Economic profit – HubbardOBrienEconomics.com Blog

Fanatics: The Unlikely Unicorn

A unicorn is a startup, or newly formed firm, that has yet to begin selling stock publicly and has a value of $1 billion or more. (We discuss the difference between private firms and public firms in Economics and Microeconomics, Chapter 8, chapter opener and Section 8.2, and in Macroeconomics, Chapter 6, chapter opener and Section 6.2.) Usually, when we think of unicorns, we think of tech firms. That assumption is largely borne out by the following list of the 10 highest-valued U.S.-based startups, as compiled by cbinsights.com.

Firm	Value
SpaceX	$100.3 B
Stripe	$95 B
Epic Games	$42 B
Instacart	$39 B
Databricks	$38 B
Fanatics	$27 B
Chime	$25 B
Miro	$17.5 B
Ripple	$15 B
Plaid	$13.4 B

Nine of the ten firms are technology firms, with six being financial technology—fintech—firms. (We discuss fintech firms in the Apply the Concept, “Help for Young Borrowers: Fintech or Ceilings on Interest Rates,” which appears in Macroeconomics, Chapter 14, Section 14.3, and Economics, Chapter 24, Section 24.3.) The one non-tech firm on the list is Fanatics, whose main products are sports merchandise and sports trading cards. Because a unicorn doesn’t issue publicly traded stock, the firm’s valuation is determined by how much an investor pays for a percentage of the firm. In Fanatics’s case, the valuation was based on a $1.5 billion investment in the firm made in early March 2022 by a group of investors, including Fidelity, the large mutual find firm; Blackrock, the largest hedge fund in the world; and Michael Dell, the founder of the computer company.

These investors were expecting that Fanatics would earn an economic profit. But, as we discuss in Chapter 14, Section 14.1 and Chapter 15, Section 15.2, a firm will find its economic profit competed away unless other firms that might compete against it face barriers to entry. Although Fanatics CEO Michael Rubin has plans for the firm to expand into other areas, including sports betting, the firm’s core businesses of sports merchandise and trading cards would appear to have low barriers to entry. There are already many firms selling sportswear and there are many firms selling trading cards. The investment required to establish another firm to sell those products is low. So, we would expect competition in the sports merchandise and trading card markets to eliminate economic profit.

The key to Fanatics success is that it is selling differentiated products in those markets. Its differentiation is based on a key resource that competitors lack access to: The right to produce sportswear with the emblems of professional sports teams and the right to produce trading cards that show images of professional athletes. Fanatics has contracts with the National Football League (NFL), Major League Baseball (MLB), the National Hockey League (NHL), the National Basketball Association (NBA), and Major League Soccer (MLS)—the five most important professional sports leagues in North America—to produce jerseys, caps, and other sportswear that uses the copyrighted brands of the leagues’ teams. (In some cases, as with the NBA, Fanatics shares the right with another firm.)

Similarly, Fanatics has the exclusive right to produce trading cards bearing the images of NFL, NBA, and MLB players. In January 2022, Fanatics bought Topps, the firm that for decades had held the right to produce MLB trading cards.

Fanatics has paid high prices to these sports leagues and their players to gain the rights to sell branded merchandise and cards. Some business analysts questioned whether Fanatics will be able to sell the merchandise and cards for prices high enough to earn an economic profit on its investments. Fanatics CEO Rubin is counting on an increase in the popularity of trading cards and the increased interest in sports caused by more states legalizing sports gambling.

That Fanatics has found a place on the list of the most valuable startups that is otherwise dominated by tech firms indicates that many investors agree with Rubin’s business strategy.

Sources: “The Complete List of Unicorn Companies,” cbinsights.com; Miriam Gottfried and Andrew Beaton, “Fanatics Raises $1.5 Billion at $27 Billion Valuation,” Wall Street Journal, March 2, 2022; Tom Baysinger, “Fanatics Scores $27 Billion Valuation,” axios.com March 2, 2022; Lauren Hirsch, “Fanatics Is Buying Mitchell & Ness, a Fellow Sports Merchandiser,” New York Times, February 18, 2022; and Kendall Baker, “Fanatics Bets Big on Trading Card Boom,” axios.com, January 5, 2022.

Are Economic Profits a Sign of Market Power?

Cecilia Rouse, chair of the Council of Economic Advisers. Photo from the *Washington Post*.

