Fungibility v. Fetishes

For an economist studying business strategy, an interesting puzzle is why businesspeople, analysts, and regulators often don’t seem to perceive the fungibility of payments. Especially in dealing with bargaining issues, a persistent “optical illusion” causes them to fetishize particular transaction components without recognizing that the share of total gain accruing to a party is the sum of these components, regardless of the mix. Proponents of the “value-based” approach to strategy, which stresses unrestricted bargaining and the core solution concept, ought to be particularly exercised about this behavior, but even the less hard-edged V-P-C framework finds it difficult to accommodate.

Some examples:

  • There’s been some noise lately about U.S. telecom providers cutting back on the subsidies they offer users who buy smartphones. None of the articles address the question of whether the telecom firms can thereby force some combination of a) Apple and Samsung cutting their wholesale prices and b) end users coughing up more dough for (smartphone + service). The possibility that competition among wireless providers fixes the share of surplus that they can collect, so that cutting the phone subsidy will also require them to cut their monthly service rates, is never raised explicitly. There is a pervasive confusion between the form of payments and the total size of payments.

  • When the SEC and the FTC investigated Intel’s business practices in the microprocessor market, one of the big “oooh” revelations was that the company paid a whole bunch of money to its prized customer Dell (ostensibly so that Dell could hit its quarterly earnings targets) in return for Dell being a loyal 100% Intel shop. The fact that these payments effectively lowered the average price Dell paid for an Intel microprocessor, and so amounted to a rebate/discount, somehow got lost. It turned out that Dell had more buyer power than those of us teaching the Harvard case on the company realized, but it’s hard to see why it should matter much to anyone what form the transfer from Intel to Dell took. A lower up-front linear price, a non-linear price with quantity discount, bonus for being 100% Intel–all are fungible from a distributional point of view. And there is no clear argument I can see that the form these payments took was more likely to make Dell stick with Intel and avoid AMD. (It is interesting that Intel appeared to place a discrete incremental value on getting from 99% to 100% share with Dell.)
  • When television content providers like Viacom or ABC/Disney negotiate with distributors (cable and satellite companies) they have three main exchange components: advertising revenues, program fees, and agreements to carry channels. These are all valuable considerations that have monetary value. Observers of these often-contentious bargaining episodes say very odd things about the strategic importance for content providers of being able to use their established popular channels (e.g. ESPN) to “lever” distributors into carrying their fledgling and less-popular content as well. But the bargaining power Disney/ABC gains by owning ESPN is independent of how they chooses to exercise it, and they could just as well drop demands for station carriage and instead insist on higher program fees. The interesting question is why the parties often end up with an agreement that puts the new low-rated channels on the system, presumably in return for lower program fees (or perhaps a different cut on advertising).

(I can think of some other good examples of payment fetishism, notably discussions of the split between up-front payments and back-end royalties for TV content producers selling to the networks, but those are a bit more complex to explain.)

Of course, we know that the form of payments can affect incentives or risk sharing, but none of the public analyses of these stories considered these factors and it isn’t clear how they matter here. Nor is there any obvious role for varying measurement costs across components as being a major issue. And since each of these considerations has a straight expected monetary value, one can’t appeal to an Edgeworth box story where strictly convex preferences make agents try to trade off excess amounts of one consideration for scarce amounts of the other–money is money, and the tradeoff should be linear and one-to-one for at least one and possibly both parties.

This may be an opportunity for behavioral or institutional theories to do some good. A behavioral story would suggest some form of mental accounting or other cognitive illusion causes parties not to recognize the fungibility of the items being negotiated. An institutional theory might focus on the legitimacy norms that form around particular traditional payment categories. One interesting aspect is how emotional the public discourse over these payment-form choices can get. Some of it is no doubt posturing, but as Robert Frank pointed out in his book on the strategic role of emotions, one way to be convincing about one’s commitments is to actually get emotional.

3 Comments on “Fungibility v. Fetishes”

  1. alex says:

    I do not know the microprocessor market in detail but, for example, in the FMGC sector it is quite common for suppliers to pay large retailers a lot of money to both launch a product, keep it on shelf or, more generally, to maintain the flow of orders. Clearly, the larger the supplier, the lower is this amount of money and, also, it depends on the retailer and so on. However, a key reason behind this practice is that this amount of money paid legally but ‘ex-order’ influences directly the performance of the retailer’s buyer. If it was a direct discount on the order or a rebate it would not cause this effect. I guess that the suggestion related to your very interesting post is that possibly at the organizational level how value is distributed may not count a lot, yet it may not be the case at the individual level. Regards

    • stevepostrel says:

      Internal firm incentives and politics are sometimes a factor. It’s interesting that Wal-Mart, for example, pretty much restricts its bargaining to getting the lowest per-unit price it can while supermarket competitors often ask for all kinds of marketing allowances, shelf fees, etc. A colleague and I puzzled about why this difference persists–the best we could come up with was that some internal firm budgeting process made the various slush accounts more desirable to supermarket managers than would lower linear wholesale prices. But that was rank speculation.

  2. alex says:

    well… as far as I remember when I working in the industry few years ago, the UK Wal-Mart firm ASDA was not so different from its competitors in terms of bargaining practices… but I may be simply remembering wrongly… Surely, in the case I was directly or indirectly involved with, it was not just the retailer’s budgeting process which had an effect, it was more a matter of how the performance of the buyers were evaluated because, for instance, these slush accounts could be used to boost their performance in specific periods of the year (e.g. for instance, they could negotiate, or sometimes force, in January a shelf fee to be paid upon request let’s say in September when they were expecting to renegotiate a contract with a larger suppliers which was likely to lower their performance in that month, and so on). Our budgeting process had an impact as well, because, at least in our case, listing fees, shelf fees and similar other payments were included in our marketing budget (and basically left to the discretion of the marketing director) and kept separated from the sales team’s budget (which instead included the wholesale prices as one of the main performance criteria). Clearly, the dynamics with large suppliers, particularly with those supplying multiple categories under multiple buyers, were even more complex. This was at least what was common practice in our industry and as far as I know in many other FMCG ones as well.

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