On the Physical Effects Fallacy
This post was prompted by something I read over at Absolutely No DooDahs. As I’ve said before, most of the commentary on Bill’s blog is highly intelligent. So, I feel bad about singling out this most unintelligent (and most unrepresentative) post. However, this myth has been around for several centuries, and has enjoyed the support of some otherwise intelligent individuals; so, it is in desperate need of dispelling.
Regarding Anheuser-Busch (BUD) and Coca-Cola (KO), Bill wrote:
Colored, flavored corn – syrup water doesn’t generate brand loyalty, and neither does fermented hops and barley malt. The desired effects of either can be gotten with off-brand products and substitutes.
This statement is false. The desired effects can not be gotten with substitutes. The demand for a product is not determined by the physical effects of that product on the user.
Most misinterpretations of economic activity begin with a failure to properly define economics as the study of human choice. If the field is further limited in scope, it can no longer explain commerce. In other words, a unified theory of economics must explain all human actions, because humans do not have one “program” for making economic choices and another “program” for making non – economic choices.
The demand for a product is derived from that product’s (expected) ultimate impact. I’m using the word “impact” simply because I want to conjure up the image of the mind as something that is being stamped or imprinted. In ancient times, the idea of the physical world “stamping” the mind was popular, and I think it’s an apt metaphor in this case.
Humans act to effect changes in their mental states; humans do not act to effect changes in their physical state. Human actions that appear to be motivated by a desire to alter one’s physical state are actually motivated by a desire to alter one’s mental state. That’s where the “ultimate” half of “ultimate impact” comes from. Alterations to one’s physical state are merely desirable insofar as they lead to alterations in one’s mental state.
Let me use a few examples. You don’t eat to prevent starvation; you eat to eradicate the sensation of hunger. You don’t take your hand off a hot stove to prevent further burning of your flesh; you take your hand off a hot stove to prevent further pain.
I’m not just splitting hairs here.
Humans are rational in the sense that they act to maximize pleasurable mental sensations and minimize painful mental sensations. They are not rational in some greater sense. For instance, humans have no inherent desire to live, they merely tend to believe living is the more pleasurable state. Some humans weigh all the pleasure and all the pain and find they’d prefer a quick exit. Many rational people have committed suicide under extreme circumstances. The fact that under normal circumstances most rational people do not contemplate suicide doesn’t necessarily mean we are hard – wired to live, it could simply mean we are hard – wired to seek pleasure, and for most of us death is the greatest displeasure.
It’s important to dispel the myth of physical primacy to understand what products really are. They are far more than their physical properties. They are agents of change.
For whatever reason, many people have trouble recognizing the fact that the physical properties of a tangible good are only important insofar as they effect changes in the user’s mental state. I’m not sure why this is.
We all know that if you were eating something particularly delicious and I began to describe a festering, rotting, rancid, pus – filled something or other, you would no longer find your meal quite so tasty. I did not alter your physical state (directly). Rather, I effected physical changes by first altering your mental state. The gagging isn’t the important part. That came after your mental state was altered.
Obviously, we all know about the placebo effect as well. If you give someone a sugar pill and say “this is a sugar pill” and you give someone else a sugar pill and say “this is a drug” you get two very different results. In reality, you have two different products.
The fact that both pills are physically identical is immaterial. An identified sugar pill is different from an unidentified sugar pill as far as human minds are concerned. Human minds take human actions and human actions are all there is to the economy. Therefore, an investor needs to concern himself solely with how products are perceived by human minds. Products’ physical properties are unimportant except insofar as they affect those perceptions.
There can be no doubt that Coke and Bud both generate brand loyalty. They are highly differentiated products. As I’ve said before, most people view Coke and Pepsi as being very different products (they may place them in the same class of products, but they do not view them as true substitutes).
There are many other competing products that are less similar physically and yet also less differentiated in consumers’ minds. Drugs are an excellent example. Some competing drugs have very different physical properties, but they tend to be poorly differentiated. In fact, if the efficacy of prescription drugs wasn’t tested in any way, and doctors were willing to hawk sugar pills, people would buy them – and I’m sure a lot of people would swear by them. After all, a lot of people already swear by various herbal supplements that do absolutely nothing.
So, if you want to make the argument that there’s something unethical about selling Coke or Bud rather than a cheaper generic, you might have some standing. But, to argue that “the desired effects of either can be gotten with off-brand products and substitutes” is absurd.
By that logic, a Red Sox fan could get the desired effects of rooting for the Red Sox by switching over to rooting for the Yankees. Yet, somehow, I think the rights to broadcast Red Sox games in New England are a lot more valuable than the rights to broadcast Yankees games – and I don’t think that will be changing anytime soon.
By the way, I do agree with Bill’s assertion that Bud and Coke are not the best options for individual investors, because Buffett’s options are greatly limited by the amount of capital he has to deploy. Neither of these stocks is super cheap right now. But, they are great businesses and great franchises.