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March 20, 2008 by Rich Whittle | 0 Comments

Knowledge@Wharton:

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, Zhang, Raju and Cui argue in a paper recently published in Management Science titled, “Fairness and Channel Coordination.”

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.”

Call it a new glove for the Invisible Hand: The manufacturer sets his price, and the retailer’s sense of fairness takes care of the rest. “We show that you don’t need elaborate coordination contracts because concern about fairness creates coordination, which perhaps explains the prevalence of using simple wholesale prices as channel contracts,” Zhang says.

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Photo by anissat.

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Tags: Operations, Psychology, Strategy