advice is to specialise in a niche topic you love. That is how you stand out from the crowd, how you attract interest from readers and sponsors. 

I've previously argued, and still think, that information about specific retailers is lacking. There are good retailers and bad retailers, ones who will go the extra mile and ones who offer zero customer service. While there has been some activity on the dedicated subreddit, this is generally an area where the community could improve. 

Geographic specialisation is another area. There are markets beyond the US where buyers want more information about which retailers are best to deal with; who is reliable, ships quickly, or offers good deals. I co-created a Facebook group for Australian FP folks on this basis, which has been quite successful — more than 200 members, lots and lots of discussion about these issues. Plus we have a local retailer on board, sponsoring giveaways. I’m surprised the guys behind United Inkdom haven’t pursued something similar (yet), and I’m sure there are other countries where buyers would benefit from improved local knowledge.  

Ultimately, I think my point here is clear: transaction costs matter. And for our community, none matter more than information costs. While we’ve made good progress on reducing these costs, there is still room for improvement. My hope is that I can highlight the underlying forces and help others to recognise the benefits of sharing information and enabling community, and to see how this benefits buyers, sellers, and enthusiasts alike.