Hello all,
I’ve been thinking about why the industry I’ve spent the most time working in, the creative industry, is filled with charlatans (as well as lots of talented and brilliant people!) and seems stuck in a race to the bottom on price. Markets are supposed to force out poor performers and scam artists, right? Why do they fail in this case – and in lots of other industries too?
The answer, I think, has something to do with fruit.
Best,
Rob
This week’s article
Selling peaches in a market for lemons
Why providing good professional services is harder than it should be
Bahlsen have just sacked off their well-received-at-the-time packaging redesign after just two years. Businesses plough billions into programmatic advertising platforms despite widespread fraud and a lack of accurate reporting, and digital marketing agencies gleefully take their money. Johnson & Johnson changed a logo that’s been recognised the world over since the 1880s for something bland and generic.
These businesses and their agencies will have gone through intense vetting processes. There are chemistry meetings, credentials presentations, strategic pitches, creative pitches, and beauty parades; agencies might spend hundreds of collective hours servicing a client before they’ve even signed up or paid a penny, and clients will choose between as many as five or six agencies who’ve all separately gone to these lengths for them.
And yet the rate of success is, as we see, not particularly high. This is by no means a phenomenon limited to the creative world. How many businesses end up frustrated with substandard IT providers? How many companies bemoan the advice they receive from management consultants?
The market for lemons
These failures happen partly because the market for many professional services is a market for lemons, an idea coined by the economist George Akerlof.
Akerlof used the example of used cars. Most buyers of second-hand cars can’t tell the difference between good cars (“peaches”) and totally duff ones (“lemons”). If you’re one of those buyers, it doesn’t make sense to pay “peach” prices; after all, you might be overpaying for a lemon. The rational price to pay is somewhere between the price of a lemon and the price of a peach, something that reflects the gamble you’re taking.
But sellers do know whether they’ve got a good car or not. If the market price for a car is somewhere between a lemon and a peach, and you have a peach, it doesn’t make any sense to sell your car – you’ll be getting less than it’s worth. But if you’ve got a lemon, you’re golden: you can sell your car easily, and probably get an over-the-odds price for it.
You can hopefully see how this goes. People with good cars don’t want to sell, people with bad cars do, and buyers can’t tell the difference. Good cars are driven out of the market which drives down prices in the market. It’s a form of adverse selection: sellers know more than buyers and so trade selectively, selling them lemons for inflated prices; and buyers will only buy when the price is right, which means sellers of peaches are forced out of the market or are forced to accept an unfairly low price. It’s a double whammy, a vicious cycle.
How do you know if you’re in a market for lemons?
The trigger for a market for lemons is the existence of an information asymmetry between buyers and sellers that means that buyers can’t accurately judge quality – but sellers can.
In the worst-case scenario, the buyers are buying what’s called a credence good, a good or service that can’t be evaluated by the buyer even after they’ve bought it. The quintessential example of a credence good is the services of a mechanic. Most people don’t know if and how their car is broken. If the mechanic says they need their oil filter changing, who are they to argue? How do they even tell whether the mechanic has changed the filter afterwards? An unscrupulous mechanic might “overtreat” their customers, selling them more parts and labour than they actually need, or might simply overcharge them for work not performed.
Do your clients or customers know exactly what you do? Can they judge you and your competitors before they make a decision on who to hire? Can they tell, after you’re finished, whether you’ve done a good job? If not, you might be in a lemon market.
What do you do about it?
At first, this informational asymmetry might seem like a good thing, like an advantage for you as the seller. Isn’t it good that you’re the expert, that you know more about what you do than your clients do? But Akerlof’s thought experiment shows us why we should fear that circumstance. Good work is driven out in favour of bad, and prices fall. Your customers can’t tell the difference between you and your fly-by-night competitors. It’s only good if you’re selling lemons.
There are two ways to fix it. The first is to somehow drive out lemons entirely. This is what regulated industries attempt to do; it’s possible to be a negligently bad lawyer, for example, but ideally not for very long before the professional standards bodies come along and yank your practising certificate. In unregulated industries, though, that’s hard to do.
The second is to attempt to even out the informational mismatch between buyers and sellers. That’s counter-intuitive: if you have information and your buyers don’t, you have more power in the deal, which is usually a good thing. But if in doing so you create a market for lemons, that power is worthless. You have to tip the balance further away from yourself and towards your customers.
Doing so is a problem of communication, and specifically of signalling. In Akerlof’s car example, you might go to great lengths to prove that your car is a peach: commissioning an independent mechanic’s survey, for example, or providing your impeccable service history.
What’s the equivalent in your industry? Perhaps independent audits; perhaps awards that judge efficacy on objective lines; perhaps something as simple as having brilliant case studies of past work, being extra transparent about your process, and communicating clearly the credentials of your people. Whatever it is, giving up a bit of bargaining power might just save you in the long term – and your market with you.