An article in the Washington Post discussed a debate among President Biden’s economic advisers. The debate was over “over whether the White House should blame corporate consolidation and monopoly power for price hikes.” Some members of the National Economic Council supported the view that the increase in inflation that began in the spring of 2021 was the result of a decline in competition in the U.S. economy.

Some Democratic members of Congress have also supported this view. For instance, Massachusetts Senator Elizabeth Warren argued on Twitter that: “One clear explanation for higher inflation? Giant corporations are exploiting their market power to further raise prices. And corporate executives are bragging about their higher profits.” Or, as Vermont Senator Bernie Sanders put it: “The problem is not inflation. The problem is corporate greed, collusion & profiteering.”

But according to the article, Cecilia Rouse, chair of the President’s Council of Economic Advisers (CEA), and other members of the CEA are skeptical that a lack of competition are the main reason for the increase in inflation, arguing that very expansionary monetary and fiscal policies, along with disruptions to supply chains, have been more important.

In an earlier blog post (found here), we noted that a large majority of more than 40 well-known academic economists surveyed by the Booth School of Business at the University of Chicago disagreed with the statement: “A significant factor behind today’s higher US inflation is dominant corporations in uncompetitive markets taking advantage of their market power to raise prices in order to increase their profit margins.”

One difficulty with the argument that the sharp increase in inflation since mid-2021 was due to corporate greed is that there is no particular reason to believe that corporations suddenly became more greedy than they had been when inflation was much lower. If inflation were mainly due to corporate greed, then greed must fluctuate over time, just as inflation does. Economic writer and blogger Noah Smith poked fun at this idea in the following graph.

It’s worth noting that “greed” is one way of characterizing the self-interested behavior that underlies the assumption that firms maximize profits and individual maximize utility. (We discuss profit maximization in Microeconomics, Chapter 12, Section 12.2, and utility maximization in Chapter 10, Section 10.1.) When economists discuss self-interested behavior, they are not making a normative statement that it’s good for people to be self-interested. Instead, they are making a positive statement that economic models that assume that businesses maximize profit and consumers maximize utility have been successful in analyzing and predicting the behavior of businesses and households.

Corporate profits increased from $1.95 trillion in the first quarter of 2021 to $2.40 trillion in third quarter of 2021 (the most recent quarter for which data are available). Using another measure of profit, during the same period, corporate profits increased from about 16 percent of value added by nonfinancial corporate businesses to about 18 percent. (Value added measures the market value a firm adds to a product. We discuss calculating value added in Macroeconomics, Chapter 8, Section 8.1.)

There have been mergers in some industries that may have contributed to an increase in profits—the Biden Administration has singled out mergers in the meatpacking industry as having led to higher beef and chicken prices. At this point, though, it’s not possible to gauge the extent to which mergers have been responsible for higher prices, even in the meatpacking industry.

An increase in profit is not by itself an indication that firms have increased their market power. We would expect that even in a perfectly competitive industry, an increase in demand will lead in the short run to an increase in the economic profit earned by firms in the industry. But in the long run we expect economic profit to be competed away either by existing firms expanding their production or by new firms entering the industry.

In Chapter 12, we use Figure 12.8 to illustrate the effects of entry in the market for cage-free eggs. Panel (a) shows the market for cage-free eggs, made up of all the egg sellers and egg buyers. Panel (b) shows the situation facing one farmer producing cage-free eggs. (Note the very different scales of the horizontal axes in the two panels.) At $3 per dozen eggs, the typical egg farmer is earning an economic profit, shown by the green rectangle in panel (b). That economic profit attracts new entrants to the market—perhaps, in this case, egg farmers who convert to using cage-free methods. The result of entry is a movement down the demand curve to a new equilibrium price of $2 per dozen. At that price, the typical egg farmer is no longer earning an economic profit.

A few last observations:

The recent increase in profits may also be short-lived if it reflects a temporary increase in demand for some durable goods, such as furniture and appliances, raising their prices and increasing the profits of firms that produce them. The increase in spending on goods, and reduced spending on services, appears to have resulted from: (1) Households having additional funds to spend as a result of the payments they received from fiscal policy actions in 2020 and early 2021, and (2) a reluctance of households to spend on some services, such as restaurant meals and movie theater tickets, due to the effects of the Covid-19 pandemic.
The increase in profits in some industries may also be due to a reduction in supply in those industries having forced up prices. For instance, a shortage of semiconductors has reduced the supply of automobiles, raising car prices and the profits of automobile manufacturers. Over time, supply in these industries should increase, bringing down both prices and profits.
If some changes in consumer demand persist over time, we would expect that the economic profits firms are earning in the affected industries will attract the entry of new firms—a process we illustrated above. In early 2022, this process is far from complete because it takes time for new firms to enter an industry.

