Information economics (Value Shop) Flashcards
Governing Value Shop relationships
Strong information asymmetry between the firm and its client is perhaps the single most important attribute of an intensive technology.
Since access to diverse sources of knowledge is important in solving complex customer problems, value shops commonly form reciprocally linked value systems of sub-contracting and collaborating firms that together harness the knowledge required to develop desired solutions.
Two key characteristics of complex services/solutions
- Intangibility (difficult to evaluate)
2. Heterogeneity (lack of standardization; customization)
Intangibility
Difficult for buyers to understand what they are buying
•Type of “good”:
- Search goods: ascertain/evaluate quality prior to purchase (e.g., shirt, etc.)
- Experience goods: can ascertain/judge after purchase (e.g., food, software)
- Credence goods: cannot evaluate quality after purchase (e.g., legal services, car repair)
Experience and credence goods
•Purchase involves information asymmetry (the service provider might know more than the buyer)
•Implication: risk of opportunistic exploitation
- Lying (hidden information)
> Misrepresentation of S’s inherent abilities or characteristics (E.g., dentist, lawyer)
- Cheating (hidden action)
> Under-supply (charge for high quality, deliver low
quality; e.g., car mechanic)
> Over-supply (e.g., dentist)
Strategies to overcome hidden information (intangibility)
- Screening
- When it is easy to evaluate suppliers (e.g., inspection, talk to existing customers, etc.) - Examine signals from suppliers
- Honest firms would not engage in the signals were it not for information asymmetry (about abilities)
- It must be most costly for suppliers who do not have the characteristics
needed - Provide opportunities for self-selection
- Expensive pre-qualification process (e.g., certification)
A typology of marketing signals of unobservable quality
Default-independent signals (up-front expenditures):
- Sale-independent (e.g., buildings, advertising spend) - Less targeted
- Sale-contingent (e.g., low-introductory price) - Customer adverse selection
Default-contingent signals (costly ex-post):
- Revenue-risking (e.g., brand alliances)
- Cost-risking (e.g., warranties) - Potentially risky for customer
Lack of standardization (heteregeneity)
Customer needs, requests, and involvement. (e.g. consultants, fitness club)
“Executional latitude” The provider can choose the level of quality (e.g. service in a restaurant,
haircut, legal advice.) Quality of service may
vary from “hour to hour”
You can have an agent (e.g., supplier) with the right
abilities, but s/he might
a) Under-supply (i.e., deliver lower quality than what you asked for) or,
b) Over-supply (charge for more than what you asked for)
Reputation and How will others find out about your behavior?
- Reputation denotes an expectation of behavior based on past demonstrations of those same behaviors.
- Reputations emerge from others (customers) talking about what you do.
- It is the positive and negative stories exchanged about you, the gossip about you, that defines your reputation.
Reputation facilitates collaboration
Reputation creates a cost for misbehavior (i.e., a credible signal)
- Customers are willing to pay a premium
- Customers are more loyal
- Customers buy broader ranges of products and services
- Attract better employees
- Companies enjoy superior profits and higher market value
What to do? (Heterogeneity)
− Future business – reputation (disincentive to cheat)
− Contracts (outcome or behavior) and supervision
* Monitor and reward outcomes vs. process: “pay for performance” vs “pay for input”
− Guarantee/warranty
− Hostages/sunk investments
− Price premiums (loss of future returns)
* Price charged > marginal cost of producing high quality
* Assumes ability to evaluate quality in the future, and knowledge about cost structure
