As you might imagine, consumers don't buy products because they have a desire to give away their money. Rather, consumers have wants and needs that they seek to meet, sometimes by acquiring products. Products that may be used to meet these needs are valuable to the consumers, and this "use value" is what the consumer seeks to gain from the transaction.
A producer creates a product or service because they want to get something from the customer. The producer wants to be able to profitably sell what they've produced, and this "sale value" is what drives the producer to create products with use value to attract consumers with money. Yet, even from the producer's side, the value they collect from the consumer isn't always entirely in cash.
When a consumer fills out a questionnaire for a producer, the producer receives information and the consumer has not only given up privacy but spent time. The annoyance of viewing advertisements for products is another common form of payment for goods and services. When a producer seeks to force customers into entering an exclusive relationship with a single vendor, the producer receives a promised future revenue stream and the consumer pays with a portion of his or her freedom.
These forms of payment can easily overlap. A company seeking to license another company's source code can call a toll-free number to avoid paying for the call, but be subjected to advertisements while on hold. Then, they negotiate to get the software for a modest fee but sign a non-disclosure agreement with an anti-compete clause saying they can't go on to develop similar software in the future, and may have to pay royalties if they use the software as part of their own product. Perhaps the customer would be willing to pay more cash to get rid of the non-disclosure and anti-compete restrictions. Perhaps they'd be willing to make a toll call to skip the hold time and the advertising. The whole transaction is full of silent haggling, due to the choices the consumer made and the options the producer supplied.
Like water finding its own level, the dynamic negotiation of the free market happens naturally, and is often referred to as an "invisible hand" setting prices and production schedules. I prefer to think of it as water flowing through a river, perhaps into a lake. When the market is saturated, the lake is full and the river doesn't flow. When demand isn't being met, the lake is empty and the river flows swift and strong. Consumer demand is the driving force behind the flow of goods and services in the economy.
Producers attempt to harness the flow of goods and services to produce cash the way a mill wheel harnesses the flow of a river. The important thing to remember is that the flow drives the wheel, not the other way around. Producers can focus on enlarging the wheel or cranking it to a higher gear, but above all they need to maintain the flow, that is, consumer demand.
Producers sometimes dig their own river by inventing a new product, but usually they seek existing rivers to harness. McDonald's (NYSE: MCD) didn't invent hunger; that's a huge river with a thousand mill wheels harnessing it up and down its length. Two more recent examples of natural rivers being harnessed would be bottled water and dating services, both of which make money off of wants and needs that have been addressed naturally for a long time. Perhaps the producer is responsible for dredging the river a bit wider to make room for their mill wheel, but they can't take credit for the river being there.
A monopoly is a dam across the river forcing all the water to go through the producer's turbine. This can be an extremely lucrative proposition for the monopolist, but it is an inherently unstable state. Water flows around obstacles wherever it can, and the slightest trickle of water going around the dam will quickly become a flood.
More on this tomorrow.
One final note: Motley Fool Radio Show producer Mac Greer wanted to shout out a heartfelt thanks to everyone who contacted him about the Thanksgiving program. While we're not able to have everyone on the show due to the sheer volume of e-mails that came in, Mac was inspired and truly enjoyed reading each of them.
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