The Pros and Cons of Our “Middleman Economy”

CURT NICKISCH: Welcome to the HBR IdeaCast from Harvard Business Review. I’m Curt Nickisch.

A great deal of what’s possible in our modern economy is thanks to middlemen. They’re why you can easily buy something designed in Europe and made in China, you can search homes for sale and apply for a mortgage without ever getting off your couch. The prices and mind-boggling access of goods that come via middleman are hard for customers to resist. They’re invaluable connectors in a global and complex economy that also gives them outsized power.

Today’s guest has written a thorough critique of what she calls the middleman economy. Kathryn Judge is a finance expert and professor at Columbia Law School. She’s here to talk us through her argument and to give some advice for how to navigate this economy as consumers and businesses. Her book is Direct: The Rise of the Middleman Economy and the Power of Going to the Source. And she joins me now. Hi Kate.

KATHRYN JUDGE: Hi Curt. Thank you for having me.

CURT NICKISCH: So let’s start with that phrase that we’ve all heard to cut out the middleman. So when you cut out the middleman, you save some money by going directly to the source. And you’re fine with that because that middleman wasn’t really doing anything for you anyway. But I think that the intermediaries that you describe in your book are companies that we use a lot like online retailers, big box retailers, that actually provide consumers a lot of value. They’re offering really handy services to consumers. So can you break down your term of middleman or can you break down your definition of middleman? What intermediaries are you thinking of here?

KATHRYN JUDGE: Yeah. Right at the beginning, it’s important to distinguish between middlemen and the middleman economy. So middlemen are absolutely pivotal to how the modern economy functions. They are the critical connectors that really do help the flow of goods, the flow of money from those who have them to those who want them, they overcome all those informational challenges and logistical challenges that can otherwise impede a transaction that would really make all parties better off.

But as you examine it further, we realize that we don’t just have an economy with a lot of middlemen, we have an economy where middlemen have grown in particular ways. I first saw this in banking and then saw it elsewhere. We have a combination of these incredibly large and incredibly powerful middlemen. And then they’re both feeding and fed by these very long supply chains, these very long layers of middlemen. And it’s that combination that, again, it arose originally because it did help create value, it did help create efficiencies, but there were oftentimes very significant costs, unappreciated costs that we’re now starting to bear. And so trying to understand how these structures originally rose because they provided value, but then really have tilted the balance of power and brought opacity in ways that are far from optimal.

CURT NICKISCH: Yeah. So let’s talk about that. Where did this economy come from? For a lot of people, it just might seem like a natural progression, the evolution of modern consumer capitalism.

KATHRYN JUDGE: And in some ways it is. But I think it’s always dangerous when we talk about natural to understand, well, what actually results in the structures that we see around us? And natural might mean there’s efficiencies here, and there certainly can be, but part of what happens spaces is you see a bunch of tradeoffs that were made, and there are tradeoffs that were made assuming we were trying to maximize particular types of values. So really, we see the size of these large middlemen growing in scale, that allows disaggregation. It allows production to be done differently. It allows funding to be done differently, where you parse out a bunch of different activities that used to all be done in one factory or one place to a bunch of different actors along a very long supply chain.

And the scale of the giant middleman allows you to parse these steps out further to a bunch of different nodes. And that does lower costs in the short run. And so if we think that consumers only care about getting the best price possible, then some of the system makes sense. But part of what you see over time is that really creates a lot of opacity, a lack of accountability. As we’re seeing right now, it results in a variety of different possible sources of fragility. And so there’s very significant costs that I don’t think anybody fully appreciated as they were putting these systems together. And those costs are even greater if people start to care about things like, well, what’s the environmental impact or how are the workers actually treated, because these systems are really designed to blind us to those aspects of the effects of what we’re buying and how we’re investing.

CURT NICKISCH: Are they designed to blind us or are they just blind us because of the way they’ve been built for other reasons?

KATHRYN JUDGE: That’s a key question. It’s a little bit of both if you look at them closely over time. A lot of what we’re seeing in that process of parsing out is the movement of activities to places where they’re effectively least regulated. So it’s where you can get the cheapest labor, it’s where you pay the lowest price for the environmental consequences of your actions. I think people would find that quite troubling. And so you do see these efforts to really prevent us from fully finding out the impact there.

