The Middleman Serves an Essential Economic Function

By Donald J. Boudreaux

Driving to the office this morning, I heard on the radio an ad for Mervis Diamond Importers. Ronnie Mervis, the owner, boasted that “by importing directly, Mervis eliminates the middleman” — and, thus, sells diamond jewelry at unusually low prices.

This stratagem of claiming to “eliminate the middleman” is common in advertising done by retailers. The great frequency of the use of this stratagem testifies to its believability, for the claim that money is saved by eliminating the middleman does indeed seem sensible. After all, wholesalers and other middlemen don't work for free; they must be paid. So if a retailer eliminates the middleman, that retailer apparently has “savings” that it “passes on to you!”

But if middlemen raise retailers’ costs, why would any retailer ever use such parasites? Simply to ask this question about middlemen is to cast doubt on the widespread myth that middlemen raise the retail costs of goods.

It’s true that middlemen (and, of course, middlewomen) must be paid for their services. But these services are paid for only because they are valuable. And these services are valuable only because, and only insofar as, they reduce the prices that consumers pay at retail. Middlemen who don’t enable retailers to lower their prices go bankrupt. These middlemen are indeed “eliminated” — by the market. In contrast, successful middlemen reduce the costs that consumers pay at retail.

A Role of Retailers

To see the economic value of middlemen, it’s helpful to realize that retailers themselves are middlemen. A man wishing to acquire an engagement ring could “eliminate the middleman” by steering clear of all retail jewelers and himself personally go mining for diamonds and gold. But doing so would obviously be a much more costly means of presenting an impressive ring to his sweetheart than buying the ring from a jeweler, despite the fact that the jeweler must be paid for his services.

Or recognize that, say, the furniture retailer that brags of “eliminating the middleman” by “buying direct from the factory” doesn’t itself manufacture sofas, beds, and dining room tables. That retailer instead specializes in purchasing inventories of furniture and then assembling these in locations that consumers find convenient to visit.

And understand that you yourself could buy furniture for your home directly from furniture manufacturers and at prices lower than you pay at retail furniture stores. But you almost never do so. You typically buy furniture from retailers. The reason you don’t “eliminate the middleman” — the retailer — when you buy furniture is that this middleman saves you money. 

To “eliminate the middleman” here would require that you buy or rent a large truck and drive it (depending on where you live) hundreds of miles to the nearest furniture factory. Although the factory owner will charge for the likes of chairs and bookcases prices lower than you’d pay at retail, these price discounts are seldom worthwhile.

The cost of “eliminating the middleman” in this manner is not only that you must spend time and money driving to and from the factory. There’s also this inconvenience: once at the factory, you can’t directly compare that factory’s offerings with those of competing furniture producers. To make such comparisons, you have to climb back into your truck and drive to many other furniture factories. 

By the time you do all this driving around, the price reductions that you get on furniture by “eliminating the middleman” won’t be worthwhile. You’ll bankrupt yourself by avoiding the middleman markup!

A Role of Wholesalers

Wholesalers supply services to retailers similar to the services that retailers supply to final consumers. No supermarket grows its own lettuce, churns its own butter, or cans its own soups. It buys these and each of the other tens of thousands of different items on its shelves from wholesalers. And just as retailers lower your cost of buying goods for you and your family, wholesalers lower retailers’ costs of acquiring inventories. 

Wholesalers specialize in transporting goods from around the country, or even the world, and assembling these in accessible, central locations at which retailers’ delivery trucks can be loaded. Also like retailers, wholesalers also generally vouch to their customers for the quality of the goods they supply.

Nothing said here implies that retailers (or wholesalers) never innovate in ways that indeed enable them to profitably “eliminate” some middlemen and genuinely pass some of these savings on to consumers. If a retailer discovers a way to itself produce some retail item at a cost lower than the price it must pay to a wholesaler, that retailer will eliminate the middleman wholesaler and produce that item itself. And this retailer will turn this cost saving into a competitive advantage by passing along to consumers at least some of these lower costs in the form of lower retail prices.

Our Economy Is a Vast Complex of Middlemen

But it’s important to remember that eliminating a supplier from a supply chain merely because that supplier charges for its services is foolish. If those services are valuable — if those services reduce retailers’ costs of acquiring some good for resale — then for retailers to refuse to purchase that supplier’s services causes retailers’ costs not to fall, but to rise. Any retailer who “eliminates” middlemen in this foolish way will itself soon be eliminated by its more competent competitors.

Because in our modern economy every one of us purchases from others nearly everything we use, our economy is a vast complex of middlemen. Its supply chains span the globe. And because these supply chains have been crafted by decades of relentless, innovation-driven competition, they are mind-bogglingly efficient. (If you doubt this last claim, ask yourself what makes possible the inexpensive blueberries that Minnesotans and New Yorkers routinely purchase from supermarkets in January.) And so let’s applaud middlemen, for without them we would all — or, rather, the few of us who would somehow manage to survive — be mired in unimaginable poverty.

 

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Donald J. Boudreaux

Donald J. Boudreaux is a senior fellow with American Institute for Economic Research and with the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center at George Mason University; a Mercatus Center Board Member; and a professor of economics and former economics-department chair at George Mason University. He is the author of the books The Essential Hayek, Globalization, Hypocrites and Half-Wits, and his articles appear in such publications as the Wall Street Journal, New York Times, US News & World Report as well as numerous scholarly journals. He writes a blog called Cafe Hayek and a regular column on economics for the Pittsburgh Tribune-Review. Boudreaux earned a PhD in economics from Auburn University and a law degree from the University of Virginia.