Efficiency and effectiveness arising from adaptation to random market variation

From Alchemy: The Dark Art and Curious Science of Creating Magic in Brands, Business, and Life by Rory Sutherland.

To people who see intelligence as the highest virtue, this all seems hopelessly unmeritocratic, but that’s what makes markets so brilliant: they are happy to reward and fund the necessary, regardless of the quality of reasoning. Perhaps people don’t ‘deserve’ to be rewarded for being lucky, but a system that did not ensure the survival of lucky accidents would lose most of its value. Evolutionary progress, after all, is the product of lucky accidents. Similarly, a system of business that kept empty restaurants, say, open through subsidy, simply because there seemed to be some good reasons for their continued existence, would not lead to happy outcomes.

The theory is that free markets are principally about maximising efficiency, but in truth, free markets are not efficient at all. Admiring capitalism for its efficiency is like admiring Bob Dylan for his singing voice: it is to hold a healthy opinion for an entirely ridiculous reason. The market mechanism is loosely efficient, but the idea that efficiency is its main virtue is surely wrong, because competition is highly inefficient. Where I live, I can buy groceries from about eight different places; I’m sure it would be much more ‘efficient’ if Waitrose, M&S, Lidl and the rest were merged into one huge ‘Great Grocery Hall of The People’.

The missing metric here is semi-random variation. Truly free markets trade efficiency for market-tested innovation that is heavily reliant on luck. The reason this inefficient process is necessary is because most of the achievements of consumer capitalism were never planned and are explicable only in retrospect, if at all. For instance, very few companies ever tested the effects of offshoring their call centre operations to countries with low labour costs – it simply became the fashionable thing to do, such was the level of enthusiasm for cost-reduction.

The following is a perfect illustration of the tendency of modern business to pretend that economics is true, even when it isn’t. London’s West End theatres often send out emails to people who have attended their productions in the past, to encourage them to book tickets, and it was the job of an acquaintance of mine who worked as a marketing executive for a theatre company to send out these emails. Over time, she learned something that defied conventional economic rules; it seemed that if you sent out an email promoting a play or “musical, you sold fewer tickets if you included an offer for reduced-price tickets with the email. Conversely, offering tickets at the full price seemed to increase demand.

According to economic theory, this makes no sense at all, but in the real world it is perfectly plausible. After all, any theatre selling tickets at a discount clearly has plenty to spare, and from this it might be reasonable to infer that the entertainment on offer isn’t all that good. No one wants to spend £100–£200 on tickets, a meal, car-parking and babysitting, only to find that you would have had more fun watching television at home; in avoiding discounted theatre tickets, people are not being silly – they are showing a high degree of second-order social intelligence.