Bonus Content!

Scarcity in the Software Century, Chapter 1

Hi everybody,

As a reminder: I’m currently writing a book called Scarcity in the Software Century. (If you missed this announcement, check last week’s email). I’m writing it week by week, and releasing the first draft to a group of subscribers. If you subscribe (it’s a paid subscription), in addition to my undying thanks and appreciation (plus a shoutout in the book when it’s done), you’ll get to:

a) An additional email from me on an approximately weekly cadence, with the chapter I’ve worked on that week;

b) Access to a forum where we’ll discuss it and collaboratively find examples, supporting ideas, introductions to key people I’d like to interview, and other ways we can help take the book from good to great;

c) Hopefully some additional fun stuff like meetups. To be determined.

You can subscribe here:

scarcity.substack.com

Here’s the short chapter that I wrote and pushed out this week: if you’d like to get them every week, please sign up.

Scarcity in the Software Century

Chapter 1: Scarcity

The Jade Gate has stood for two thousand years at the Yumen Pass, near the confluence of three branches of the ancient Silk Road. One branch headed east towards the seats of the Chinese Dynasties, and the other two headed west towards India, Persia, and the Roman Empire. Through that gate, entrepreneurial caravan drivers carried strange and wonderful goods from one side of the world to another, from the sources where they were available to their destinations where they were desired. 

What kind of items? Materials like tin, copper, ivory and lead; jewels like jade, topaz, pearls and lapis lazuli; textiles, especially Chinese silks; Roman statues, lamps and mirrors; exotic game, fish, pheasants; rice, pepper, spices, grapes, apricots, and other exotic fruits like the coveted “Golden Peaches” of the Central Asian orchards. Whatever you wanted, it could probably be found somewhere on the Silk Road; for a price.

By the first century AD, Romans were spending more than 10% of their total GDP on imported items from far away. Their massive annual spending did not reflect the original cost of any of these goods; not by a long shot. But it did reflect something real: the price you had to pay in order to obtain these items, from as far away as the other side of the world. It didn’t matter that pepper was available in India; it was scarce in Rome. So long as the Romans desired Indian pepper, a global horde of sailors, merchants, traders and importers were prepared to bring it to them.

The people and cities that lined these trading routes weren’t just peripheral observers of global trade; in many cases they were entirely organized around moving shipments of precious cargo from one place to another. Towns like Samarkand on the Silk Road owed their existence and prosperity to the fact that one empire to their west desired something greatly that was only available in another empire to the east. They were the window through which those treasures needed to pass. So long as Chinese Silks were scarce and valuable to the Persians, and Indian spices were scarce and valuable to the Romans, the Samarkands would have plenty of work to do, and could expect to be paid handsomely for it. 

After all, in the ancient world, scarcity was big business. 

It still is.

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The world continuously organizes itself around scarce resources. If you want to understand why something is the way it is - a relationship, an ecosystem, an industry, or a war - start by asking what is scarce, and why. 

The economic and social phenomenon of scarcity is practically synonymous with the concept of demand. Scarcity, for our purposes, means something distinct from rarity, or other words we use to describe something that’s present in some small amount. The truth is that scarcity tells us more about the pursuer than the object being pursued. It does have something to do with the quantity or availability of some resource, but more to do with how badly people want it. Put simply, scarcity is when our desire to obtain something exceeds our capacity to get it. The true opposite of scarcity is not abundance, it is indifference. 

That’s not to say that scarce objects, resources, conditions or experiences do not matter. They greatly matter. They matter because we are pursuing them, and because we need them. Many of these basic needs represent fundamentally important kinds of scarcity, like food and water. For most of human history, food was a scarce resource; for many people today, it is still. Without food, you starve. It’s something we objectively need; along with other basic requirements like water, shelter, and warmth. All of these things are objectively necessary, but they are not necessarily scarce for everybody. If you live in the tropics, warmth is still “necessary”, but only in a theoretical sense. To you, it is plentiful, often to excess. If you are an upper-middle class American, food and water aren’t scarce to you. You are historically fortunate to be in such a position.

There are other kinds of scarcity that aren’t objectively desirable so much as they are positionally desirable. These tend to be the more interesting kinds of scarcity we encounter in the modern world, particularly for those of us who are lucky enough to have our basic needs covered. Positional scarcity isn’t scarcity like food and water, and more like being at the front of a line. Status is positionally scarce: having a nice watch or sports car or brand name college degree may have some objective utility, but the majority of its value is in the standing it grants you relative to others. Many of the world’s oldest and biggest industries, like fashion and real estate, are built entirely around positional scarcity. 

