If a company makes excessive profits, does it truly mean that the consumer is being ripped off? In the short run, it may definitely seem so, but in the long run, excessive profits can actually mean higher consumer welfare. How does this work?
It’s this little thing called incentive. With a high profit margin, companies have greater incentive to innovate and improve upon existing product lines. Not only that, they also have more cash to actually pour into Research and Development than companies with a smaller profit margin. The end result would be better and sometimes cheaper products for all of us in the long run, and hence as consumers, all of us benefit.
Of course, there is the usual arguments about how high profit margins actually lead to complacency and the stagnation of innovation. This is only true with a near complete lack of competition and without the threat of potential entrants – any firm facing competition would be forced to innovate and improve to protect their profit margin. If firms do not innovate and improve upon their products, over time, their high profit margin would be eroded by competition from other firms. Hence, it is actually within the firms’ self interest to continue to innovate despite high profit margins.
Let’s take my all time favorite company – Apple (APPL) – as an example. (Interestingly, it was a story about huge iPhone profits that prompted me to write this entry – link here) Despite huge profits brought about by runaway iPhone sales, Apple has continued to innovate and improve upon its product (and mind you, many such innovations are unprecedented in the cellphone market). Hardware wise, we have seen new hardware every year since the original iPhone launch back in 2007. Software/Firmware wise, it’s actually the same one major revision per year – iPhone OS 2.0 in 2008, bringing with it the iPhone App Store – not without its issues – but nevertheless a popular and welcome feature (as can be seen from the many “versions” of it across other mobile platforms – Blackberry App Store, Windows Mobile Marketplace, Android Market etc) and iPhone OS 3.0 in 2009, featuring many features demanded by iPhone users (eg. Copy and Paste/Internet Tethering/MMS etc). Moreover, the price of the iPhone has been dropping (partly thanks to carrier subsidy). As such, I really don’t mind paying a little extra if I know that the money would go a long way into improving the products.
But still, I definitely wouldn’t mind if Apple actually uses some of that money to ensure better build quality and quality check for its products. Just saying you know?