Many of the business people I do know are well versed in economics, but none of them apply this science of their each day work. No other science is so thoroughly ignored by its practitioners. The reason for that is that economics has gone astray by borrowing ideas from physics.1 This falsely presents trade as a “closed equilibrium system.”2 Rather, trade is a fancy, adaptable and open system in constant imbalance.3
Instead, economics should adopt ideas from evolutionary biology. After all, it was the early economists who were the primary to acknowledge evolutionary processes. The political economist Thomas Malthus spoke elegantly in regards to the “struggle for existence” in 1798.4 Charles Darwin even attributes to Malthus his concept of “natural selection” or “survival of the fittest,” which was his central insight in .5
When Darwin applied Malthus’ concept to biology, he rightly stated:
[C]and we doubt (considering that many more individuals are born than can possibly survive) that individuals having any advantage over others, nevertheless slight, would have the very best likelihood of surviving and propagating their kind? On the opposite hand, we may make sure that any variation within the least degree injurious can be strictly suppressed. This preservation of favorable individual differences and variations, and the suppression of those that are injurious, I actually have called natural selection, or the survival of the fittest.6
Charles Darwin
The same is true of business enterprises. Many more enterprises are created than can survive. Advantageous enterprises, nevertheless small their advantage, have the very best likelihood of surviving and expanding, while others perish. Favorable variations are thus preserved, while harmful variations are destroyed. This is “natural selection.” Accordingly, trade is evolutionary, and economics should recognize this reality.
To say that trade evolves is just not a metaphor. It is true in a technical sense. Any population subject to the pressures of “cumulative selection” will evolve. This is the case if the agents of the population (1) reproduce reliably, (2) possess variable and heritable traits, and (3) reproduce at a rate that is predicated on their variable traits.7 Commercial products undoubtedly possess these characteristics:
Products are reproduced by firms with great fidelity, that’s, they’re replicated. Products also possess variable characteristics, and these characteristics affect the replication rate of a product. For example, Ford cannot sustain, let alone expand, the F-150 product line if consumers don’t prefer the F-150 over substitute products, and consumers’ purchasing decisions rely upon the F-150’s differentiating features.8
This is just not debatable. Also, the main focus must be on products and never on firms, which is a neo-Darwinist view. Neo-Darwinism has revolutionized biology. The theory states that the true unit of evolutionary evaluation is the gene and never the organism as Darwin had thought. In other words, genes are the true “replicators” and organisms are merely their “survival machines.”
An identical hierarchy exists in commerce. A product, be it a commodity or a service, is the DNA of an organization, and products are made up of many subunits or “premiums.” The premiums are the gene of commerce; they’re the “units of inheritance” that differentiate product lines. Accordingly, premiums are the first “replicators” of commerce, and corporations, like organisms, are merely its “survival machines.”
The company is a business organism
An organization is like an organism, “an open system that survives through some form of exchange with its environment.”9 It needs energy to sustain itself. Without energy, an organization would succumb to the forces of entropy and dissolve into its environment. Like any organism, an organization must subsequently “earn its living” by generating a surplus of energy without the input of external resources.
To achieve an energy surplus, a firm’s energy consumption or revenue must exceed its energy expenditure or cost, including capital costs. That is, a firm must produce a product that customers consider more worthwhile than the resources the firm uses to provide it. If it may well do that, a firm will achieve an energy surplus or profit and survive. If not, the firm will experience an energy deficit or loss and fail.
The more profitable an organization is, the more value it creates, and value creation determines the “fitness” of an organization. An organization that makes 20% profit is subsequently “fitter” than a competitor that makes 5% profit. The former is best adapted to the necessities of its area of interest. “Fitter” firms have higher survival rates and grow faster. Their products subsequently gain market share. This creates a form of industry.
Investors should subsequently prefer “fit” firms or those with high profits. However, high profits attract competition. For entrepreneurs, this can be a sign that they’ve the chance to create their very own value. To do that, entrepreneurs will replicate the distinguishing features of a “fit” company’s product. So how can a “fit” company maintain its profitability? This is where an evolutionary perspective proves extremely useful.
The hierarchy between intermediate product and company: A brand new model
Evolutionary theory is the very best tool for assessing the sustainability of profits. Excessive profits can’t be sustained without durable competitive benefits, and sturdy competitive benefits are best understood from an evolutionary perspective. However, such a perspective have to be focused on the proper unit of evolutionary evaluation. In commerce, that is the product and its “premise.”
An organization is determined by consumers for its sustenance. However, consumer selection occurs at the extent, meaning that firms, moderately than firms, are the true units of evolutionary evaluation. More specifically, because the value proposition of a product (e.g., Ford’s F-150) is determined by its various subunits (e.g., engine, brand, style), the true unit of research is best described as a premium.
In other words, products are like DNA. They are complex structures made up of subunits called premes, and premes, like genes in DNA, fight for inclusion in products. A preme is any attribute that affects the worth of a product. It might be as insignificant as employees saying “you’re welcome” at Chick-fil-A or as significant as iOS for Apple products.
So premes are the “premetic material” of products and their firms, and premetic materials are throughout us in the shape of ideas. They float around like pollen, able to fertilize the mind of a receptive entrepreneur. As such, premetic materials mutate or change at warp speed. All it takes is a brand new idea. And mutations change products quickly as entrepreneurs seize on essentially the most promising information.
As the product changes, the structure of the firm changes when it comes to worker skills, operations, production facilities, raw materials, suppliers, distribution channels, etc. In other words, our theory suggests, counterintuitively, that products create and shape firms in the identical way that DNA creates and shapes organisms. It is just not firms that create and shape products.
To achieve excess profits, a firm’s product must offer consumers a superior, differentiated value proposition. This, by definition, requires a premetic that is exclusive to the firm’s product. Otherwise, profits will erode through commercialization because the premetics diffuse into competing product lines. Thus, the sustainability of a firm’s “fitness” or excess profits is determined by the speed of premetic diffusion.
Unique preemption material is the source of excess profits. For excess profits to be sustainable, a firm-specific characteristic must prevent the spread of preemption into competing product lines. Such characteristics are competitive benefits or economic moats. There are many firm-specific characteristics that prevent the spread of preemption, including brands, search costs, economies of scale, and more.
Apple | A “fit” company: Apple’s operating system, iOS, is a feature that customers value, and its proprietary nature prevents it from being widely distributed. It provides Apple with differentiated premium material, which in turn gives Apple a competitive advantage. As a result, Apple consistently earns greater than 200% of its physical capital employed.10
Ford | An “unsuitable” company: Ford has almost no unique premetic material. Its products consist of subunits or premes sourced from non-exclusive suppliers. Ford subsequently lacks the raw material essential for a sustainable competitive advantage. As a result, Ford consistently earns below-average returns on tangible capital employed (i.e., 4.7% in 2023).11
The difference in profitability between Apple and Ford is resulting from the character of their respective raw materials. Apple is exclusive, Ford is just not. The former consistently generates excess profits, Ford doesn’t. Apple is price excess of its tangible book value, Ford doesn’t. Apple’s profitability is exclusive in its industry, Ford’s lack of profitability is the norm in its industry.
Key finding
Green with envy of physics, economics focuses on what might be measured. Today’s economics is just like the drunk who looks for his keys under the lamppost. When asked if he lost them there, he replies: “No. But here is the light.” We can and must do higher.
