Asset Specificity
Building a Bridge: The Specific Asset Problem
Asset specificity is the characteristic of an asset that makes it particularly valuable in exchange. A Leatherman or a Swiss Army knife has low asset specificity because it can be used for seemingly anything. A bridge has a high degree of asset specificity because it can really only be used for one thing. Now, exceptions may exist. London Bridge is in Arizona, so it’s not like a bridge can’t be moved. All asset specificity guarantees is that it can’t be moved for cheap.
The ability to repurpose assets is important from a bargaining point of view. When something has a high degree of asset specificity, there can occur what is known as the specific asset problem, a holdup of the highest degree. The specific asset problem states that something in its second-most valued use is extremely diminished. This becomes especially poignant when we think of networks or systems that depend on that particular piece of the puzzle to operate.
A bridge that connects two parts of a railroad is considered a specific asset. If someone other than the railroad owns the bridge, there’s a high probability that the toll for that bridge will be out of this world, just because the owner of the bridge is, like all of us by nature, opportunistic.
Fictional accounts of a bridge's asset-specific nature abound. Little John wouldn’t let Robin Hood cross a bridge in Sherwood Forest. The Bridge on the River Kwai is about forcing a group of British enlistees and officers to build a bridge for the Japanese supply lines.
In Game of Thrones, Robb Stark needs the Army of the North needs to cross House Frey’s stone bridge in order to battle the Lannisters, the family holding the Iron Throne. As it stands, House of Frey happens to be the only way to cross the river. As a result, Robb Stark’s “toll” to cross is to be promised to one of Lord Frey’s (less than appealing) daughters. When Robb reneges on his promise, it leads to the Red Wedding. And if you don’t understand this paragraph, you really should start watching that show.
“The Frey’s have held the Crossing for 600 years, and for 600 years they have never failed to exact their toll.” – Lady Stark, Game of Thrones
Although by it’s nature, real estate is asset specific, typically, real estate can be repurposed. We see it all the time. A Winchill’s donuts changes its signage slightly and is transformed into a Michelle’s donuts. The screened entryway to a house becomes a storefront for Tarot readings. If you can readily change an asset and use it to do something else, then there’s a good chance your asset is worth similar value in exchange.
Then the other day I saw this:
See the problem?
What company would want their NEW business to be located at a building that has someone else’s corporate logo ingrained in the infrastructure of their establishment?
It makes me feel bad for the real estate agent trying to sell the old Pizza Hut building. It's mostly likely a recurring headache for someone at Yum! Brands, who owns the Pizza Hut chain of restaurants. Without a significant overhaul in the form of capital spending to "fix" the roof, the abandoned Pizza Hut stands to sit vacant for some significant amount of time.
Asset specificity can describe why monopolies are illegal. Competition in the marketplace keeps a check on any one firm from exacting too high a toll from consumers. Competition is good, we’re taught, and that’s why centrally planned governments crumbled all across the world in the late 1980s. In the case of the USSR, Moscow could not coordinate their outlying states’ resources efficiently, and it led to breadlines and dismay with the Communist form of governance.
Sometimes a company hamstrings its growth efforts by aggressively using asset specificity. For the longest time, Sony was able to hold the personal music player market under their thumb. I once had to pay $40 for a power outlet for a portable CD player, simply because Sony was the only one I could buy the right charger from. Karma prevailed, however, when Sony tried to introduce the A-track file format to replace the ubiquitous MP3 form of digital music. Why would someone pay for limited accessibility to their music? If they couldn’t use their music on, say, an iPod, then where did that leave Sony? For a short time, up until April 2015 when it released a new model, it meant they were out of the Walkman business, apparently.
There is no nutshell to put asset specificity under. If it’s on your side, you have nearly unlimited bargaining power, and the regulators of the marketplace find that threatening. If someone else is boasting the leverage, you’re set to get your goods from them, and it’s going to cost you. - AE 5.17.15
The Ambidextrous Economist is good for one thing and one thing only.
You can reach him at AmbidextrousEconomist@gmail.com