Never heard of Luxottica? We haven’t either

By Tiana Luo

During my last trip to the department store, I stopped by LensCrafters to check their prices. Sure enough, the plainest, most innocuous pair of glasses cost a hundred and fifty dollars. And I thought I was getting ripped off when I purchased my prescription glasses this summer for $56! Turns out, I got lucky. If you don’t go to Walmart or Costco, you could easily be paying $200 or more for a new pair of glasses. When shopping for a new pair of sunglasses, the price is much the same. Why would a combination of wire, plastic, and glass cost half a fortune?

The secret lies on a mountainside in northern Italy, where a small tool shop opened in 1961 selling spectacle parts. It has since expanded to the world’s largest, multi-billion eyewear conglomerate on earth: Luxottica, a company whose name is as little-known as when it first started 60 years ago. Today, it controls an estimated 60-80% of the eyewear industry.

Its founder, Leonardo Del Vecchio, is now the second-richest man in Italy. From the tool shop in 1961, Luxottica went through a period of rapid expansion through Europe. It became publicly listed on the New York Stock Exchange in 1990. The listing raised money for the company, which began buying out its rival brands, starting with the Italian brands Vogue Eyewear and Person.

Luxottica revolutionized how we see glasses by making licensing deals with designer brands, starting with Armani in 1988. Thirty years ago, glasses were medical devices worn only by nerds and old people-- but after Luxottica partnered with stylish brands like Prada, Chanel, Dolce & Gabbana, Ralph Lauren, Tiffany, Versace, and Coach, it turned eyeglasses into high fashion. As part of their licensing partnership, the brands send in their sketches for inspiration. Luxottica itself designs the frames: threaded leather for a “Chanel-bag” look, the Gucci double-g’s, the Ralph Lauren polo pony. The resulting frames sell at more than 20 times the price they cost to make. Would people still pay the same amount-- upwards of $500-- if they knew the designer brands they love did not actually design their glasses?

Luxottica’s best seller, however, is not a fancy designer label-- it’s a brand they acquired in 1999, Ray-Ban. Created by American company Bausch + Lomb, Ray-Ban sold out to Luxottica for a pittance of $640 million, considering how well it’s doing today. In 1999, Ray-Bans cost $29 and you could get them at the corner drugstore. Now, the iconic (and historic) Wayfarer and Aviator sunglasses are $150.

In 1995, Luxottica launched a hostile takeover of the United States Shoe Corporation with the goal of acquiring its subsidiary, LensCrafters. Its ownership of LensCrafters, the largest optical chain in the US, and Sunglass Hut, which it acquired in 2001, played an important role in their hostile takeover of Oakley. The Californian sports equipment manufacturer had a price dispute with Luxottica in the early 2000s, and, as a result, Luxottica stopped carrying Oakley from their stores. This included Sunglass Hut, the largest sunglass chain in the world. In consequence, Oakley’s shares dropped 33% in price, and Luxottica bought it in 2007 for $2.1 billion.

Besides LensCrafters and Sunglass Hut, Luxottica also owns Pearle Vision, Oliver Peoples, and several boutique chains. It runs department store subsidiaries Target Optical and Sears Optical. Luxottica is what is called a price-maker, a company that sets the industry-wide price for others to follow. It’s tough to compete with Luxottica: if you’re a manufacturer, you want your glasses to be sold at LensCrafters or Sunglass Hut. If you’re a retailer, you want to have Ray-Bans and Oakleys in your stores. Luxottica’s biggest competitors are Walmart, Costco, and online companies like Warby Parker. It combines the monopolizing strategies of horizontal integration-- buying out competitors like Oakley-- with vertical integration-- controlling all stages of production, designing to manufacturing to distributing. Luxottica even owns EyeMed, the nation's second largest vision-care insurance company, covering eye exams and glasses. In other words, a near monopoly-- which helps explains why glasses in general are so expensive. Luxottica can charge as high a price as it wants.