Economically speaking, there’s a pretty basic way that we can think about scarcity: Revenue minus cost. Why? Well, for a few reasons. First of all, how much revenue somebody will pay for something depends on many factors. Do they want it? Where are they? When do they want it? How high in demand is it? Cost, too, will vary: Can you procure this thing? From where? How easily? The amount people were willing to pay for Golden Peaches was presumably higher in China, where they were luxury items, than in Central Asia where they were ordinary. Along the Silk Road, where buyers and sellers came into contact with one another, you saw a lot of bargaining: a kind of “real-time scarcity evaluation.” 

Plus, we all know what Revenue minus Cost equals, which is Profit. Scarcity is a prerequisite for durable economic profit. As an entrepreneur looking to earn a living, there needs to be some reason you can credibly and durably charge more for something than it costs you to make or deliver as a service. Scarcity is that reason. You will never encounter a situation in the real world where somebody is consistently charging an attractive profit for some good or service they’re selling, without some corresponding scarcity lurking behind their offering. 

Sometimes the truly scarce resource isn’t apparent from the outside. In retail sales, for instance, the desirable shelf space at the front of the store is a highly scarce and valuable resource that retailers use as leverage in their negotiations with vendors. If you’re looking for a short cut to figure out what resource is scarce in any given industry, ask what the decision makers spend most of their time stressing and negotiating over. If it surprises you, it might be an important scarce resource you hadn’t thought about before.

Profit is a great motivator for entrepreneurs, hustlers and generally ambitious people to find something scarce that they can provide to a demanding audience. But it’s not always obvious how much you should charge: how badly do your customers really want what you’re selling? How scarce are your offerings, to them? Not everyone is alike; as an entrepreneur who is trying to make a living by providing something scarce, you need to know who wants what you’re selling, and how badly.

There’s a classic exercise we learn in college that illustrates this challenge. The professor asks the whole class to write down on a piece of paper the maximum amount they would pay, right now, for a pair of plane tickets to Hawaii, or front row concert tickets to Taylor Swift, or something like that. A hat gets passed around, then the professor aggregates all the answers and illustrates their distribution in a graph. The result will mostly likely be a mixed bag: some people, who really love Hawaii or Taylor will be willing to pay hundreds or perhaps even thousands of dollars. Other people might offer nothing at all. These items are not scarce or valuable to them. Most people will lie somewhere in the middle. 

The sum of these answers is called a “Demand Curve”, and it’s the best, most concise illustration of scarcity that exists. A well-constructed Demand Curve is the best answer to the question “Is such-and-such item or product scarce?” There is no one yes-or-no answer; only a comprehensive assessment of “To whom, and at what price?” 

Scarcity is an opportunity to do work and get paid for it. Entrepreneurship is doing that work: both for yourself, and also for investors who back you with their capital. Your goals at the end of the day are to convert capital into more capital, temporarily in the form of some vehicle to provide customers with something scarce that they want. That temporary form could be a business, it could be a trading expedition, it could be a factory, it could be anything, so long as it provides something scarce. When we talk about “entrepreneurial capitalism”, whether we’re talking about Silk Road arbitrageurs or modern-day founders and Venture Capitalists, we mean the same “there-and-back” transformation of capital: from its starting form, where it can be anything, into a temporary form that looks to seize some opportunity to profit from scarcity, and then ultimately back into capital, which can be anything it wants once again. 

Funny enough, the person who arguably highlighted this facet of capitalism most successfully was its biggest critic: Karl Marx. Marx correctly understood that capital, and the capitalists who possess it, only care about the temporary format it adopts (a business, a factory, whatever) so long as it is producing attractive rates of return. The minute those returns disappear, you can expect that capital to be withdrawn. While this point of view presumes that the investor is both a) highly impatient and b) able to sell at any given moment (neither of which are necessarily true), the insight is important to us. He correctly highlights that the flexible and opportunistic nature of entrepreneurial capitalism means that entrepreneurs and their investors are continually seeking the best possible place to be

“The best possible place to be”, as we understand it, is “wherever there is scarcity that works for you in this moment.” These are not opportunities that can be taken for granted. There needs to be some compelling reason why you can expect to make superior profit that will not be either eaten away by regulation or competition, and those windows of opportunity are not always open. These discontinuities of scarcity are the lifeblood of entrepreneurial capitalism. 

These windows of opportunity can arise for all kinds of reasons. They might be discontinuities of distance and geography, as the Silk Road merchants exploited. They might be discontinuities of political or national origin: bootlegging alcohol between the United States and Canada during Prohibition would be a classic example of opportunistic arbitrage of a local scarcity. 

But the biggest and most disruptive discontinuities happen when something about scarcity in the human world changes dramatically. The most important windows of opportunity, the biggest fortunes, and the most powerful instances of entrepreneurial capitalism transforming the world have happened when we’ve conquered scarcity in an important way: by creating new technology. 

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That’s it for this week - subscribers will also have access to all my notes, draft layouts, and other sketched out ideas for how this story will take shape. As a reminder, you can find my book topics outline and approximate publishing schedule here.

Thanks and have a great week!

Alex