Ethical Business Practises can lead to Greater Profits

According to John Zhang and Jagmohan Raju, both Wharton marketing professors, and Tony Haitao Cui, a University of Minnesota marketing and logistics professor, many people aren't purely mercenary in their business dealings. They care about fairness -- and they should, the researchers say, because doing so can maximize their 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, the authors contend in their paper.

Zhang, Raju and Cui's model is rooted in the emerging field of behavioral economics. Behavioralists, as practitioners are known, have shown with experiments that people sometimes value fairness over profit maximization. In one such experiment, called the ultimatum game, one player receives a sum of money and gets to propose how to split it with a second player. The second player must accept the proposed division for either of them to receive any of the cash; if she rejects it, both end up with nothing. Classical economic theory suggests that the proposer should keep just about everything for himself -- 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's 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 hard-nosed economists," Zhang says. "They are fair minded. And this kind of experimental outcome has strategic implications. We are saying that you don't need a hard-nosed attitude to make a profit in the real world. In some areas, fairness will address the channel relationship in such a way that everyone can be better off."

Zhang acknowledges that, in the real world "You do have to watch out for opportunistic behaviors." Sometimes, social norms will prevent these people from trying to take advantage of those with whom they do business. They might be concerned about their reputation. Or if they have repeated interactions with someone else, they might act fairly out of fear of reprisal.

Large companies, because of their impersonality, might create situations where people care less about treating others fairly. That can be especially true if their employees are compensated for achieving short-term goals. "All else being equal, if you are working for a bigger company and you will get promoted if you make a short-term profit, you don't worry so much about fairness," Zhang says. "However, disregarding fairness can be detrimental to the company in the long run, as fairness is the lubricant for the sales machinery."

Adopted from: In the Game of Business, Playing Fair Can Actually Lead to Greater Profits, knowledge@wharton