Indiaknowledge@Wharton | Channelling gains, fairly

Indiaknowledge@Wharton | Channelling gains, fairly
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First Published: Sun, Apr 20 2008. 11 55 PM IST

Illustration by Malay Krmakar/ MINT
Illustration by Malay Krmakar/ MINT
Updated: Sun, Apr 20 2008. 11 55 PM IST
Illustration by Malay Krmakar/ MINT
Tune into television’s The Apprentice, and you get an all-too-common view of business. Every week, the wannabe moguls try to impress Donald Trump by preening, cajoling and conniving. In this world, toughness is the measure of every chief executive, and the boss glories in firing people and squeezing every penny out of suppliers.
Yet, according to John Zhang and Jagmohan Raju, both Wharton marketing professors, and Tony Haitao Cui, a University of Minnesota marketing and logistics professor, many people aren’t purely mercenary in their business dealings. They care about fairness—and they should, the researchers say, because doing so can maximize their profits.
A manufacturer and a retailer can both end up making more money if they are fair-minded, setting prices with an eye to achieving an equitable outcome in their joint marketing channel, as opposed to merely maximizing their individual profits, the researchers argue in a paper, “Fairness and Channel Coordination”, recently published in Management Science.
When people are fair-minded, they don’t need to waste time on elaborate negotiations or enter into complicated contracts to coordinate their marketing channel and maximize profitability, the authors contend in their paper. “A constant wholesale price will do. When a fair channel is coordinated through a constant wholesale price, the retailer perceives no inequity. Therefore, a constant wholesale price as a channel-coordination mechanism can help to foster an equitable channel relationship.”
When the retailer sees that he is being treated fairly by the manufacturer, he will reciprocate by picking a retail price that rewards the manufacturer. Because each gets an equitable share of the channel’s profit, they won’t squabble. “If you are fighting against each other, ultimately the whole channel will suffer,”Zhang notes.
Conventional wisdom says the manufacturer needs to enter into an elaborate contract with the retailer to align their interests. It may take the form of revenue sharing, quantity discounts or two-part tariffs. “In practice, you rarely see that,” Zhang points out. “You mostly see a simple wholesale price contract.”
Practitioners of behavioural economics have shown with experiments that people sometimes value fairness over profit maximization.
In one such experiment, called the ultimatum game, one player receives a sum of money and gets to propose how to split it with a second player. The second player must accept the proposed division for either of them to receive any of the cash; if she rejects it, both end up with nothing.
Classical economic theory suggests that the proposer should keep just about everything for himself—say, 99%—and offer just a crumb to the person across the table. That way, he has maximized his benefit, and the other player will accept because she’s a bit better off than she was.
In reality, responders typically reject splits in which they receive less than 20%. In some cultures, people will even reject splits of less than 50/50.
“The ultimatum game tells you that people aren’t hard-nosed economists,” Zhang says. “They are fair-minded. And this kind of experimental outcome has strategic implications. We are saying that you don’t need a hard-nosed attitude to make a profit in the real world. In some areas, fairness will address the channel relationship in such a way that everyone can be better off.”
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First Published: Sun, Apr 20 2008. 11 55 PM IST