In this world, toughness is the measure of every CEO, and the boss glories in firing people and squeezing every penny out of suppliers. Many people aren’t purely mercenary in their business dealings. They care about fairness and they should, 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.
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. 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.
The manufacturer sets his price, and the retailer’s sense of fairness takes care of the rest. It can be shown that it does not need elaborate coordination contracts because concern about fairness creates coordination, which perhaps explains the prevalence of using simple wholesale prices as channel contracts.
Here’s how it works. When the retailer sees that he is being treated fairly by the manufacturer, he will reciprocate by picking a retail price that rewards the manufacturer. Because each gets an equitable share of the channel’s profit, they will not squabble. If you are fighting against each other, ultimately the whole channel will suffer. Conventional wisdom says that the manufacturer needs to enter into an elaborate contract with the retailer to align their interests. It may take the form of revenue sharing, quantity discounts or two-part tariffs.
You mostly see a simple wholesale price contract. Given that, what’s happening? What we show is that, as a retailer, you care about fairness: You want to be treated nicely, and you’ll treat me nicely if I treat you that way. For this kind of coordination to work, the retailer has to be able to ascertain the manufacturer’s costs. Otherwise, he can’t gauge fairness of the wholesale price. With transparency it works better.
You would know what’s fair and what’s not. Without it, you have to rely simply on reputation and trust, which can take a long time to develop. Transparency isn’t a difficult condition to satisfy. Retailers typically have access to information on their suppliers’ costs. This is true, for instance, when the manufacturer supplies a standardized product or a commodity. In that case, competitive offers from manufacturers will reveal significant cost information to a retailer. This is also the case when the retailer engages in the private-label business and therefore knows quite a bit about manufacturers’ cost structure.
Classical economic theory suggests that the proposer should keep just about everything for him self say, 99% and offer just a crumb to the person across the table. That way, he has maximized his benefit, and the other player will accept because she is a bit better off than she was. In reality, responders typically reject splits in which they receive less than 20%. In some cultures, people will even reject splits of less than 50/50. The ultimatum game tells you that people aren’t hardnosed economists.
All else being equal, if you are working for a bigger company and get promoted as you make a short-term profit you don’t worry so much about fairness. However, disregarding fairness can be detrimental to the company in the long run, as fairness is the lubricant for the sales machinery.