Being a keen cyclist I tend to ride a few hundred kilometres a week, and as such my two bikes tend to need regular maintenance and repair to keep them in good working order.  Whilst I’ve made an attempt to become more learned in the various mechanics of bike repair, it’s still not something that comes particularly naturally.

So, over the years there have been numerous trips to the local bike shop to ask for help and advice on various bits and bobs.  Now, here’s the rub.  If they’re an ethical bunch then they’ll be honest and upright in the advice that they give you.  If not however, they could suggest things need replacing when they really don’t.  If you’re relatively clueless on these matters, could you really tell the difference?

This type of situation, whereby the supplier tends to know much more than the buyer, is known as a credence service.  A new study suggests that in such scenarios, the economy is actually worse off when those service providers care more about the customer, which is all rather counter-intuitive.

Why is this so?  Well, the researchers suggest it is precisely because the consumer is generally not able to determine the veracity of any recommendation made to them, so the value of any repairs or recommendations made may remain unknown.

The researchers developed a model of just such a market, which contained two service providers.  One of them was a self-interested type who you would imagine would not have the customers best interests at heart.  The other was a much more ethical provider that cares about the customers well-being as much as their own profit.

The standard heuristic is that the latter would be much more beneficial to society than the former, but the study suggests that it is in fact the opposite that is the case.

“For a provider with social preferences, the optimal strategy that maximizes the combination of its profits and social satisfaction is to charge a uniform price and provide services to all consumers.”  the authors explain.

Now, it’s generally unknown to the customer which type of company they’re dealing with, although in this age of social reviews and online customer feedback, this may be a dubious assumption to make.  The researchers suggest that making that assumption however, the customers would generally accept a higher price from the ethical supplier than from the purely profit motivated one.  The reason for this is, they suggest, that the ethical supplier will generally provide a uniform price for their service, even if the customers requirements exceed that price, due to the satisfaction they take from a job well done.

The profit centred company however will tend to service the low-cost customer first and foremost, as they will make them the most money.  They won’t be so keen on the customer with relatively high demands.

Thus, their logic goes that, the customer who isn’t aware of their exact condition (ie high or low cost) will more likely go with the ethical company who whilst charging more money won’t refuse their custom.

This in turn influences the whole market, as more customers go with the ethical but higher priced supplier, this then prompts the profit-centred supplier to raise their prices to be in line with their rival.  As the researchers explain “…when more providers have social preferences, their optimal uniform price increases, which gives the purely profit-maximizing provider more of an incentive to mimic that uniform price. When the profit-maximizing provider rejects high-cost customers for service, there is a social loss because the value of the service to these customers may still be higher than the provider’s cost. In contrast, when a smaller fraction of providers have social preferences, the purely profit-maximizing provider will have less incentive to mimic the uniform pricing policy and will actually prefer charging different prices based on the customer’s cost.”

Of course, much of this rests on the ability of the consumer, both in not knowing the state of their own condition, nor in knowing which supplier is ethical or not.  In an age where information is freely available online to help educate consumers on both states, it does raise some questions over this basic assumption.

Nevertheless, an interesting counterpart to the prevailing point of view regarding the value of ethical suppliers to the market.