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Imagine a situation in which there is a very small amount of your product, and the demand for it is growing like crazy. What would you do?

Manners matter

People are much more interested in being treated fairly than in coming out ahead vs. their alternatives during a negotiation or transaction. This wonderful overview paper by Richard Thaler about the Anomaly of Ultimatums reviews a bunch of work in microeconomics that reviews this in action – we have a long way to go to really understand the phenomenon – but it’s an interesting discussion about the phenomena and its impact on how to couch “offers” or negotiations.

The Ultimatum Game

The ultimatum game involves two people and a pile of money. For example you take $10 and ask one of the participants, called the proposer, to decide how much money to keep and to offer the rest of the money to the other participant, the responder. Now the responder gets to either accept or reject the offer. If accepted, the money is divided and both walk away. If rejected, then neither player gets anything. They both walk away poor. Take a moment and think about this - How much money would you offer someone if you were the proposer? How much money would you be willing to accept if you were the responder? The way this plays out in practice is fascinating! Responders are generally unwilling to accept anything less than 30-40% of the total. Offers of 20% and lower are frequently rejected, and a 50% split is often the most common result. Thus, it seems that responders are willing to “punish” proposers who try to be too unfair, even when accepting anything is better than nothing and would leave the responder better off. The really interesting stuff comes in when you change the rules slightly. Instead of having just one responder, you can have three or four of them all write down their best offer simultaneously, allowing the proposer to accept the best offer. Under this situation, the proposer is not viewed a being unfair, the proposer is simply taking the best offer available, and the responders are willing to accept much less. In fact, often the responders will even try to punish the other responders (by lowering their bid further!) if they feel they are behaving poorly in the game.

Google and Big Oil

Google continues to raise its prices faster than the rate of oil and gasoline, yet Big Oil is being hauled up in front of congress to defend themselves against price gouging, while Google is still seen by most as living up to their motto, “do no evil,” with near perfection. How can this be? Are Big Oil’s profits more “unfair” than Google’s? Economics says “no” but the general public seems to think “yes.” I believe the difference is a good lesson to reflect on especially for new business owners. Google’s prices for paid advertising are set by an auction process - so when the price of an ad goes up - you obviously have only your competition to blame. Google didn’t raise the prices of the ads, your stupid competitor did. Right? Yes. Oil & gasoline on the other hand, are priced differently. Oil prices are set by oil companies, and gasoline prices are set by refinery companies. Therefore, when prices go up (sometimes abruptly), people tend to eye the oil & refinery companies with distain and resent the price increases. Which is reasonable, because the oil companies were making plenty of money before, so they don’t need to raise their prices, right? No. The reason prices go up is not because the oil or refining company’s want it to. The prices go up because the relationship between supply and demand changes. Oil is a scarce resource, and lots of people want to use it. Therefore, when this supply & demand relationship change, you see big price swings. The exact same situation is happening for the scarce resource that Google sells - online ad space. Neither Google nor oil companies dictate prices, prices are basically set for them by the relationship between supply and demand - which their customers and competition control. However, people feel “ripped off” when oil companies raise prices because they percieve unfairness in the price raise.

As we’ve seen from the ultimatum game, this can have disastrous consequences for the efficiency of a market, and can actually make people behave in ways you might not expect them to toward your product or your company. When you’re thinking about how to handle your next price raise, negotiation, or partnership consider the fact that no matter what the “hard realities” are people have a deep desire to be treated fairly and with respect - and will go out of their way to punish you if you don’t respect that.

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