And why wouldn’t they? Glasses are something people wear on their face every day. They’re a feature people associate with their identity-- perhaps as a result of Luxottica’s marketing-- and people are willing to pay hundreds of dollars per frame, even if it only cost $30 to make. Sure, some of that money goes into hidden costs like wages, overhead, research and development… but there’s no denying that profit margins are huge. What do you think? Is Luxottica a classic example of capitalism gone wrong, an unfair exploiter of unaware consumers? Or is it an intrepid trailblazer, transforming the negative societal stigma of wearing glasses?

In 2014, Luxottica partnered with Google to develop Google Glass-- web-connected eyewear. In 2017, it announced a merger with Essilor, the second-largest company in the industry, which specializes in prescription lenses-- an area of the field Luxottica has until recently left unexplored. Each year, Luxottica makes 77 million pairs of sunglasses and optical frames. At least half a billion people are wearing their glasses right now. Are you?

Is Bitcoin a Bubble?

By Matthew Turk

Using a cryptocurrency like Bitcoin is best described as a mysterious alternative to PayPal. That is partially one of the main reasons why so many criminals use Bitcoin to transfer money. But for the majority of investors who are not criminals, the entire concept of cryptocurrency can seem...cryptic. However, underneath the grandiose complexity of digital currency lies one of the most fascinating and innovative technologies that humanity has ever seen.

Unlike banks and online services, Bitcoin belongs to no sovereign nation and has no verification or overseeing of transactions. If a holder of Bitcoin decides to transfer money through cryptocurrency, there is no underlying intermediary that charges a fee. It is a truly direct transaction, just like handing someone physical money. After 2009, this seemingly odd and quirky idea caused investors to experiment in the financial world. As more investors tried to find their way in, it began to steadily rise, and last year, the value of a Bitcoin skyrocketed after established investors and companies collectively decided to venture into the wild west world of cryptocurrency as the world heads deeper into the Digital Revolution.

Alas, like all great things, cryptocurrency must someday end. Rise and fall is a simple fundamental idea of the Financial Instability Hypothesis by economist Hyman Minsky. That’s what classical economics predicts. Although Bitcoin has recently faltered in the wake of new governmental regulations, its overall rising price reflects how hard it is to get a Bitcoin from one of its existing holders, who are mostly avid believers in cryptocurrencies. Once an investing pattern in the price emerges, lenders and other financiers will realize they’ve over extended themselves with an investment leaving an absence of financing from external sources and a one-way ticket to financial collapse. Then the burden of the price drop becomes too steep to finance exclusively with the assets cash flows. It’s how the the free market works; it grows slowly, skyrockets, crashes, and recovers. It happens in companies, real estate, and it happened during the dotcom bubble burst in 1997. The Internet exploded because it seemed like the most promising new innovation. New companies emerged every day, totaling in 1,300 new ones during that period of time. Money flowed in from investors, and the media did not cease to rave, which brought the rest of the world onto the bandwagon, including many people who had no understanding of the Internet, but threw money in regardless. This yielded unbelievable numbers during the time. For example, Amazon’s stock price during the late ‘90s went from less than $2 to over $107 over three years. It wasn’t long before skeptics began to take a second glance at companies like Amazon and wonder if the new technology companies were overvalued. So one by one, investors tried to get their money back before a crash, and that’s exactly what happened. Eventually once the trend began to spread, the investing world went into panic, stocks became volatile, and larger and larger numbers of people began to pull out. By this time, Amazon’s stock was worth $7 and the company was on the brink of bankruptcy. Amazon and the other names we know today are the corporations that survived the crash and steadily rose in price as the Internet’s potential gained more credibility and solidarity.

Fortunately for Bitcoin, it is not exactly subject to the same dynamic as the dotcom bubble. It may not actually burst, and could just continue to expand for decades. While individuals may suffer catastrophic losses from ill-advised financing of Bitcoin purchases, since Bitcoin is not directly linked to the global economy (the financial system providing its funding), the ability for individual losses to generate the cascading effect that would lead to a Bitcoin bubble bursting are not a structural feature of the market for it. This is because the human race is nowhere near seeing the full capabilities of technology, and the potential of cryptocurrencies can only grow over the next few decades as the natural progression of scientific breakthroughs occurs.