On the other hand, some of this was inadvertent, it really grew up over time. And it is something that then we have to think about in a different way if we want to bring a broader set of values to the table, or there’s just other gains that we want to get out of those exchanges.

CURT NICKISCH: If the system was built up in a way because of choices we made and things we demanded and built the economy for, right, now, if consumers want to demand more sustainability or they want to demand transparency, it seems like you could change the economy and you could change how these supply chains work to deliver that if that’s something people are asking for.

KATHRYN JUDGE: Yeah. And I would say, we actually do see change. So two points, one, we can change, but we don’t start on a blank slate. And part of what the book exposes is that in the process of becoming just such helpful connectors, middlemen build this incredible infrastructure. Amazon has this incredible logistic network, so does Walmart. So they’ve originally built this infrastructure, they develop relationships, they develop expertise that make them really good connectors, but after they have all of those advantages, which really allow them to serve, they’re also able to use those advantages to shape the evolution of the market structure, to influence the evolution of the regulatory scheme that governs both their activity and others in ways that are self-serving.

So one thing to bear in mind is that even if this grew up in ways that really do create value, and oftentimes it does, there can be a tilting of the balance of power, where they can hold onto power and entrench regimes that put a little more in their pockets and a little less in everybody else’s.

CURT NICKISCH: Is there another example of how middlemen hurt customers?

KATHRYN JUDGE: So real estate is a great example of this. You know, real estate agents created the MLS. It makes it easier for us to search homes. In the United States, we still pay 5%, oftentimes upwards even of 5%, for real estate agents. For your typical American family, they have more wealth in housing than they do in financial assets. And so this really affects their bottom line. And part of what we’ve seen is real estate agents and really the lobbying group that operates on their collective behalf, which is much more powerful than any individual real estate agent, has entrenched a system that really forces people to rely not just on one, but two full service agents that are very expensive to utilize, so that comes straight out of the bottom line.

The downside is that once middlemen become entrenched they really do have the ability to use all of that control over infrastructure and information to entrench systems that benefit them at the expense of us individually.

CURT NICKISCH: But there’s also the digital-ness of this too – those are platforms?

KATHRYN JUDGE: Certainly. I like to think many of them as middleman are actually middleman light, depending how the platform is structured. I mean, part of what’s interesting about the platform world right now is you actually have a microcosm of this broader phenomenon. Amazon is both a seller of goods, it also has this incredible platform for third party sellers. But the way it structures transactions, you don’t get much opportunity to really connect or interact with or understand who is it that’s selling you that good and what’s their story and what’s the story behind the product.

By contrast, Etsy is intentionally designed to enable that type of connection, to enable correspondence and communication and a mutual understanding. So the seller actually really knows who’s buying their goods and a buyer can know something about the seller. So part of what’s interesting when you get to the platform space is you have choices depending on how it’s structured, about how much control the middleman retains and how much instead, actually, the control continues to sit with the producers and the consumers.

CURT NICKISCH: Do you see the whole artisanal and local and bespoke movement as kind of a backlash to this?

KATHRYN JUDGE: I do see it as a backlash. And again, that doesn’t mean that for most of our purchases or investments, what we ought to be doing is bypassing all middlemen and going to the source. The aim of the book is to say let’s understand the extreme of the middleman economy and let’s understand the extreme of the direct, the richness of the experience, the connection that can happen, the wealth of information that you can get when you go directly to a farm or you go to a craft market. And then let’s use those two extremes to understand how to better navigate that massive gray space in between. And a lot of the gains come in learning how to navigate that gray space, learning how to choose better between different middlemen, learning how when to cut out one middleman. So that way you’re relying on one rather than multiple, when one will do.

