Haggling and Hiring: Economic Lessons from the Real World




INTRODUCTION

This blog was prompted by an article in the Sunday New York Times  Business Section of April 14 titled, “Sometimes We Want Prices to Fool Us.”  The article is about the J. C. Penny’s merchandising disaster.

HAGGLING

In 2012, J. C. Penney’s sales dropped 25% compared to 2011.  Over two years ago, Penny’s brought in Ron Johnson from Apple Stores to turn the company around.  Mr. Johnson eliminated sales and coupons and promised shoppers “everyday low prices,” Walmart’s slogan.  This saved huge amount of money on inventory and advertising costs and smoothed out cash flow.  Great strategy.  Penny is near bankruptcy.  Ron Johnson has been fired and sales supplements are reappearing in my newspaper.

Simple economic theory assumes one equilibrium price.  Each potential consumer compares his/her expected “pleasure” from buying the product to the cost (price) of the product, and then decides whether or not to buy it.  This says nothing about the psychology of consumers or the buying process in general.

This is not the way retailing usually works.  As the article says, consumers love sales, discounts, and coupons.  They love frequent flyer points and loyalty programs.  They derive “pleasure” from getting a good deal, from not paying list price.

Consumers look at prices.  The list or full price is sometimes called the anchor or anchor price.  That is, some consumers compare the sales price with the list price to see how much they are saving.  Typically, the greater the percent saving, the greater the satisfaction.  Daniel Kahnemann, a psychologist, recently won a Nobel Prize in Economics by discovering this behavior.  The owner of my local pizzeria knew this 40 years ago.

All retailers and service providers know this.  So they mark-up the wholesale price to earn a target margin that includes an expected percent of the goods to be sold on sale.  The target margin is a weighted average of the different prices.

They also know that most Americans don’t like to haggle.  Why, I don’t know.    Buying on sale, with coupons and rebates, or through a loyalty program is a passive, low-cost way for people who don’t like to haggle to get a lower price. 

At retail, price discrimination is built into the list price.  Rather than one price, retailers expect to sell the same product at different prices to different groups of customers.  Colleges compute tuition discounts for each student they accept.  At the extreme, airlines change prices in real time as they sell seats.

There’s another aspect to the purchasing process economics doesn’t consider – how the consumer pays.  As explained in an earlier blog, consumers who pay with credit cards do not experience the same “pain” as consumers who pay with cash.  The combination of the two changes – the pleasure of getting a sale and paying with a credit card - changes the pleasure/pain ratio of the purchase and probably increases total sales.

Setting net prices along the supply chain can be an expensive and incredibly complicated process.  Haggling is an integral part of the entire purchasing process.  Walmart employs 5,000 people in China just to negotiate the terms of purchasing products in Asia.  Companies also spend a great deal of money on people and IT to compute and track net prices.  Net prices and terms of sales are negotiable after the sale and delivery of the goods, as companies haggle over interest on late payment, returns, advertising allowances, warranty costs, delivery costs, support service and any other part of the transaction.
           

HIRING

The J.C. Penny story may have another lesson.  It has to do with the hiring process.

Given the dynamics of competition in mass retailing, the last place a hiring committee should have been looking for a new CEO was Apple. Apple Stores is a strategy of Apple’s to keep the price of their products high.  “Everyday high prices.”  Apple differentiates by features, nerd appeal and design, not by price.  This is the absolute wrong experience for someone to turn around Penny in the brutal mass merchandising industry.  What was the hiring committee thinking? 

A related consequence.  Ron Johnson brought in Silicon Valley types to help him run Penney.  From newspaper reports, this compounded his ignorance and arrogance.  It is not hard to imagine the political and personal infighting and mutual antagonism (to put it mildly) that erupted as the Silicon Valley types began working with (dictating to?  belittling?) Penny’s existing managers in Plano, Texas.  To make matters worse, Johnson and some of his Silicon Valley hires would fly into Plano from San Francisco on Monday morning and fly back on Friday.  What kind of message did that send to the simple folks back in Texas?

Who gets hired?  Ambitious managers learn early that the best candidate often doesn’t get the job.  The candidate with the best interviewing skills and slickest resume does.  The key is selling yourself, often to members of the “search” committee who do not understand the business.  The candidate with the most impressive interviewing or presentation skills will probably get the position.  Or, often at the highest levels of management, the best networking skills.

The press releases announcing the hire usually contain words like “forceful,” “dynamic,” “visionary” or “strategic thinker.”  After two or three years, the words translate into ignorant and arrogant.  After getting a golden parachute, the CEO spins his/her resume and goes on to the next position, citing his/her success as a CEO.  This is easy.  Most of the time, the economy expands and so do the sales and profits of most companies.  In the short-run, profits can expand even further through cost-cutting (laying people off and reducing fringe benefits); reducing capital investment, training, R&D and marketing; and what is euphemistically called “financial engineering.”  Then the CEO moves on before the long-run bill comes due.

Another lesson, which brings me to the current flap over the hiring of the new Athletic Director at Rutgers.  Given the problems, Rutgers’ president and board announced a list of criteria to be used for choosing the new AD.  It was long on ethical behavior and developing “student-athletes.”  To anyone who has been reading about college sports over the years, the last place Rutgers’ search committee should have looked was the University of Louisville.  Louisville has an incredibly successful athletic program, with basketball as the premier sport.  Louisville’s AD deserves credit for this success.  But anyone who reads a sports page, especially during “March Madness,” knows that how Louisville succeeds is the opposite of the supposed standards Rutgers was applying.  Was the hiring committee ignorant of this when they hired the assistant AD from Louisville?  Apparently, from recent articles.  They were also apparently ignorant or ignored red flags.  So what if she was as abusive as a coach as the one Rutgers fired.  So what if she had been sued for sexual discrimination and had convenient lapses of memory.  Will they fire her?  I doubt it.  The important consideration is that Rutgers is about to join the Big Ten, the big leagues of college sports. Succeeding, or at least being competitive, is the overriding consideration.  A lot of money is involved.  Leaving aside the original PR fluff and the $150,000 Rutgers paid a “communication company” to do damage control, Rutgers hired someone from a successful program.  Nothing else matters. 

The practical lesson is that when you are reading a job description, try to find out what they are really looking for.  If you were approached by a search firm, ask lots of questions.  If you get an interview, listen closely to the comments and questions from key members of the search committee.  Try to learn what are the key issues involved and outline how you would resolve them.  If they hire you, it is time to start haggling over the compensation package.    
_____________________________________________________________________________

Please see the related post,
http://bennettgreenberg.blogspot.com/2009/09/you-your-brain-and-your-credit-card.html




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