The Balancing Of Market Information

by , Oct 25, 2012, 11:40 AM
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In my three previous columns on disintermediation, I made a rather large assumption: that the market will continue to see a balancing of information available both to buyers and sellers. As this information becomes more available, the need for the “middle” will decrease.

Information Asymmetry Defined

Let’s begin by exploring the concept of information asymmetry, courtesy of George Akerlof, Michael Spence and Joseph Stiglitz.  In markets where access to information is unbalanced, bad things can happen.

If the buyer has more information than the seller, then we can have something called adverse selection. Take life and health insurance, for example. Smokers (on the average) get sick more often and die younger than non-smokers. If an insurance company has 50% of policyholders who are smokers, and 50% who aren’t, but the company is not allowed to know which is which, it has a problem with adverse selection. It will lose money on the smokers so it will increase rates across the board. The problem is that non-smokers, who don’t use insurance as much, will get angry and may cancel their policy. This will mean the “book of business” will become even less profitable, driving rates even higher.   The solution, which we all know, is simple: Ask policy applicants if they smoke. Imperfect information is thus balanced out.

If the seller has more information than the buyer, then we have a “market for lemons” (the name of Akerlof’s paper). Here,  buyers are  assuming risk in a purchase without knowingly accepting that risk, because they’re unaware of the problems that the seller knows exists. Think about buying a used car, without the benefit of an inspection, past maintenance records or any type of independent certification. All you know is what you can see by looking at the car on the lot. The seller, on the other hand, knows the exact mechanical condition of the car. This factor tends to drive down the prices of all products --even the good ones -- in the market, because buyers assume quality will be suspect. The balancing of information in this case helps eliminates the lemons and has the long-term effect of improving the average quality of all products on the market.

Getting to Know You…

These two forces -- the need for sellers to know more about their buyers, and the need for buyers to know more about what they’re buying -- are driving a tremendous amount of information-gathering and dissemination. On the seller’s side, behavioral tracking and customer screening are giving companies an intimate glimpse into our personal lives. On the buyer’s side, access to consumer reviews, third-party evaluations and buyer forums are helping us steer clear of lemons. Both are being facilitated through technology.

But how does disintermediation impact information asymmetry, or vice versa?

If we didn’t have adequate information, we needed some other safeguard against being taken advantage of. So, failing a rational answer to this particular market dilemma, we found an irrational one: We relied on gut instinct.

Relying on Relationships

If we had to place our trust in someone, it had to be someone we could look in the eye during the transaction. The middle was composed of individuals who acted as the face of the market. Because they lived in the same communities as their customers, went to the same churches, and had kids that went to the same schools, they had to respect their markets. If they didn’t, they’d be run out of town. Often, their loyalties were also in the middle, balanced somewhere between their suppliers and their customers.

In the absence of perfect information, we relied on relationships. Now, as information improves, we still want relationships, because that’s what we’ve come to expect. We want the best of both worlds.

2 comments on "The Balancing Of Market Information ".

  1. Durk Price from eAccountable
    commented on: October 25, 2012 at 11:59 a.m.
    Relying on my gut instinct, I really liked this post. While not necessarily a pitch for "social media" the post acknowledges by inference that you can't ignore the possibilities behind it either.
  2. Kenneth Hittel from Ken Hittel
    commented on: November 11, 2012 at 1:12 p.m.
    Gord, I will happily second your conclusion, "We want the best of both worlds." But there's still room for some nuance here. Since you referenced the life insurance industry, let's considered: In 1996 I listened to John Patrick, internet evangelist at IBM, tell my company's Executive Management Committee, "Get rid of your agents or go out of business." Not just premature, but grossly wrong. But the EMC was just as wrongheaded on their end: Provide price quotes, tell people how much our products actually cost? God forbid -- we'll put our agents out of business. Things have been gradually changing over the last 15, 10, 5 years. Companies like New York Life, which once proudly published the article, "Looking for a Quote? Not here," are now providing price quotes for term life insurance. MetLife is not only providing quotes, but selling online. I remember a MetLife exec exclaiming, "You'd be surprised how much life insurance you can sell when you tell people how much it costs." Removing the price information asymmetry (actually just easing it a bit: most products are never quoted) has been a big step towards selling MORE life insurance. And not necessarily by cutting out the middle man, the agent or broker. Quite the contrary, armed with detailed information about the products, how they serve as solutions to common financial needs, and HOW MUCH THEY COST, newly enables people to establish the wanted one-on-one relationship with the financial professionals in their communities. Disintermediation? Certainly. Re-intermediation? Just as certainly, when companies are smart enough to ease life insurance information asymmetry.

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