This notion of ongoing development does not even take into account the larger technology that encompasses cryptocurrencies. Bitcoin is simply a consequence of the increasing demand for more digital interconnectivity in the professional world. On the fundamental level, Bitcoin is an innovation that stems from a concept from the 90s that was named “the blockchain” by a group of people who are collectively named Satoshi Nakamoto. The idea of the blockchain was to create a digital ledger, or record of every financial transaction and business interaction ever that keeps signatures and proof of the events and chains them together with cryptographic hash of the previous record. Each object on the timeline of the ledger is referred to as a block. By design, a blockchain is inherently resistant to modification of the data, making an excellent technology in today’s age. Once blockchain technology reaches its full potential, there will be new types of apps that keep track of and verify your education, work experience, medical records money, and more. This will be favored by users so much because it takes out skepticism and is usable by anyone. The sky's the limit for blockchain technology in the future, and Bitcoin along with it.

However, considering Bitcoin solely as an investment, its value cannot rise indefinitely either. At some point, in the next few decades, some investors will start selling and Bitcoin's price will fall or its value will plateau when it becomes a legal currency and steadily rise with the blockchain technologies. But the one issue with that financial trend is that experts are not sure whether Bitcoin is money or an investment. This goes hand in hand with Bitcoin’s status as a brand-new entity. So Bitcoin in summary is an asset in search of an equilibrium price. This price discovery process is unlikely to proceed without the market price getting excessive. It’s also quite possible that the ideal price of Bitcoin is higher than what it trades for today. But using history as our guide, it’s more likely that this process of price discovery will be volatile, and that the current price will deflate before a true pricing mechanism is established. Of course, this time could well be different. But history does tell us that it's dangerous not to take the past into account. Bitcoin is an asset that has jumped more than 1000% in the last year, so remain vigilant and understand the risks as time unravels the answer to the question.

How Does Information Asymmetry Factor into Your Daily Lives?

By Rohan Jain

As I have learned from reading the book “Naked Economics” by Charles Wheelan, humans tend to be risk-averse when it comes to making decisions.  Especially as the complexity levels increase, (such as kids, income, etc.) people tend to lean towards the choice they trust, relate with the most, and think is the most Pareto efficient.  Nevertheless, the reasons that these decisions can be so tricky is due to the information asymmetry (unknown information) contained within them.  In the moment, we may think our decisions are rational when in fact the marketers are just setting up ploys to make us get their product.  So what are some of the factors that go into making a decision like this, and which of those factors do marketers try to take advantage of?  There are many factors to this, some which marketers can’t control, like personal utility, costs vs benefits, and working on a budget.  But the most efficient and effective way for companies to reach a Pareto efficient outcome (the best possible outcome through trade)  is by creating a true “brand” for their product(s).  Luckily for marketers, this strategy is much more dominant than others because as human beings, we like to know what to expect. By abiding by our dominant strategies, we can be sure there is no outcome that leaves us unsatisfied.

Let's say you are stuck in a small city in the middle of South Dakota for a day, and there are only two restaurant options for dinner.  With a wife and two kids, you are on a relatively tight budget when  deciding on a place to eat.  Unfortunately, you have never heard of either of the restaurants, but have an idea of what kind of food they sell.  One is an Italian place, and the other is a Mexican cuisine.  Your wife and you both prefer Italian over Mexican, but just want to check out both of the restaurants’ menus to make sure.  You then go on your phone and check Yelp to see how the reviews are.  After going to both places, you find that the Italian place is cheaper, but are unsure if either of the restaurants will maximize the utility (personal happiness; enjoyment) of the kids.  In this scenario, the family had to spend a lot of time gathering as much information as they could, which can be a steep cost since the kids are hungry.  When they made their final decision, they were able to evaluate all of the key variables and make the most rational choice, although they had to be risk-tolerant due to the surprise factor that may come with the choice.   Now let's say that instead of the old Mexican place, there is a Chipotle.  You instantly recognize the name and know exactly what you are going to expect from it.  Because of your previous knowledge about the place, you don’t feel obligated to search for more information because there is no information asymmetry to look for.  Even though the Italian place may still be cheaper and Italian food may be your preference, you would still choose Chipotle due to the lack of asymmetric information.  Again, when it may seem behaviorally rational in the moment, it is only companies trying to seduce you by providing you with all the information ahead of time.  So in the big picture, this decision could have actually ended up being irrational due to the number of variables pointing the other direction. However in reality, you were just following your dominant strategy by valuing expected benefit over costs.

