By MN Gordon

Short Circuited Feedback Loops

Finding and filling gaps in the market is one avenue for entrepreneurial success.  Obviously, the first to tap into an unmet consumer demand can unlock massive profits.  But unless there’s some comparative advantage, competition will quickly commoditize the market and profit margins will decline to just above breakeven.

Unfortunately, finding and filling gaps in the market is much easier said than done.  Even the most successful serial entrepreneurs fail more often than they succeed.  What’s more, success in one endeavor doesn’t guarantee success in another.

Anyone who has ever developed and marketed a new product from concept through sale knows how difficult it is to achieve profitability.  For every good idea there must be a hundred bad ones.  Yet the only way to really know the difference between a profit generating idea and a cash hemorrhaging fiasco is through trial and error.

Success and failure provide real feedback.  They deliver information – at a profit or loss – to businessmen and investors.  What’s working?  What isn’t?  What adjustments can be made to help eke out a profit?  These are the types of information that only the market can provide.

But what happens when the feedback loop is short circuited and a potential gap in the market is not really a gap after all?  What if fraud and folderol turns a desert wasteland into a tropical oasis mirage?  What happens is that otherwise intelligent investors are duped into throwing good money after bad.

Swindle and Speculation

In his perennial classic Manias, Panics and Crashes, author Charles Kindleberger includes an entire chapter on the Emergence of Swindles.  One of Kindleberger’s insights is that speculative booms, often resulting from the cheap credit provided by loose monetary policy, sow seeds of white collar crime and subsequent financial distress.  Here we turn to Kindleberger for edification:

“Commercial and financial crises are intimately bound up with transactions that overstep the confines of law and morality, shadowy those confines may be.  The propensities to swindle and be swindled run parallel to the propensity to speculate during a boom.  Crash and panic, with their motto of sauve qui peut, induce still more to cheat in order to save themselves.  And the signal for panic is often the revelation of some swindle, theft, embezzlement, or fraud.”

No doubt, sleight of hand, smoke and mirrors, trick plays, and the like, add a certain lighthearted delight to life.  The fumblerooski.  The melon drop.  The kid that throws mud at your car half a block before his brother’s car wash.

Cons and scams like these sharpen our wits.  They prepare us for people and situations that aren’t quite as upright as they first appear.  Specifically, they help protect our pocketbook from encounters with mutual fund brokers, Dan Rather, and charity fundraisers.

Of course, large scale operations to separate fools from their money are no joke.  The consequences can be ruinous.  Victims may never recover.