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27-Aug-2006
The Beauty of Competition, by Victor Niederhoffer

The beautiful thing about competition, or what I like to think of as fighting for your own interests in a fair game, is that it leads to great personal rewards while at the same time making the world a much better place. It is easiest to see this by thinking about the struggle for existence memorialized by Darwin in the Origin of Species and The Descent of Man that leads us to come into existence at all by winning out in the struggle to find a mate and pass our characteristics on to future generations. The qualities we pass on, through competition are those that are most suitable for living, surviving, and breeding.

On the economic front, Adam Smith in the Wealth of Nations and Friedrich Hayek, in the Road to Serfdom and Armen Alchian in Economic Forces at Work showed how the competition of business people leads to the material benefits and natural harmony that have so enriched and extended our lives. Smith concentrates on the salubrious process of competition between business people that leads to the quantity, and quality, and availability of the material goods that we all find so beneficent as well as total wealth for the Nation. Hayek showed that competition is a discovery process. What people want is dispersed, and idiosyncratic, and often unknown to consumers themselves.

The process of competition leads to purveyors discovering those wants as an unintended consequence of pursuing their own interests. Alchian had extended these ideas to the profit maximizing behavior of business that leads to firms prospering and expanding that are best suited to meeting the particular desires of the consumers of their products.

The terrible thing about not fighting for your own interests or altruism is that it leads to lack of success in your own life, mediocrity and lack of development of your own abilities and bitter disharmony in society. The alternative to winning by competition is often taking something from others by forces. That leads people to become frightened about what others might take from them or even worse what you can get from them. Extending this idea to its natural consequence shows why societies that do not have a proper outlet for competition tend to be poverty stricken and chaotic.

My early training in competition was in the world of sports and games. I was raised at the Brighton Beach Baths, the largest country club in the world, with about 10,000 members paying 10 dollars a year with ample facilities for every kind of racket, water, ball sport and board and table game. One highlight of this training was the constant money games that were played on the handball courts with hundreds of hustlers trying to figure out a game or con, like playing with your lefty backhand or while sitting on a chair against an unfettered opponent.

One of the highlights of early competition was that at the age of 11, I won a pair of sneakers by beating the best adult paddle ball player in a money game. But by far the biggest highlight was seeing weekly tournaments among the best handball players in Garber Stadium where the best handball players in the world vied for prize money of $25 for the winner of the doubles and handball tournaments.

The person I developed my own competitive gestalt from in these tournaments was Vic Herskowitz, who many consider the best handball player of all time. His competitive style was to hit as hard as he could, as aggressively as he could from both sides of the court, never to complain and always to maintain a very pleasant and positive demeanor towards the game.

However, the person I admired the most was my father, Arthur Niederhoffer. His competitive style was to try to win points by moving forward at all times, going for the "off the wall killer", comparable to a volley put away in tennis. His cardinal rule on the court was always to give the other side the benefit of the doubt. All the opponent's shots were called good, and all your own close ones were called out. Whatever the opponent did was considered as exemplifying the greatest of prowess and skill. Whatever shots you were able to hit were considered terrible, and your own game was "the world's worst" no matter how many people you could beat. It took me a long time to develop that approach in my own competitive activities.

Read Extinction and the Markets, and other posts about competition.

Mr G. comments:

I was born in an ex-communist country so I grew up very aware of the deleterious effects of a government stifling competition. I also grew up with a father who taught me the beauty of competition in sports and in broader life. However, I think we have to approach this subject carefully; in some cases the pendulum has swung too far in the direction of competition in the US. What suffers in the end is our ability to take a nuanced approach to determining the optimum competition/ cooperation mix in any given case.

Cooperation can be as powerful as competition in certain cases. If you look at the drug industry, you will see that they tout something they affectionately call "coopertition." Biotech firms compete with one another, as well as with pharma companies, but in very significant ways they all cooperate at the very same time.

I head up global pricing at a medical device company. We are certainly not allowed to get together in a room with our competition and decide on pricing for our industry, but you can be sure we do end up cooperating on prices. Almost all companies do. A simple prisoner's dilemma two by two matrix will show you why and how. Just play out the "repeated interaction" version and you will see how cooperation through signaling will produce a maximum payoff for each player.

Looking at it from a different perspective, you can see that, in some cases, the customer benefits if pricing cooperation exists to some degree -- stable prices lead to money for R&D, which in turn leads to innovation. Sure, the fear of declining prices driven by competition also serves as an impetus for R&D, but there is an optimum for each variable. If competition is out of hand, prices drop too quickly and the product launch does not make the R&D / plant expansion investment back, reducing the chances that there will be more investment in innovation. Again, the biotech industry serves as a good example. It has probably the least competitive markets (because of patents) but R&D spend is high, profit is high, and innovation is strong.