So how are corporations like Chipotle and McDonald's able to create brands so persuasive that it creates dramatic decision jumps for consumers?   Let's take McDonalds as an example for this question.  In the book, “Naked Economics,” Charles Wheelan explains how big of a role signaling (conveying information about oneself to another party) plays in branding. He says, “The ‘golden arches’ have as much to do with information as they do with hamburgers,” and that “Every McDonald’s hamburger tastes the same, whether it is sold in Moscow, Mexico City, or Cincinnati.” What Wheelan is trying to point out here is that information is the key to signalling, and the more of it one has, the better chance he/she will follow the signal that brands/symbols can be key indicators of signaling  However, the abundance of signaling in the form of advertisements in today’s society can be too overwhelming at times for one person to handle. When we encounter commercials on TV, advertisements on billboards, or any other common display of marketing, what we often define as unimportant can actually have a huge impact on our daily lives.  Marketers are hired for a reason, mainly because they are ‘masterminds at work’ when it comes to branding.  They will get jingles and slogans and $5 Footlongs stuck in your head where you store them in your ‘junk drawer’, but when it is time to make a real decision, you are able to recall some of the signals you may have heard from these campaigns and fill in the information gaps.  Advertisements are a perfect way of signaling because they provide the buyer with less information asymmetry, and provide the seller with more business.  

So why in some cases is adverse selection (when there is an imbalance between the information a buyer and a seller holds) necessary for something to sell?  In cases like restaurants, information asymmetry is the last thing you want because it makes the customer less likely to go there.  Although most restaurants would like to have no asymmetric information, it can be hard for local restaurants to appeal to buyers from all over the world because they don’t typically advertise and haven’t franchised their brand in a way to widely provide information.  Lucky for them, their market isn’t directed towards worldwide consumers, it is directed towards local consumers who are more familiar with it.  This is a whole different market, but in most cases, brands that aren’t franchised tend to be better quality due to less allocation of resources.  Mass production tends to be a common indicator of lower quality goods, which is another reason choosing Chipotle/McDonalds over the local Italian place might be an irrational decision.  We’ve only talked about one broad market (restaurants), but in markets like retail, adverse selection may be necessary from the seller's point of view.  If a seller is trying to sell shoes and has an equal number of peaches (good quality shoes) and lemons (poor quality shoes) in stock, by releasing its asymmetric information, half of its shoes won't sell, causing market failure.  Thankfully, when there is a lack of information, we rely on sources such as Yelp, word-of-mouth, rating sites, and many other sources.  The hardest part of decision making is knowing who and what to trust based on the information given.  When making decisions, the majority of humans are risk-averse and tend to just go with the recognizable brands because even if it might not be the best option, at least you know what you’re getting.  Although I believe this thinking is behaviorally rational, I don’t believe it is always practically rational.   But for people who are more risk-tolerant, it’s best to take into all of the variables before finalizing a decision such as budgets, maximizing value, costs vs. benefits, personal utility, and others. This way, you are primed to make the most rational decision possible, no matter how high the risk.  In conclusion, asymmetric information may be relevant in certain situations, but it is important to realize that the most rational decision is always the one that makes the most sense to your situation.  

