"You spend a good piece of your life gripping a baseball and in the end it turns out that it was the other way around all the time."
As humans, we rely often on the information that is visual and immediately available to us. When this information is reinforced through persuasive and audible argument, strong emotions and feelings are often evoked, causing us to potentially over (or under) value certain attributes of a ‘product’; this product could be a car, a piece of technology, or even a fellow human. Danny Kahneman calls this the ‘affect bias’; we value some things more than others on the basis that they evoke more powerful emotions within us. In his book Thinking, Fast and Slow, Kahneman references a portfolio manager who chose to invest in Ford after seeing a production line that he deemed to be evidence enough of wider company success. So, what effect does this create in a competitive environment where resources are scarce? Empirically speaking, it has created an opportunity for arbitrage and a whole host of underdog stories.
Arbitrage relates to the ability to purchase an asset, and without fundamentally altering it, sell it on at a greater price. This is a useful concept when considering the opportunity of a monopoly in a market to price discriminate; if there are arbitrage opportunities a firm can not price discriminate, as they would otherwise be losing out on revenue. This has some particular relevance to how market structures can impact arbitrage. In a perfect world where there are an infinite number of firms and consumers, there are no opportunities for the resale of assets, as consumers possess perfect information and an infinite number of substitutes. As markets become increasingly concentrated, information tends to become increasingly asymmetrical, meaning information for consumers tends to be progressively imperfect. This creates a situation where an entity can act as a middle-man between markets, and capitalise on the information asymmetry between sellers and buyers in different markets. This requires a greater level of knowledge than the other agents within the market; as they must know what the seller undervalues and the buyer overvalues more so than the agent they are attempting to leave holding the bag: the sucker.
One of the most well known examples of using arbitrage as a strategy for growth is, surprisingly, the Oakland Athletics baseball team. Characterised in the book (and film) moneyball as an innovative and creatively destructive force within the market for baseball players, this is perhaps the greatest anecdotal evidence that arbitrage exists in most places where the human experience and opinion are the main determinants of value. With a budget dwarfed by the likes of the Boston Red Sox and the New York Yankees, the team, under the guidance of Billy Beane, took the direction of resisting acquiring players that evoked strong feelings in fans and scouts, and took instead to objectively identifying which players were systematically undervalued. This meant rejecting a recruitment strategy that focused on supposedly relevant factors like foot speed and appearance, and focussed instead on the ability to make it to first base, and the ability to hit for ‘extra base hits’. What this meant is that the team could compete, albeit with a misshapen team of players (one pitcher had a clubfoot. really.) for an almost comically smaller budget. When the time came for the contract of the players to be renewed, Oakland could no longer afford them. They were moved onto another team after as little as few weeks for a price, having picked them up from next to nothing. The price other teams often paid was in the form of a draft pick or their own undervalued players, adding greater momentum to the virtuous cycle. Oakland weren’t fundamentally altering players in order to create a new product, but rather using them in ever so slightly different ways as to showcase to the wider market their value as baseball players. Players like Jeremy Giambi, picked up by Oakland for as little as $275,000 per year, later played for the aforementioned Boston Red Sox, as they rebuilt their team to capitalise on this arbitrage opportunity. This rehault ostensibly paid dividends when the team won the 2004 World Series, and went on to collect the ultimate baseball prize 4 times more, the latest as recently as 2018.
This teaches us an important lesson. There are monstrous extrinsic and intrinsic awards available to those who are able to resist the subjectivity of emotions and look deeper into irregularities within and across markets. Quite often such irregularities are the product of imperfect information, and irrationality on the part of individuals. With minimal effort, and some careful reframing, anyone can be said to have a chance to buy an asset from one firm and sell it onto another at a huge markup. What is required, however, is the chutzpah to convince the one man that his treasure is dirt, and the other that the other man is a fool, a sucker*. Many individuals lack the characteristics, or knowledge, required in everday life to seize arbitrage opportunities. It would seem that very few have the requisite trait of extreme self-confidence; the 'gift of the gab', the ability to talk a dog off a meatwagon, or the ease with which they could sell ice to an eskimo. You might recall the kid in High School that bought Lucozades from the corner newsagents at £1 each, and proceeded to sell them for at least £3 each. This is the type of enterprising individual that is the archetypal arbitrage specialist. I would recommend reading the likes of Thinking, Fast and Slow, Misbehaving, and Moneyball, for a more coherent, technical, and accurate explanation of the biases that influence us as consumers and economic agents. Only then can the wider implications of such biases and the rewards for withstanding them be appreciated and recognised in a wider context.
*This is not an analysis of the arbitrage that occurs within the financial markets, but a more anecdotal post on how such opportunities arise, and are seized upon, in our everyday lives.