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What are Networked Companies?
Supply chains Procurement systems Sales channels Out sourcing Off shoring Inter-Organizational Systems E-Lance and Free-Lance Web Sevices New constructions of transacting entities
that do business in fundamentally new ways.
Where technology affects transactions
Why study them?
New methods of transacting offer new challenges for management
Understand what they are Understand the problems and
conflicts Find and use the right tools to
analyze problems and recommend solutions.
The basic phenomenon
Advances in Information and Communication Technology have enabled new methods of interacting and transacting.
Buying, selling, contracting, supplier relationships, vendor relationships, price setting, etc…
Where the Tools meet the Technology
EconomicsSociologyManagement
Core Issues
Transacting In-house or out-source? Boundary of the firm Sourcing agreements Contract management Employees & personnel management
in networks Intermediaries Pricing
Economics as a Discipline
Assumes that people have endogenous utility functions and they pursue them
Largely a problem of optimization Must make certain assumptions about people/firms to
solve optimization problems Defines generic roles and structures for agents/firms
– calculates equilibrium point If you can live with the assumptions and logic, it can
be very powerful!!!! Base discipline for Strategy, Finance, Marketing,
Accounting…..
Sociology
“Sociology is a science which attempts the interpretive understanding of social action in order thereby to arrive at a causal explanation of its course and effects.... Action is social when it takes into account the behavior of others and is thereby oriented in its course“ (Weber, 1947).
Preferences and actions are exogenously determined….The big sponge view
Road Map
Life Insurance & Suicide
Suicide Frequencies
0
0.2
0.4
0.6
0.8
1
1.2
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29
Months after life insurance policy issued
Fre
qu
en
cy
Information Asymmetry
Differences among individuals in their information, especially when this information is relevant to determining an efficient plan or determining individual performance.
In simple terms: a situation that exists when some people have better information than others.
Example: Insider trading
2 types of Information Asymmetry
1. Hidden characteristics Things one party to a transaction knows
about itself, but which are unknown by the other party.
2. Hidden actions Actions taken by one party in a
relationship that cannot be observed by the other party.
Scenarios
You rent a car, you’re young, beautiful a free spirited, wind in your hair. Go ahead, trash the car, drive it hard, Why Not????
You’ve been working hard all day. The boss leaves for a few hours. Go ahead, kick back, relax, drink a beer, surf the net….Why Not???
Moral Hazard Originally from the tendency of people with
insurance to reduce the care they take to avoid losses or reduce insured losses. Now the term refers to a form of post-contractual opportunism that arises when actions desired or required under the contract are not freely observable.
Situation where one party to a contract takes a hidden action that benefits him or her at the expense of another party.That is.. you do not directly bear the consequences of your actions.
1. potential divergence of interest2. basis of gainful exchange or transaction3. difficulties in monitoring and enforcing
Solutions I
Signaling Attempt by an informed party to send
an observable indicator of his or her hidden characteristics to an uninformed party.
To work, the signal must not be easily mimicked by other types.
Example: Education… ESADE MBA
Solutions II
Improve monitoring Competing sources of information Monitoring by markets Explicit incentive contracts. Linking pay to
some operational output Achieving goal congruence Sources of social governance eg. reputation,
peer approval, morals, religion, culture, Corporate culture: Workable principles or routines
of shared expectations that guide behavior in the face of uncertainty.
Problem
Characteristics of population have specific mean and distribution, but those buying insurance have different profile. Why?
Examples: Choice of medical plans High-interest loans Auto insurance for drivers with bad records USAA
Adverse Selection
pre-contractual opportunism that arises when one party to a bargain has private information about something that affects the other's net benefit, implying that it would be dis -advantageous for another party to enter the contract
Situation where individuals have hidden characteristics and in which a selection process results in a pool of individuals with undesirable characteristics
Solutions
Screening Attempt by an uninformed party to sort
individuals according to their characteristics.
Often accomplished through a self-selection device A mechanism in which informed parties are
presented with a set of options, and the options they choose reveals their hidden characteristics to an uninformed party.
Example: Price discrimination
Opportunism: degrees
1. Self interested behavior2. Self interested behavior
unconstrained by morality3. Opportunism with guile: you may
actually not mind, or even enjoy - doing something at someone else's expense!
Opportunism: Debate!!!
Is it soooo bad???? Just how prevalent is it? How to we mitigate or protect
ourselves against it? If we consciously choose not to be
opportunistic, is it because we are simply “good” people, or is it because we believe there will be long term benefits?
Buying a Car
You are here!
