Credence Goods attract Experts who Cheat

August 27, 2008

If I had to choose the second concept that was critical to know in the study of franchising, it would be This one.

Lionel Hutz

HINT: If they’re talking about protecting franchisees and not talking about credence goods, they’re all hat and no cattle [all show and no go].

Some goods and services, by their very nature, come with much higher risks than others. These risks can be compounded and therefore astronomically high if:

  • there are few experts to choose from in a market,
  • the costs of switching experts is very high,
  • this is the first time you have contracted for these expert services, and
  • the experts organize themselves to protect one another.

As we shall see, franchising has compounded, interdependent and very aggressive expert stakeholders [see Big Franchising: franchisors, franchise bar, lenders, sales agents, consultants, politicians, media, etc].

  • As a franchise investor, you are at a severe disadvantage because of credence good service providers.

A Credence good is a good or services with the following 3 characteristics:

  1. the value is difficult or impossible for the buyer to determine accurately before they buy it,
  2. the buyer can’t know if it was useful [even after they did buy it] and
  3. also, the seller does know the value of #1 and #2 [could therefore exploit this ignorance for their own self-interest: information asymmetry leads to opportunism risk]. Wikipedia

Uwe Dulleck and Rudolf Kerschbamer:

Consumers’ concerns about being defrauded seem not to be unfounded: Emons (1997) cites a Swiss study reporting that the average person’s probability of receiving one of seven major surgical interventions is one third that of a physician or a member of a physician’s family. Wolinsky (1993, 1995) refers to a survey conducted by the Department of Transportation estimating that more than half of auto repairs are unnecessary…These examples reveal that infomational asymmetry matters. Free download: On Doctors, Mechanics and Computer Specialists – The Economics of Credence Goods

Gillian K. Hadfield, University of Southern California:

Economists refer to a good as a credence good if it is provided by an expert who also determines the buyer’s needs. Buyers of credence goods are unable to assess how much of the good or service they in fact need; nor can they assess whether or not the service was performed or how well. This puts buyers at risk of opportunistic behavior on the part of sellers: they may be sold too much of a service or billed for services not performed or performed poorly. Theoretical work on markets for credence goods predicts that markets for credence goods may be characterized by fraud (billing for unnecessary services or services not performed) and a price mark-up over cost…Legal services are credence goods… Free download: The Price of Law: How the Market for Lawyers Distorts the Justice System

Winand Emons, University of Bern:

With a credence good, consumers are never sure about the extent of the good that they actually need. Experts such as doctors and lawyers, as well as auto mechanics and appliance service-persons (the sellers) not only provide the services, but also act as the expert in determining the customer’s requirements. This information asymmetry between buyers and the seller creates strong incentives for the seller to cheat. Free dowload: Credence Good Monopolists

We will come back to credence goods and how these types of services really help value being stripped from investors with deceit [opportunism].


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