Last Thursday, during boot-camp, we were exploring the cavernous world of asymmetric information, and how it could lead to market failure. Information asymmetry occurs when one of two parties to an exchange has more or better information than the other party. This may give the incentive to the better-informed party to use this advantage to exploit the other. Examples occur all the time, like when you take your car to the mechanic and he suggests repairs you don’t need. Or when you take a taxi in an unknown city, and the driver takes the longest route to charge you more.
Week three of the boot-camp could be kind of a drag – as I hint during the first sentence – for some. Participants are three quarters of the way in to complete all the requirements – which include a lot of homework on accounting, marketing and basic economics – which they must fulfill satisfactorily to move to the next phase. They may start wondering “What does asymmetric information, and moral hazard, and adverse selection, and market failure have to do with the business idea I’m here to start?!!”
As I was trying to explain these concepts, imagining everyone posing themselves the above question in their head, a student participant interrupted and said something like: “In the last 10 minutes, with the few examples we’ve discussed, we just went through about four or five great business ideas right here, right now!” I was so immersed into making sure I could explain these concepts well that I had lost track of the basic undercurrent that ties all of them together.
I spent time thinking about this over the weekend, and it took me back to the 1990’s, and I realized several things. In the early nineties, the media in all its forms started talking about the information highway, and how it was going to revolutionize everything. And it did. If you were a well read and interested late teen or an adult back then and compare your life then to now, you have had the privilege of seeing the future become reality. The changes brought about by the internet are generational in scope, like the industrial revolution was.
So, what did I realize? Some of the biggest tech giants of today, in essence, are solving the information asymmetry problem. And people have flocked to them and the value they provide. As we explained last week, ways to solve the information asymmetry problem include, among others, making information less asymmetrical. Nobody wants a rip-off. The potential of a rip-off may make you forego needed regular maintenance on your car or your home A/C, or your knee or your diet, which may cause further damage and costlier repairs in the long run. That is a suboptimal solution – a case of market failure. Optimally, you would have enough information to assess that the maintenance costs are justified today since you would not have the costlier later repairs due to underservicing. The surprising thing, which should not be surprising after all, is that the internet – the information superhighway – is the basic undercurrent which has made all sorts of markets more efficient – making transactions more transparent – and increasing the level of prosperity for billions of people around the world.
We are now all more able than any time before to solve the information asymmetry problem daily. Think of the times when you looked for a rating on a product or a vendor on eBay, Amazon, Yelp or the like. Think of all the reviews you have read before going to watch a movie or buy a book. Think of all the times you browsed through Web MD to find out more about a physical ailment. Think of the blogs you have read or follow on nutrition, or exercise.
Still aware of the many ways in which information is manipulated, and the opportunities to exploit reviews and ratings, the fact that we also can navigate the market for information in search of the truth has made us smarter and better equipped to deal with everyday challenges. The vast availability of information has leveled the playing field – which is what market efficiency strives for – and made us all wealthier in many ways. This has come at a cost in some of the markets for information, specifically the need to sometimes sift through data and be able to decide what is valid or truthful or not. It has increased our need for discernment. Wisdom gives you that. Wisdom comes from experience. Experience comes from living through things. Youth puts you at a disadvantage for that. The ability to learn from the past, through interactions with older, more experienced people, or thoughtful research of original sources helps bridge the disadvantage. I guess there is a “discernment loop”. Live, read, research, interact, evaluate, validate, repeat. The information superhighway has enabled it for us like for nobody else in the past. Value creation ideas will continue to come out of this loop, make sure you are in the middle of it.