Price= 11,000Nom. Value= 100Distance= 12mi.Value(dist).=1.89
Price= 15,000Nom. Value= 95Distance= 15mi.Value(dist.)=1.05
Price= 10,000Nom. Value= 140Distance= 18mi.Value(dist.)=1.94
Bounded Rationality
The limitations of human mental abilities that prevent people from foreseeing all possible contingencies and calculating their optimal behavior.
Also includes limitations of human language that prevent people from communicating things that are known.
We assume agents are rational, but only sort of rational
Theoretical garbage can
Fairness - Retaliation
Negative Reciprocity & Envy: You hurt me, I will hurt you back! I will even take pleasure in it making you suffer loose something at my expense.
Explanations: Comes from survival instincts in nature
Only in very simple societies do we find less negative reciprocity (people are happy with relatively small shares of money).
Altruism & Fariness
Economist world view based on self interested behavior.
I help you, even when I get nothing back for it..
How do we explain it? Why don’t companies reduce salaries
in hard times? The fire people instead
An experiment
Imagine you are stranded on a beach on a sweltering day and that someone offers to go for their favorite brand of beer. How much would they be willing to pay?
Subjects agree to pay more if they are told that the beer is being purchased from an exclusive hotel rather than from a rundown grocery. It strikes them as unfair to pay the same.
But a beer is a beer and should be worth the same???
Social preference: I accept prices that I feel are fair to you…
Buying a house
I am selling my house for 350,000 If you knew I bought it 3 years ago for
320,000, would you think it is a good deal?
If you new I bought it 3 years ago for 150,000, would you think it is a good deal?
What is the average rainfall of New Zealand?
45cm 55cm 63cm 79cm 114cm 123cm 156cm
The Law of Small Numbers – Weber’ law (people are petty…)
I. You are buying a glass of orange juice. You can buy it here for 4 Euro, or walk across the street and buy it for 3 Euro. What do you do?
II. You are buying a big screen TV. You can buy it here for 800 Euro, or walk across the street and buy it for 799 Euro. What do you do?
III. the impact of a change in intensity of a stimulus is proportional to the absolute level of the original stimulus. In financial terms, a $500 gain on a $100 investment is greater psychologically than a $500 gain on a $1000 investment.
Investors
Alex invested 100,000 Euro and gained 27,000 for a total of 127,000 Euro.
Anne invested 300,000 Euro and lost 39,000 for a total of 261,000 Euro.
Who is happier? Why?
Prospect Theory
Prospect Theory Says
1 unit of loss hurts about twice as much as 1 unit of gain. So….We are loss averse
What would you rather have; 10 Euro today, or 5 Euro today and 5 Euro next week? Changes are more important than absolute levels
What is better – you crash your car once and it costs you 1000 Euro. You crash your car twice and it costs you 400 and 600 Euro respectively.
Changes..
What is happiness? Are rich people really happier? (Of
course they are) We anchor everything to our current
status. Sooo What: Combine losses, spread
out gains We tend to hold onto loosing stocks..
...Decisions Are Not Always “Rational”
Tickets; $7.95
$1.00 Discount for Children &
Seniors
Tickets; $7.95
$1.00 Discount for Children &
Seniors
Tickets; $6.95
$1.00 Extrafor Middle Aged
People
Tickets; $6.95
$1.00 Extrafor Middle Aged
People
Price Perception Issues are Complex...
More Acceptable Pricing Product-Based Open Discretionary Discounts and
Promotions Rewards
Less Acceptable Pricing Customer-Based Hidden Imposed Surcharges Penalties
Time
You are going to order a new BMW for 60,000 Euro.
The car dealer A tells you that you can get the car delivered in 7 days.
Car dealer B, who is 4 blocks away, tells you the car can be delivered in 3 days.
Do you walk down the street to the other car dealer – price and other options being equal?
Time
You are going to order a special BMW for 140,000 Euro.
The car dealer A tells you that you can get the car delivered in 94 days
Car dealer B, who is 4 blocks away, tells you the car can be delivered in 90 days.
Do you walk down the street to the other car dealer – price and other options being equal?
Procrastination
Scenario A May 1: Work 7 hours May 2: Relax
Scenario B May 1 Relax May 2 Work 7.7 hours
Today is April 30th - which option would you choose?
Procrastination
Scenario A August 1: Work 7 hours August 2: Relax
Scenario B August 1 Relax August 2 Work 8 hours
Today is April 30th - which option would you choose?
What is the average rainfall of New Zealand?
63cm 79cm 114cm 123cm 156cm 164cm 178cm
Framing Effects
People base their decisions on the references given
Extremes aversion 2nd cheapest wine most expensive
Endowment Effects
What would you pay for this chair?
10.00 Euro fine How much will
you sell this chair for?
10.01 Euro???
What are market transactions?
They are defined by:
Moral hazard Adverse selection Information asymmetry Bounded rationality Opportunism
Uncertainty
