CONTRIBUTOR / Niko Matouschek
ALVIN J. HUSS PROFESSOR OF MANAGEMENT AND STRATEGY
KELLOGG SCHOOL OF MANAGEMENT / Economics
Part 1 / If You’re Getting Ripped Off, It’s Not Surprising (0:00)
A hallmark of successful economies is that they exhibit a high level of trust. You can generally assume, even without a formal contract, that you won't be take advantage of. You might also assume that the U.S. economy is one to be trusted, but a history of corporate misdeeds signals caution for the consumer.
Part 2 / Is It Naïve to Invest in Trust? (1:21)
How do firms create the trust that helps economic exchange flourish? One strategy is to hire people who are trustworthy. Another is to pursue a long-term plan that emphasizes the importance of future business. Transparency is the key to this strategy: Customers must be able to observe how you have treated customers in the past.
Part 3 / When It’s Unwise to Trust (3:48)
It is rational to trust firms that care about the future, and foolish to trust firms that do not. Companies that are not pursuing a long-term strategy have little incentive to be either transparent or trustworthy, and signal this in a variety of ways.
I think it’s an underappreciated fact that successful market economies, like the U.S., exhibit a lot of trust — trust between market participants who are both anonymous (they don’t know each other well) and who are self-interested.
If you look at the sharing economy, for instance — to a large extent, their success depends on their ability to create trust between third parties, trust between somebody who wants to rent out their apartment and trust between somebody who wants to rent that apartment.
Or if you think about yourself — every day, you trust people who you don’t know and you trust them to do things that are actually not in their self-interest. And more often than not, you don’t get disappointed.
If I told my wife that the U.S. economy exhibits a lot of trust, she would be very skeptical — rightly so because the history of corporate misdeeds is a long and distinguished one to which we’ve had many colorful, recent, new entries.
But the fact that people get ripped off is not really surprising. What’s surprising is that they’re not getting ripped off more often. What’s surprising is that I can go into essentially any store anywhere in the United States and be reasonably sure that I won’t be sold a lemon. That’s what’s surprising.
BUMPER: Is It Naïve to Invest in Trust?
Firms do so in two ways, both of which involve making it costly for themselves to break their promises in the future. The first is that they hire people and are run by people who don’t just care about profits but also care about being trustworthy.
There’s essentially people, if you want, who incur a psychic cost if they break their own promise.
Now, in an age in which many emphasize the cutthroat nature of business, this may sound naïve and quaint, but it’s not, because, in a market in which trust is important, being trustworthy gives you competitive advantage.
A historical example of this are the Quakers in the 18th century, who played a very important role in the British economy at the time, even though there’s only a relatively small number of them.
And it’s often argued that one of the reasons for why they had such an important role in the economy was precisely because they were known to be trustworthy; they were known to follow through with their promises, even if it was not in their immediate economic interest to do so.
And that’s what gave them a competitive advantage; that’s why people seek them out to trade with them.
We see the same thing today with firms like Keller Williams and the like, trying to hire people who are not just skillful but also what they call “ethical.”
I don’t think that that’s just a cheap PR stunt; I think firms try to hire trustworthy employees not just because it’s a moral value that they might care about but because it’s an economic asset in which they can earn a return.
The second is that firms commit themselves to a long-term strategy that emphasizes and importance of repeat in future business — because if I’m not just a pop-up store but I also care about future business, then there’s a cost to me of breaking my promise to you today, which is that there’s going to be less business for me in the future.
So, repeat transactions can serve as a commitment device. For this to work, though, two things have to be true: First, not only me but also my employees have to care about the future enough.
And so, it’s important that I’m providing them with the right kind of incentives — with long-term incentives and not just short-term incentives.
And the other issue is that transparency is important. It’s important that customers are able to observe how I’ve treated other customers in the past.
So, that’s why things like feedback mechanisms in the electronic marketplaces are really useful because, there, if I cheat you, you’re going to go online and write a review, and that’s going to be costly to me. And because I know that, I’m less likely to cheat you in the first place.
BUMPER: When It’s Unwise to Trust
I think it’s rational to trust firms that care about the future, and it’s foolish to trust firms that don’t care about the future.
For instance, it’s foolish to trust a pop-up store. A pop-up store is not going to be around tomorrow, so they have no incentive to keep any promises they are making to you.
Maybe less obviously, firms that are close to bankruptcy — those are run by managers who care much more about today’s profits than about future profits because if they don’t increase today’s profits, they’re going to be out of business in the first place.
Another example would be firms in which employees are being rewarded very strongly for short-term performance — for quarterly earnings or quarterly performance — because, again, decisions are then made by employees who care a lot about the present profits, and they care much less about future profits.
So, again, these are the kind of firms in which I’d be suspicious about whether or not they’re going to keep their promises.