Friday, January 22, 2010

Price, Incentives and Performance

Yesterday's edition of The Wall Street Journal had a tease on the front page that directed readers to this story on page one of the second section.

The story is about Burger King and its franchisees and the fight about the $1 double cheeseburger. Corporate sees it as an edge in keeping the value-oriented customer; some franchisees say they can't sell it profitably at that price. The whole issue is now the subject of a possible lawsuit.

Initially, the most interesting part of the story (for me) was the photo of the burger on page one. But the more I thought about it the story, the more potential I saw. Here is my reasoning.

We usually teach about institutions (rules and beliefs) within the context of a nation or society, pointing out how the institutions can shape decisions. We also often discuss how personal beliefs can shape our choices. But we sometimes forget that rules in the workplace also have an effect and can thus be classified as institutions.

The rules in the workplace are meant to affect choices and decisions and to promote or inhibit certain behaviors. In the WSJ story, the choice of setting prices is something that is usually left up to individual franchisees - that's why advertising may include "at participating stores" as a tag-line. But what if the pricing is part of an overall corporate strategy? Or what if failure to adhere to pricing actually leads to an overall loss of business or market share?

Furthermore, go back to the basic idea of institutions - rules meant to influence choices and decisions. And add the fact that changing institutions is often a slow (at least within societies) process. Can we look at the group of franchisees as a "society?"

If we carry this a step further, couldn't the same reasoning be applied to issues like compensation at financial institutions. Compensation was structured to influence certain behavior (choices). Changing the rules is bound to cause backlash because it means changing behavior, behavior that may even be "second nature" by now. To have true change may take time.

Although one can make a case that firms are not democratic republics and government regulations can be imposed, it doesn't mean employees or franchisees won't vote with their feet.

I'm not sure what side of the issue I would come down on, but the discussion may allow your students to get their arms around the impact of institutions, and why they can be hard to change at any level. Just some things to consider - all from a double cheeseburger. I look forward to your comments.


Anonymous said...

Tim, I just finished reading Saving Adam Smith. I was pleasantly surprised by the author's ability to weave Adam Smith's principles into a novel. I enjoyed the appendix too. I haven't read Theory of Moral Sentiment in its entirety, only bits and pieces, and I've read that it is a favorite of Bill Gates. It's next on my econ book list.
Thanks for the book tip.
Sue Bolly
Nicolet High School
Milwaukee, WI

Tim Schilling said...

I'm glad you enjoyed the book. I'm glad you're trying The Theory of Moral Sentiments. It can be a bit daunting but I think you'll find it rewarding, and it adds a whole new dimension to your view of The Wealth of Nations.