Source: Jeff Stein, “White House economists push back against pressure to blame corporations for inflation,” Washington Post, February 17, 2022; Mike Dorning, “Biden Launches Plan to Fight Meatpacker Giants on Inflation,” bloomberg.com, January 3, 2022; and U.S. Bureau of Economic Analysis.ec

Solved Problem: Why Will No One Buy This Farm?

Supports: Economics: Chapter 12 – Firms in Perfectly Competitive Markets (Section 12.5); Microeconomics: Chapter 12, Section 12.5; and Essentials: Chapter 9, Section 9.5

Solved Problem: Explaining Entry and Exit

An article in the Pittsburgh Post-Gazette had the headline: “The Last Harvest: Beaver County Organic Farm Closes after Failure to Find Successor.” The article discusses the decision by a 71-year old famer to close down his organic vegetable farm after failing to find a buyer for it despite a 10-year search. Several people, including his four adult children, considered purchasing the farm but in end none did so. His only requirement in selling the farm was that the buyer use the land to grow organic crops. The famer was puzzled by his inability to find a buyer because “There’s money in organics.” The article notes that: “In a U.S. Department of Agriculture study, organic food products generally commanded a [price] premium exceeding 20% over conventionally grown vegetables.”

a. Does the fact that organically grown vegetables sell for prices that are 20 percent higher than the prices of conventionally grown vegetables mean that growing organic vegetables will earn a farmer a larger economic profit than growing vegetables using conventional methods? Briefly explain.

b. Is it likely that the requirement that a buyer had to agree to use the land only to grow organic vegetables affected the inability of the farmer to find a buyer? Briefly explain.

c. What is the likeliest explanation for the farmer being unable to find a buyer for his farm?

Source: Khris B. Mamula, “The Last Harvest: Beaver County Organic Farm Closes after Failure to Find Successor,” Pittsburgh Post-Gazette, January 3, 2021.

Solving the Problem

Step 1: Review the chapter material. This problem is about the reason that firms exit an industry, so you may want to review Chapter 12, Section 28.2 “If Everyone Can Do It, You Can’t Make Money at It.”

Step 2: Answer part a. by discussing whether the fact that organic vegetables sell for higher prices than conventionally grown vegetables means that growing organic vegetables will earn a farmer a larger economic profit than growing vegetables using conventional methods. Profit depend on costs as well as prices. We’ve seen in this chapter that organic growing methods typically have higher costs than conventional growing methods. Therefore, the fact that organic vegetables sell for higher prices than conventionally grown vegetables doesn’t guarantee that farmers selling organic vegetables are earning an economic profit. In fact, in the long run we would expect that entry and exit will ensure that the price farmers sell vegetablesfor will just equal the average cost of growing them, whether the vegetables are grown organically or conentionally. In other words, in the long run the higher price of organic vegetables will just offset the higher cost of growthing them and farmers will earn a zero economic profit whichever method they use to grow vegetables.

Step 3: Answer part b. by explaining whether the farme’s requirement that the farm be used only to grow organic vegetables affected his difficulty in finding a buyer. Generally when a firm exits a market, as this farmer is exiting the market for organic vegetables, the firm’s resources will be sold and used for other purposes. For example, when the market for renting videos collapsed, the buildings video rental stores had been in were used for other purposes. (A former Blockbuster video store near where one of the authors lives was converted into a tire store.) Or a resaurant serving Italian food may close and the tables, chairs, and ovens may be used by a restaurant serving Thai food that opens in the same building. By insisting that his farm only be used for growing organic vegetables, the farmer limited the number of buyers who would be interested in buying it. Anyone who wanted to use the land to grow vegetables using conventional methods or wanted to use it for a nonagricultural purpose would not buy the farm.

Step 4: Answer part c. by discussing the likeliest reason that the farmer was unable to find a buyer for his farm. We would expect that someone wanting to sell a firm that is earning an economic profit would have no trouble finding a buyer if the price being asked would allow a buyer to also earn an economic profit on the buyer’s investment. That the farmer in this article couldn’t find a buyer after 10 years of searching is an indication that a buyer of the farm at the price he was asking would at best break even. As noted in the answer to part b., that the farmer wouldn’t allow a buyer to use the land for any purpose other than organic farming reduced the number of potential buyers.