And that’s actually where a lot of businesses have created value for themselves. Costco became the biggest wine seller in the country, in part, by finding ways to bypass distributors and buy directly from wineries. And so that reduced the cost that they were paying for their wine. There are small winemakers, who’ve cut out middlemen to do something very different, to really connect with customers, to cultivate a relationship where both our customers know them, they know their customers, they can learn in a timely way, oh, look, our customers are buying kind of less of this wine and more of that. What are the changes that we should make? So there could be benefits for businesses big and small in being able to make some upfront investments, which oftentimes is what it requires to bypass a standard middleman and create at least a slightly shorter chain.

CURT NICKISCH: I mean, I love that Costco example. I wonder if you can talk about some other examples of businesses because a lot of our listeners work in a lot of these companies and could be part of some of the solutions that you’re proposing.

KATHRYN JUDGE: Yeah. And the nice thing about it is once you understand these big patterns, it really allows you to make better decisions individually, but also for your company. In trying to understand both where you’re sourcing, but also how you’re selling, what are the tradeoffs that we’re making that we might not have been consciously making, depending on are we relying on middlemen, are we going directly and what middlemen are we relying on?

CURT NICKISCH: And how are we communicating that to our customers?

KATHRYN JUDGE: Yeah. So I think the direct to consumer movement, which got really popular and now is ebbing a little bit, but is here to say, is another example of a movement that comes in this gray space. Direct to consumer usually doesn’t mean you have farmers selling directly to consumers. Instead, you have companies that recognize there is a demand for sustainability, there’s a demand for more transparency, there’s people who are willing to pay a modest premium in exchange for a good that they think was ethically made, but who want, not just kind of some third party coming along and slapping a label that says fair trade –

CURT NICKISCH: Which comes with a cost, right?

KATHRYN JUDGE: Which comes with a cost and which might or might not really provide the benefits that you think go along with that. And so part of what direct to consumer does, a lot of the movement has been, let’s start from the ground up, and not only kind of cut out an expensive middleman, but also create a different type of supply chain. And so in many, not all of the cases, but in many of the instances, what you have is an effort by the company to create a more sustainable way of sourcing goods, to create shorter supply chains.

And then through a website or through limited in person stores, as have been growing recently, to create also a cohesive experience for the customer, to create a structure where customers provide feedback directly to the DTC company. So that company immediately knows, okay, the customers really like this. They don’t like this. They have that real time feedback about what’s selling, about what’s not selling, but also what customers are saying about new types of products. And then if they’re doing a good job, they can build in a certain type of responsiveness.

So I think DTCs another example of there’s a hunger out there for something different. And we’re seeing new types of companies that are emerging to provide that alternative. Michael Dell is the original DTC company. And even that was an example of a complex good, but you cut out a middleman, you can create value and you can create a really valuable company.

CURT NICKISCH: I mean, you’ve made an argument for consumers demanding and companies working towards a better system, despite maybe some incentives that are forces against that. Is there a role here for policy?

KATHRYN JUDGE: Policy has a critical role to play and it really happens in a couple of different ways. One, policy makers very often are helping to perpetuate the system that we have in place. And that’s not necessarily because of any ill intent. It’s you have a system that everybody knows works well. And oftentimes, the policy makers are a little risk averse, and then you have the middlemen bringing their insight to the table to say, “Look, you think you’re going to be helping consumers or investors through this change, but really you’re going to be making them worse off.”

And so what we’ve seen time and time again, whether it’s fixed fees when you wanted to trade stocks, because the New York Stock Exchange was a really great innovation, but then resulted in people paying way too much for way too long, to issues today around real estate, we see oftentimes rules that actually protect and entrench a system that was great when it was first created, but where technology could enable a much more efficient, lower cost system, but you need the regulators to have the nerve to help to facilitate that change.

Other key things that policy makers can do is to really think both about top down and bottom up. So we’ve seen a revival of competition law and antitrust that’s been quite healthy, just trying to think, how do we try to promote a healthy level of competition for the economy, for consumers so we see the growth and the balance of power that we want to see? But there’s also a really important role for policymakers to play in helping to level the playing field from the bottom up. So if you think about Amazon, you think about Walmart, they both have huge fleets of trucks, they have warehouses that cover the country. So it’s very easy for them to get goods into the hands of their customers very easily. And that’s great, but it does put a small producer at a very significant disadvantage.