Looking into Economic Government Intervention

By Ian Shayne

Since the inception of the United States, liberals and conservatives have often argued the extent to which the government should involve itself in the economy. In 2008, Wall Street investment banks nearly destroyed the world’s economy and the debate increased in intensity. In 2010, Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was a large piece of federal legislation that developed a group to oversee the transactions of Wall Street investment banks. Now, soon after the House of Representatives voted in favor of the Financial C.H.O.I.C.E. Act, an act to push the government off the backs of banks, the following question becomes even more essential to consider: does government oversight stimulate positive growth?

In the case of the Dodd-Frank Act, government oversight proved to be successful. The public would have been furious if the government simply bailed out the criminal bankers without any regulation. The public (i.e. the consumers) would lose even more faith in the banks and stop investing, which could lead to a significant financial loss for the banking industry, which holds much of the world’s money. Oversight also lowers the probability of another crisis because the Federal Reserve can regulate it. The government has few motives not to involve itself. Now, we have established that government is often crucial for a strong economy, but how much is too much regulation?

Price ceilings can sound advantageous at first glance, but with some thought, they can be incredibly detrimental to the economy. If the market equilibrium price is lower than the ceiling, they are unnecessary. If the ceiling is set below the market equilibrium price, shortages may occur. Any positives? Price ceilings can prevent unfair treatment by the sellers if they all agree to charge a ridiculous price for a particular good.

Price ceilings may be a form of government and economic policy, but I would like to explore the answer to one of the questions in Naked Economics that infuriated Wheelan: if economists know what makes countries rich, why are some countries poor? Part of the problem is rich countries tangling themselves up with the Samaritan’s Dilemma.

One example of this is U.S. energy independence. At first, it seems exceptional. The United States would not have to rely on foreign oil. But, there is a downside: foreign economies. Countries that rely on oil would lose a substantial amount of money and insurgency might ensue. Why should the U.S. care? Being involved in a proxy war in Syria, the United States should probably avoid foreign conflict and hostile relations will oil-rich countries. The positive side? The Samaritan’s Dilemma effect. Possibly, oil-rich countries could realize the lack of demand for their oil and invest in human capital. With oil in high demand, they have no incentive to do so.

Now, let us discuss market invention again—a key difference between communism and capitalism. Some right-wing politicians, like Bush official James Capretta, often state that the affordable health care is an example of wealth redistribution. Is affordable healthcare like the Samaritan’s Dilemma? Does it create a perverse incentive in which impoverished people are encouraged to stay in their current financial situation? Probably. Then, why is this a no-brainer? Perhaps because taking away health insurance for low-income citizens will cause death. Not just a couple deaths, but over 43,000 annually!

After stating arguments for both sides of government intervention in the economy and the extent to which government should play a role, I realize that I have not yet provided an answer to the question I, myself, posed: how much is too much regulation? Communism is clearly too much regulation, but so is libertarianism. Macron pitches centrism. Is that right? I do not want to spark a political debate, but, the United States government debates between the “thirty-five yard lines” of the political spectrum. Personally, I could not wish for a better place to be.

Are Humans Always Rational?

By Rohan Jain

This argument is dependent on how you define the terms rational and irrational.  In terms of behavioral economics, rational can be defined as maximizing your utility logically in one area, while irrational can be defined as doing just the opposite.  With this terminology, if you are judging someone based on what they are doing to maximize their utility, they should be judged as rational because they are being logical in terms of satisfying their personal preference.  However, if you are judging someone on their process of executing their utility, even if it may seem tempting, you should not look at their system of getting there as irrational based on efficiency and logic used.  

In Naked Economics, Charles Wheelan talked about his initial reaction to reading an article in the New York Times about South American villagers cutting down virgin rainforests and destroying rare ecosystems.  He initially knocked over his Starbucks latte in what he called, “surprise and disgust.”  He then started to rethink his position on the topic as he put himself in the villagers shoes.  He imagined a life where his kids were starving and are at risk of dying from malaria, and thought about the tempting incentives that would come with chopping down these rainforests (allowing him to feed his family and buy a mosquito net).  These seemingly irrational behaviors are not as unreasonable as Wheelan thought initially, after all.  

