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Ode to the middleman

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Wednesday, Feb. 22, 2012

You hear them daily: advertising pitchmen exclaiming on radio and TV that this jewelry store or that furniture retailer "saves you money by bypassing the middleman!"

Seems sensible, doesn't it• Wholesalers and other middlemen don't work for free; they must be paid. So if a retailer "bypasses" or "eliminates" the middleman, that retailer has "savings" that it can "pass on to you."

But if middlemen only raise retailers' costs, why does anyone ever use such parasites to begin with?

Simply to ask this question about middlemen is to cast doubt on the widespread myth that the dominant effect of middlemen is to raise the retail costs of goods.

It's true that middlemen must be paid for their services. These services are valuable, however, because they reduce the final prices that consumers pay at retail.

Middlemen who fail to reduce the final price go bankrupt; these middlemen are "bypassed." But middlemen in general reduce the costs that consumers pay at retail.

To see the value of middlemen, it's helpful to realize that retailers themselves are middlemen. The furniture store that brags of "eliminating the middleman" by "buying direct from the factory" doesn't itself manufacture sofas, beds and dining-room tables. That retailer specializes in acquiring inventories of furniture and assembling these inventories in locations that are convenient for you to visit (such as the strip mall down the street).

If it were generally true that middlemen raise consumers' costs, you'd be foolish ever to buy furniture from a retailer -- including the one who "eliminates the middleman." You would be better off going directly to the factory to shop for furniture.

But you almost never do so. You buy furniture from retailers. The reason you don't "eliminate the middleman" -- the retailer -- when you buy furniture is that the middleman saves you money.

To "eliminate the middleman" here would require you to rent a large truck and drive it (depending on where you live) hundreds of miles to the nearest furniture factory. The factory owner might be willing to sell to you a nightstand or chair for less money than you'd pay at retail. But this price discount likely isn't worthwhile. Not only do you spend time and money driving to and from the factory; once at the factory, you can't easily compare that factory's offerings with the offerings of competing furniture producers. To make such comparisons, you'd have to get back in your truck and drive to other furniture factories.

By the time you do all this driving around, the price reduction that you get by "eliminating the middleman" won't be worthwhile. You'll bankrupt yourself by trying to save money!

Wholesalers provide similar services for retailers. No supermarket grows its own lettuce or cans its own soups. It buys these items from wholesalers. And just as retailers lower your cost of buying goods for you and your family, wholesalers lower retailers' costs of acquiring inventories.

Wholesalers, for example, specialize in transporting goods from around the country, or even the world, and assembling these in accessible, central locations at which retailers' delivery trucks can be loaded. Wholesalers (like retailers) also generally vouch for the quality of the goods they supply.

None of this says that retailers can never innovate in ways that indeed allow them to save money by "eliminating" some middlemen. But it's useful to remember that middlemen's services -- such as supplying convenient access to large stocks of goods -- are valuable even though they involve no actual production.

Donald J. Boudreaux is a professor of economics at George Mason University in Fairfax, Va. His column appears twice monthly.

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