So one of the ways the government can help level the playing field is to invest even more heavily in the post office. Subsidize the post office, subsidize the ability of small producers to utilize the postal system as a way of getting goods to their customers. And so helping provide that infrastructure that middlemen often provide can just make it a little bit easier, both for producers and for consumers to opt out of the dominant system and to exercise that ability to have a choice to do something a little differently.

CURT NICKISCH: Do you have any other tips for companies or entrepreneurs that may want to venture off into the space? You know, it could be helpful for businesses to look at how healthcare companies have responded to the pandemic and realized that some of their supply chains based in other countries don’t work well when you have a health crisis that you have to respond to immediately and a lot of those supply chains and a lot of those platforms are being sort of rebuilt differently today. So you could look at other industries to see how they’re responding, but do you have any other tips or great businesses that one could look to?

KATHRYN JUDGE: Yeah. So I mean, you’re going to make context sensitive determinations, but there are a lot of ways, once you understand this is something you need to think about, that you can figure out both what are the risks that we’re exposed to, but also where are the value opportunities that we’re not fully tapping into?

So one way you might think about how do we start to examine risks is by engaging in stress testing. That was part of what banks have always done. That’s part of what regulators have gotten even better at is to say, “Okay, let’s engage in a forward looking scenario, X, Y, and Z happen. How is that going to affect our business?” And so part of the way you start to mitigate the possibility of tail risk that are really disruptive is to understand them ahead of time and figure out, well, what are those vulnerabilities? How can we build in some resilience?

And then there’s also upside. I mean, one of the real advantages at times from being more thoughtful about when you’re using middlemen is oftentimes there is a subtle shift of power. They usually are the easier option in the short run. So if you’re selling a good or a service, middlemen oftentimes are the easier way to be able to build those initial connections with customers. On the other hand, that middleman then is getting that data, they’re getting the information and they’re controlling the relationship. So at times, putting that extra investment in up front so you’re trying to build, if not as your sole mechanism of distribution, but at least a key mechanism of distribution as a direct link, that can provide very valuable feedback. You can help to have relationships where you’re starting to have customers that are continuing to come back to you over time, because they understand more about you and your product and your company.

And so part of it is trying to be thoughtful about when do we want to make the upfront investments necessary to forgo the convenience of the ease that middlemen offer, because we think that there is some real gain to us either in terms of enhancing resilience, enhancing accountability, or because it’s really going to enrich our relationship with our customers.

CURT NICKISCH: Yeah. You’re essentially saying make the trade offs differently and that a lot of trade offs have been made really heavily favored towards cost. And there are opportunities for businesses to make those trade offs differently, find a better way to make those trade offs and offer value to customers in other ways.

KATHRYN JUDGE: Yeah. And to make those tradeoffs more thoughtfully. So sometimes you might engage in evaluation and realize the decision you’ve made is exactly the right decision to be making. I think part of what we’re seeing right now, just by the extent of the supply chain problems is that a lot of companies had not ahead of time been paying attention to what those risk exposures might be and they’d made trade offs without even realizing that they were making the trade offs.

So part of the aim here is to say understanding intermediation design and both the valuable role that intermediaries play, but also the information and control they retain for themselves, can really give you insight into where are we making the optimal decision for us and where might a different decision really help to unlock value.

CURT NICKISCH: Well, Kate, this has been really, really great. You’ve given us a lot to think about. Thanks for coming on the show.

KATHRYN JUDGE: Thank you so much for having me. It’s been a joy.

CURT NICKISCH: That’s Katherine Judge, professor at Columbia Law School and the author of the book Direct: The Rise of the Middleman Economy and the Power of Going to the Source.

If you got something from today’s episode, we have more podcasts to help you manage yourself, manage others and manage your career. Find them at hbr.org/podcasts or search HBR in Apple Podcasts, Spotify or wherever you get your podcasts.

This episode was produced by Mary Dooe. We get technical help from Rob Eckhardt. Our audio product manager is Ian Fox. And Hannah Bates is our audio production assistant. Thanks for listening to the HBR IdeaCast. We’ll be back with a new episode next Tuesday. I’m Curt Nickisch.