Let’s say that we were to depict someone as irrational because instead of studying for a test, they were watching TV all night.  When depicting someone as irrational, we have to take into account the fact that the decision is rational in the very moment the person is satisfying their short term utility.   Even if it has a detrimental effect on their long term utility (doing well on their test), which entails consequences that seem to have been made by irrational actions,  the initial decision is in fact rational.  This whole thing can be seen as irrational, when really it was an effect of a rational action that was put in place fulfill one's short-term utility.  

In a chapter entitled “Unbelievable Stories about Apathy and Altruism” from Stephen Dubner and Steven Levitt’s Superfreakonomics, there was a very interesting game study performed that provided insights into this conflict. Ultimatum was a 1980’s lab game that gave one contestant $20, and asked him/her to split the money in any way he/she wants with an anonymous co-contestant.  If they decide not to split it, or if the other contestant rejects the money, they both walk away with nothing.  This games results proved that most people were unselfish, given that the average amount given away was about $6. Later, a variant of this game was performed where instead of choosing how much of the $20 to give away, you had two options.  Either to split it down the middle, or give your co-contestant $2.  Again, people were unselfish, as 3 of every 4 participants did split down the middle.  This game shows altruism at its finest, and how the common people are very similar in their decision making process. This phenomenon raises an important question -- if the decision to split the money is thought of as irrational, does the fact that most people still do it make the decision behaviorally rational?

In conclusion, the underlying theme is that we are all optimizing individuals making decisions to maximize our personal utilities.  Whether perceived as rational or irrational by the public, the decisions made are internally rational to the person.  After evaluating their choices, circumstances, and risks, decisions can be made accordingly based on imminent or long-term utility.  It’s hard to counter the theory of behavioral economics because it covers such a wide range of topics.  The media, marketers, and salesman can sometimes overcast rational decisions, and turn them into irrational decisions by changing the way we think.  Now we must think about how critics of classical microeconomics affect our lives, and how we can get around them.  If the only irrational people are the ones misperceived, then who is actually irrational?

The Future of the Workforce: What Leaders Should Expect

By Nia Robinson

At seventeen years old when someone asks me what I want my future to entail, I can easily answer the question. “Well first I will get my Ph.D. in Economics, then I will be an Economics Professor at some Ivy League, then I will get with the right people and become a council member of the President’s Economic Advisory Council, and then I will run for President of the United States in 2054.” Pretty straightforward right? Maybe not, but the even stranger thing is that many of my peers have extreme plans for their future too. Their ideas range from working for Google as their CEO, or working with the ACLU for the next big case, and even working on becoming the next Mozart or Kanye West. So, why is it so much easier for people of my age to plan out our future? Because every day we see notifications and posts in the media that spur our interests about what our future could be like. But the reality is, most of the jobs that the future leaders of America might think they want now, will not even be available in that form when we go into the workforce. Even more so, most of the jobs that my peers and I probably will have, are not even created yet. With rapid urbanization spreading across the globe and the future technology breakthrough, what will the job market be like by 2050? Will I even be able to even run for President anymore? Or will America assign that job to some genius, creative robot?

Seems absurd but every day companies are working on improving our infrastructure, machines, and technology and jobs are adapting. Leaders right now need to understand that the future of work will be “the survival of the adaptable.” That is why one of the most important things leaders need to anticipate about the future is the importance of open mindedness. No doubt, that is important now, but in the future this trait will not only help leaders deal with the inevitable changes that will occur in the structure of the workforce, it will also help leaders deal with ways to move their business and company with the tide of the change.

