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




Comments

Post a Comment

Most Popular Posts

Adam Smith's Pin Factory

Image
Adam Smith - Our Founding Father ADAM SMITH VISITS A PIN FACTORY   Adam Smith’s description of a pin factory is on the first page of  The Wealth of Nations .  (Chapter 1 – “Of the Division of Labour”)  Drawings of pin factories of this period show workers using hand tools. Smith says the process can be broken down into 18 distinct steps, including packaging the pins. Smith mentions that pin factory workers were poorly paid, despite their high productivity.    Adam Smith says he visited a pin factory employing 10 men who produced 48,000 pins per day.  If each of the ten workers had done all the steps themselves, Smith says each worker could produce only 10 or 20 pins per day.  So the pin factory replaces 2,400 to 4,800 pin makers. The increase in labor productivity (output per person per day) is as high as 50 times that of individual pin makers.     This reduction in unit cost or average cost (AC) and the huge i...
Read more

Bilateral Oligopoly

Image
The best movie about the Gunfight at the O.K. Corral is titled My Darling Clementine. A great western - great cast, great photography.  DEFINITION OF A BILATERAL OLIGOPOLY Models of market structure assume that the demand side is represented by a large number of buyers.  The structure of the market, and the assumed market outcomes, depends on the number of suppliers and how they compete.  Suppliers either post one price or exploit their knowledge of buyer categories by using price discrimination.  Despite the comments about the key role of consumers in determining economic performance, consumers are fairly passive when the discussion focuses on imperfectly-competitive industries.  But many markets are not structured this way; the buyers are not passive consumers but large corporations that do not passively accept suppliers’ prices.  Net prices are actively negotiated.  These markets are often bilateral oligopolies. In a bilateral oligo...
Read more

The Stock Market Crash of 1929 and the Beginning of the Great Depression

Image
Famous Headline Introduction The usual reasons given for the Great Depression – the stock market crash of 1929 and the later collapse of the banking system – do not tell the whole story. Available economic data indicate (there were no national income accounts in 1929) that a recession had already begun before the stock market crash. The crash of October and November of 1929 was a catalyst that made the recession worse but the partial stock market recovery in early 1930 did not end the recession. Industrial production continued to fall quickly and unemployment rose rapidly in 1930. Continuing farm and businesses failures over the next two years wiped out thousands of small rural banks and threatened total financial collapse in early1933.  For a fuller explanation, we have to go back to the 1920s to see additional reasons for the origins and the rapid decline in output at the beginning of the Great Depression. We have to look at the int...
Read more

List of Posts By Topic

FIND POSTS BY CATEGORY CATEGORIES Basic Concepts and Theory Market Behavior and Structure Market Dynamics and Information:  How Markets Work The Industrial Revolution in England American Economic History American History Demographics and Economics Management World War I:  The Beginning of the 20th Century The Roman Republic and America - Differences and Some Possible Parallels Economic and Fiscal Policy Financial Markets and Investment Strategies Foreign Exchange Markets The United States American Foreign Policy and International  Relations Geopolitics and the Global Economy Geopolitics of Oil and Natural Gas Visionaries BASIC CONCEPTS AND THEORY Introduction to Economic Theory Economic Development and Economic Growth Production Functions and Supply Chains Demand  Analysis The following post was contributed by Dennis Schuchman. Artificial Intelligence (AI) and Real Intelligence (RI) You, Your Brain and Credit Card s Critique of Basic Economic Theory MAR...
Read more

Explaining Derivatives - An Analogy

Image
You go around to farmers with cows. You buy all the cows and pay the farmers a small fee to milk the cows and sell the milk. You pay for the cows with ass(et)-backed securities called MBSs (Milked Bovine Securities) that you tell investors are udderly safe. But some of the cows don't give enough milk (cow flow problem) or give no milk at all. You take some of the asset-backed securities, say they're backed by the subprime cows, and use them as collateral to sell another set of securities called CMOs (Cow Milk Obligations). Then you buy CDSs (Cow Dried-up Swaps) from AIG (Angus Insurance Company) to insure the CMOs when the cows stopped giving milk. If you work it right, you collect more on the CDSs than you pay out to retire the CMOs. The money you get from selling the dead cows go to pay the CLOs (cow leather obligations). You could also sell CDOs (cow dung obligations) that depend on how much cow dung is produced. This is a typical Wall Street product - turning sh...
Read more