I would extend this and argue that competition is neither good nor bad. It is just a framework for producing an outcome. The degree to which competition is beneficial depends entirely upon the values of those who are competing. Certainly I agree that competition is a more efficient way of getting something done, but the key question is what do you want to get done?

What makes the West great is that we value better things than those who have not kept up. We value the open mind rather than fundamentalist thinking; private property rather than government owned property; money rather than whatever communists and others proposed as alternatives (although, I am not sure there ever was a clear proposal on the table for an alternative); industriousness rather than taking it easy; new technology rather than keeping things as they are; etc. These values have also led to problems, but I would argue that the net effect is positive. However, competition is only the framework that allows us to achieve these values more efficiently in some cases. It is like gearing an investment, you can gear the heck out of it, but if you picked the wrong direction, you are in trouble.

In the past, we needed to sound off on competition with a clear, loud voice because we were fighting a competing ideology, which was itself sounding off loudly, but which got it all wrong. Today, we still have to sound off clearly, but it is also important to begin looking more closely at what the best competition/ cooperation mix is for specific cases.

Russell Sears replies:

The Death of Big Pharma has been Greatly Exaggerated

Rather than subject Big Pharma to a slow painful death of torture at the hand of a tyrant. Let me suggest a couple of different scenarios.

A fundamental tenant of Democracy is that regime changes will take place when the current regime becomes too tyrannical. Either the regime changes or the tyrant makes concessions to retain power.

It is no secret that we have 2 powerful scientific forces converging, the power of computers and the understanding of genetics.

Now suppose that these forces live up to their full promise, and individual treatment of disease becomes a reality, at least for countries that allow customized medicine.

Such a migration of "medical tourist" are already occurring due to the high cost of litigation. Add too this a new wave, and you will see some major changes. Other countries will gladly welcome big pharma business enacting more business friendly laws. Local demand for these treatments will insist regimes or tyrannical rules will change.

Lets suppose that a few companies do die. These are not just brands, pusher of mass drugs. These companies are life savers and supporter of the physically weak and vulnerable, but often rich and connected. This do massive public good for a very thin or even negative profit, many small unmarketable drugs, that are life savers to the few.

Its not like driving a Ford, versus Chevy, you drop a big company and many people lives will turn into hell. Lay that at the feet of the current regime.

The meal for a lifetime is that long term doomsday forecast often paint detailed and realistic rendering extrapolating the current conditions to terrible long term view. But miss that these very forces are what causes regime changes or at least curves in the current road.

Full disclosure I own AMGN, PFE and probably have at tangled web of interest in big pharm. companies and the drug industry in general, because my wife is a Rph.

Stefan Jovanovich comments:

I think one can make an historical analogy between the position of the major drug companies now and that of the integrated steel companies in the middle of the last century. Like the steel companies then, the drug companies still have enormous cash flows that exceed their requirements for reinvestment - even with the assurance of continuing demand. Their problem is that they are an easy and obvious target for populist posturing. We have yet to see the political equivalents of Truman's threatening to nationalize the steel companies in the Korean War and Kennedy's "jawboning" with U.S. Steel as a means of controlling inflation, but they are surely coming. The question I have for the site is "What are the pharmaceutical equivalents of the mini-mills?" Is there an analog to what Nucor was in 1965?

Dylan Distasio mentions:

While I think you raise an interesting point, I do not necessarily believe that there is an equivalent of the mini-mill model in the pharmaceutical industry due to the nature of the drug approval process.

A steel mini-mill can recycle scrap in a local geographic area, and sell it for a handsome profit. Bringing a new drug to market is incredibly time consuming, and expensive due to the government regulatory hoops that have to be jumped through no matter who is working on it.

It is very difficult (probably near impossible) for a smaller, leaner biotech company to bring a drug to market without the help of either a major pharma or a very large biotech player like Amgen that for all intents and purposes is a big pharma.

Unless the capital markets are particularly kind to a smaller biotech, they are going to burn through enough cash even after multiple trips via secondaries to get a drug to market without the help of a big pharma company via a licensing agreement. Even if they do survive on their own from a cash perspective, sales and marketing in the current environment is very tough without the resources of a big pharma firm to peddle it.

I think the closest analogy to a mini-mill would be smaller players that focus on a pipeline of drugs for illnesses that have too small a target audience for the bigger players to invest the required resources into.

I am sure that major pharma will once again come under the populist gun, but I think they have enough capital, political and otherwise, to survive most of these scenarios.