Another thing leaders need to anticipate about the future is the importance of embracing social responsibility. Our world is become ever increasingly globalized and there will be less and less respect for businesses that do not address or talk about what is going on in the country and for the ones who insensitively do so. Just like it is important for America to unite, it is incredibly important for leaders to be able to unite their employees. The social climate is not going to change soon. In fact, there will always be problems, in the past, in the present, and to the future. Yet in our future, with social media becoming a larger and larger platform, the social tensions in our world will be more public and cause more doubt. Leaders need to anticipate the strength of social responsibility in the workforce so they can lead their business to be respectful and admirable to their community and to the people in their country.

As I focus on my future, I hope to be a part of what this world looks like by looking at the long-term implications of decisions I make to better my community. By embedding social responsibility into the workforce to reshape the business climate, I would like to foster results in my community that benefit not one person, but the public good. Future leaders should establish practices wherever they go that focus on the greater social responsibility, so that they can build an environment, team, and community that they are proud the world can see.

Migrants and the Eurozone

By Miro Ehrfeld

           Political crisis in Syria and other war stricken areas have led to an unprecedented influx of asylum seekers throughout Europe within the last two months. With hundreds of thousands of migrants flooding through the European border, leaders are torn between stability and sympathy. The push toward the accommodation of refugees, by Germany especially, has edged the European economy into ever more unstable conditions. Having not fully recuperated from earlier issues in Spain and Greece, the fate of the Euro is now more unclear than ever.

As migrants slowly make their way to Germany through Croatia and Hungary, Germany is frantically trying to gage how to best receive thousands of migrants into a country with 80.6 million inhabitants. Furthermore, Germany already has an existing unemployment rate valued at 4.7% as of April 2015. With the Euro to Dollar ratio down forty cents from 2014 economists are scratching their heads as to how Europe will deal with the issue. The skill level demanded of the German workforce is very high which will make it difficult for migrants to secure well paying jobs. Fortunately, Germany provides a socialized education system that will benefit asylum seekers greatly.

When taken in context, this population increase could be beneficial to the German economy in the longterm. The reproduction rate of Germany today is 1.4 children per family. This migration counteracts the decreasing trend. Another indication of optimism in the Euro's future can be seen in the mass purchasing of depreciated Euros in anticipation of its inevitable rise. Although the economic situation appears to be perilous,  hopefully Europe will rise to the challenge both socially and economically.

 

Chipotle's Imminent Recovery

    By Austin O'Toole

    For the past couple of months, people have been telling me that I’ve been risking my precious life by eating at Chipotle.  The company has been plagued by a series of unfortunate events, in which an E. Coli outbreak was linked to multiple outlets across the country.  This event has resulted in a precipitous 30% decline in sales, which is practically unheard of.  While ”worry wart investors” have been scrambling to divest their money, I’ve been doing the exact opposite for three main reasons.

    Let’s get real; according to the CDC, 52 people were infected by the E. Coli virus by Chipotle chains across the country.  Without any context, this may seem like a huge number; however, considering that Chipotle restaurants serve around 750,000 people a day, this value becomes miniscule.  In fact, it’s so miniscule that if you took those 52 people and assumed that all of them were infected on the same day, your odds of being infected would only be about 0.0069%.  You’re 4 times more likely to die by choking on your Chipotle.  Not only that, but also, take into account that Chipotle is worth $200 million.  They clearly have enough resources to manage and resolve the problem. Thus far, they have dealt with the issue appropriately by implementing food safety standards and closing locations when they are affected, ensuring that consumers do not contract the virus.  

    Second, Chipotle’s strong reputation offers a large barrier to entry.  More often than not, a majority of millennials have flocked to this chain since it offers a healthier option to fast-food using fresh ingredients, making it more difficult for competition to succeed.  The most successful Mexican fast-food chains are Taco Bell and Qdoba.  With that being said, Taco Bell is designed for the more price-conscientious consumer, leaving Qdoba.  Although this Chipotle “catastrophe” was the optimal time for Qdoba to take a large percentage of Chipotle’s market share, they were unable to succeed.  Qdoba’s parent company, Jack in the Box, has found moderate success in recent months, making those “worry wart investors” turn to them as an alternative investment; however, looking solely at Qdoba, according to an article published by Time Magazine, Qdoba experienced an outbreak of Typhoid fever earlier in August of 2015, showing how their food is not any “safer” than Chipotle’s.