Government Finance 101. Fiscal Policy: Welcome to Alice in Wonderland

Image
  PRELIMINARY SUMMARY OF FISCAL 2024 BUDGET The deficit in fiscal 2024 was around $1.8 trillion, about $5.0 trillion in revenue and $6.8 trillion in expenses. Interest on the national debt this year is around $960 billion, over twice the interest on the fiscal 2021 budget. Interest expense this year passed outlays for the military. Leaving aside Social Security and Medicare, interest expense is about 20% of total budget outlays. Interest expense is about half the budget deficit.   The fiscal 2024 deficit was 6.4% of GDP.  SOME BASIC DEFINITIONS AND A LITTLE DETAIL Some basic definitions for people in government suffering from political amnesia:   Deficit.    The difference between the federal government’s spending and its revenue in one fiscal year.  The fiscal year starts on October 1.  So fiscal year 2024 started on October 1, 2023. You know right away this is going to be confusing. Debt .  Short for national debt or ...
Read more

John von Neumann Sees the Future

Image
John von Neumann JOHN VON NEUMANN CREATES THE FUTURE If you want to understand the world we live in, you have to know about the thinking of three men – Alan Turing, Claude Shannon and John von Neumann.   I’ve talked a little about Alan Turing in an earlier essay.   All three men knew each other, discussed their ideas with each other and promoted each other’s ideas. John von Neumann has been called the smartest individual of the 20 th Century.   Even an outline of his accomplishments, which you can read about in  Wikipedia, is hard to believe.   He invented game theory, which I discussed in two earlier posts.   He headed up a group of mathematicians who invented new statistical techniques at Los Alamos that made the atomic bomb possible.   In 1944, he wrote a memo that outlined the structure of the modern computer.   He then managed the design and building of a modern general computer and consulted on the building of virtually all ...
Read more

The Roman Republic Commits Suicide: A Cautionary Tale for America

Image
Roman Legion Why Study Rome? Americans have focused on comparisons between Rome and America twice in American history.  The first time was during the period from before the Revolution to after the ratification of the Constitution and Bill of Rights, when the founding fathers and others looked to the Roman Republic for ideas and inspiration on how to structure the new government. After the American Revolution, the founding fathers, having read the Roman authors detailing the collapse of the Roman republic, worried about internal threats to the survival of their new republic.   The second time was when the United States became a superpower, especially after WWII, and then again after the collapse of the Soviet Union in 1991. Commentators compared America to the Roman Empire at the height of its power. There was some discussion about how America became a permanent warfare state and how it affected domestic democracy and civil society. ...
Read more

Josiah Wedgwood, the Wedgwood Pottery Company, and the Beginning of the Industrial Revolution in England

Image
Wedgwood Anti-Slavery Cameo A better introduction to the beginning of the Industrial Revolution than Adam Smith is the history of Josiah Wedgwood and the Wedgwood Pottery Company. This is how one company actually ushered in the Industrial Revolution. The revolutionary generation that first adopted steam engines saw the following trends and changes: Manufacturing was being modernized by a small group of entrepreneurs. Much of the new raw material processing and manufacturing was concentrated in a small area in the middle of England, away from London. These modernizing entrepreneurs formed a new economic, intellectual and social network. Modernizing entrepreneurs like Wedgwood tended to be members of Dissenting sects (like Quakers) or Nonconformist churches (not members of the Church of England), Whigs (liberals) in politics, and believers in “progress.” They were optimistic about the future, influenced by the ideas of Hume, Rousseau, Locke and Adam Smith. They believed...
Read more

“Pax Americana”: The World That America Made

Image
There are two kinds of empires: the kind that rules through ruthless exploitation, and the kind that seeks to induce allies into defending themselves through economic incentives. (George Friedman) INTRODUCTION America's power and influence in the world rests on three broad, interrelated bases: 1) Overwhelming military power that can be projected anywhere in the world,   supplemented by security arrangements with allies and supporters. 2) A large, innovative, dynamic domestic economy as the basis for global economic and technological leadership. The economy provides the resources and technology to support the military and a global foreign policy. 3) Claims to moral and ideological leadership and influence, particularly the promotion of liberal democratic societies and supporting political institutions. This post will discuss the economic aspects and related security objectives of American foreign policy. It will focus on the structure of the global...
Read more