    This last point is for all of the Calculus nerds out there.  If you look at Chipotle’s stock over the past three to six months, you’ll notice a general parabolic trend, similar to that of f(x)=-x2. Now, although that it may appear that the value of each share is decreasing, one would notice by taking the second derivative that the rate at which it’s decreasing is decreasing.  In simpler terms, theoretically, this means that the stock price is starting to stabilize and should begin to increase once again, assuming Chipotle does not experience additional bad luck.  

    Obviously, this is all speculation; however, I’m almost positive that Chipotle’s stock will rise from the dead.  It’s reputation among millennials is still favorable, and Chipotle’s competition was unable to take a large percentage of the market. This suggests that many of Chipotle’s customers were simply waiting for the “storm to pass” and will return to their favorite burrito joint in the upcoming months.

 

Private Equity Bubble

By Austin O'Toole

In an attempt to gain more revenue and outperform the markets, more high-net-worth individuals and institutions are turning to private equity as an alternative investment.  At a glance, this alternative appears to be in an investor’s best interest.  Over the past five years, private equity funds have beaten the S&P 500 and Nasdaq by an average of about 7.33%.  Not only that, but if you look at 2014 alone, according to Bain Capital, exit buyouts were at an all time high of about $450 billion. Also, fundraising for firms such as Preqin hit $500 billion, and AUM hit an all time high of about $3 trillion. Clearly, these returns have provoked an interest in many investors; however, this all may be coming to an end as asset valuations in many sectors have become increasingly overvalued.

As displayed in the graph below, the assets in private equity firms have grown exponentially since 2000; though, many firms are beginning to realize that their valuations are in fact incorrect. Companies, such as Fidelity, have reevaluated their investments and have decreased valuations by as much as 25%. According to Renaissance Capital, 60% of IPOs that went public in 2015 are now trading below their IPO price.  Not only that, but also IPO returns were down 4% from their IPO price in the third quarter, which was the only negative quarter since 2011.  These “unicorn valuations” have created an unstable environment that is on the brink of collapsing.

There are three main reasons private equity’s bubble will “burst” in the upcoming years.  First, the federal government is beginning to increase interest rates.  These higher interest rates correlate to higher costs of capital, which in turn will reduce the returns many private equity companies will obtain. This lower equity impedes firms from generating additional revenue.

Second, as Andy Kessler from the Wall Street Journal has pointed out, banks have been decreasing their lending for leveraged deals over the past few years.  Regulators have been starting to refuse to give out loans more than six times earnings before interest, taxes, and depreciation.  This ultimately hampers a private equity firm’s ability to make deals and raise revenue to purchase companies.  

Third, private equity hinders the economy.  A private equity firm’s main objective is to generate as much revenue as possible; therefore, many of these firms cut back on innovations, such as new products and services.  While they do create wealth for pension funds, private equity firms can reduce wealth in the economy, by as much as 0.5%-1%.  

It is no longer a matter of if this bubble will burst, but rather when it will.  Marc Andreessen, cofounder of the Silicon Valley venture capital firm Andreessen Horowitz, stated, “When the market turns, and it will turn, we will find out who has been swimming without trunks on.”  When this bubble bursts, it will have a detrimental impact on the economy, similar to that of the Dot-com bubble in 2000. When the market turns, two major events will happen.  One, companies will increase layoffs, seeing as they have a reduced amount of revenue to cover expenses.  As what happened during the Dot-com bubble, many of these companies will run out of capital and will either be acquired or liquidated.  Two, this burst will send prices falling precipitously and will wreak havoc on late-coming investors.  This downward shift reduces spending power, which could, in worse case scenarios, sedate the economy and cause a recession.  Although I do not believe that this downward trend will occur in the near future, history suggests that we will see the private equity bubble burst if company valuations do not become more realistic.  

 

 

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