Managing in Business to Business Markets:

Contracts, Negotiation and

Conflict Resolution
Week 4 Behavioural Foundations of Managing
Supply 2: The Ethics of Purchasing and Supply

CBSP, The University of Birmingham, 2005/2006.

Models of self-interest orientation and business ethics

We have considered three models of self-interest orientation.

Two of these have come under the title of trustworthy behaviour

(altruism and simple self-interest seeking), the other has been termed
opportunism.
But what are the ethics of these different positions?
Ethics are defined as a theory or system of moral values.
In this session, we look at some key positions of business ethics and
consider them in relation to the two parts of business actions: ends and
means.
In other words, what do the different schools think of self-interest
seeking and what do they think about the manner in which that selfinterest is sought?

CBSP, The University of Birmingham, 2005/2006.

The ethics of purchasing and supply: what are your values?

Exercise: Which of the following do you believe to be ethical?
1. Merchant banker encourages clients to buy dot-com shares on the basis that they are stars, when privately they
considered them dogs Adverse Selection
2. WPP claimed 3127 hours ($1.7m) of work that wasnt in its relationship with US Office of National Drug Control. Clifford
Chance law firm similarly accused. CC staff were apparently pressured to act that way Moral Hazard
3. Pharma company gave out free harmonic scalpels to clinicians in UK hospital (which meant that they escaped the
hospitals audit control system), knowing that the product needed consumables to be purchased in order for them to be
used Lock-in / By-passing customer rules
4. Accenture encouraged Inland Revenue to sign a contract that (a) would lead it to be locked-in and (b) was inadequate to
cope with future requirements Lock-in
5. Pharma companies hired out ghost-writers to produce biased drug trial articles and then paid clinicians to put their
names to them. Then appeared in top-ranked medical journals Aimed at leading to Adverse Selection
6. Numerous UK financial institutions sold endowment mortgages and pension schemes on the basis that they were low
risk, when actually they were high risk but also yielded high commissions Adverse Selection
7. A UK public sector organisation bluffed in a negotiation with a fabrics supplier that it had an alternative source of
supply lined up that was cheaper, when in fact that was not the case Strategic Misrepresentation

8. PWC charged clients 57m of bogus expenses: charged full-rate air fares and then got kick-back from airlines Moral
Hazard
9. Safeway used overwhelming market power to force meat supplier to lower prices to bankruptcy levels
10. Lloyds of London insiders created preferential baby syndicates for themselves, whilst letting external investors
insure the company for its more riskier customers Moral Hazard
11. Management consultancy undertook research and then wrote a report. It billed the healthcare provider client for the
work. However, much of the claimed work was not done: it took most of the report from a previous project Moral Hazard

12. Automotive industry new entrant and partner of established automotive assembler collects intellectual property from
partner during joint venture until it feels able to go it alone. Then ends JV and enters market as a rival
CBSP, The University of Birmingham, 2005/2006.

The ethics of purchasing and supply: contested values / methods

Most classes are divided on the cases on the previous slide. The (Western) literature
on business ethics is divided too. Essentially, what you believe to be ethical depends on
your more general political perspective.

Social Democratic View

Deontology: Duties and Rights

Consequentialism: Outcomes

Freedom as effective power

Rewards should equal contribution,
notwithstanding market power

Relatively equal societies valid

because not only just, but stable,
civil and more productive

Individuals have obligations to society

State intervention OK to achieve goals

Business has multi-fiduciary duty

CBSP, The University of Birmingham, 2005/2006.

Business cannot stand aside

The ethics of purchasing and supply: contested values / methods

Liberal Economic View

Deontology: Duties and Rights

Consequentialism: Outcomes

Freedom from interference (e.g. the

state)
Freedom as choice (e.g. as a consumer) Self-interest produces greatest
prosperity hidden hand
Right to market rewards as producer
Business only has duty to shareholders
Whilst conforming to social norms

CBSP, The University of Birmingham, 2005/2006.

Free markets create free

societies

The ethics of purchasing and supply: contested values / methods

Deontology: Duties and Rights

Consequentialism: Outcomes

Legal Approach
Liberal economic view except
What is legal is ethical not social
norms

Usually associated with liberal

economic view on hidden hand

Business as a Game
Liberal economic view except

Business does not need to play by the

Usually associated with liberal
normal rules of society as no-one expects economic view on hidden hand
ethical behaviour, therefore cheating is
not unethical
CBSP, The University of Birmingham, 2005/2006.

The ethics of purchasing and supply: contested values - exercise

These alternative ethical positions can then be applied to the concept of
opportunism. In the boxes below, put Yes or No, depending on whether
the ethical position permits that type of behaviour.

Self-interest Seeking
(Ends)
Social Democratic
View
Liberal Economic
View
Legal
Approach
Business as a
Game Approach

CBSP, The University of Birmingham, 2005/2006.

With Guile
(Means)

The ethics of purchasing and supply

One thing not mentioned in the consequentialist column of the first three
ethical positions is the positive macro consequences of an absence of
opportunism, particularly blatant opportunism.
There is a great deal of evidence to suggest that a poorly functioning
system of contract law and corruption present a drag on economic
development.

There can, therefore, in the case of the business as a game position, be a

distinction drawn between private interests and the public good, and again
between the short-term and long-term.
An individual may gain in the short-term from opportunism (free-riding),
but, if many behave the same, the economy will most likely suffer and,
potentially, that individual will in time end up losing too depending on his
or her dependence on the economy in question.
Even where all individuals do have a stake in an economy, there can still
be collective action problems.
CBSP, The University of Birmingham, 2005/2006.

Managing in Business to Business Markets:

Contracts, Negotiation and

Conflict Resolution
Week 4 Searching the Market: The Problem
of Adverse Selection

CBSP, The University of Birmingham, 2005/2006.

Classifying goods and services

Goods and services are classified by marketers into three information

categories.
Search goods goods and services whose quality can be satisfactorily
evaluated prior to purchase. Basic physical goods come into this
category.
Experience goods goods and services whose quality can only be
evaluated after both purchase and a reasonable amount of use. For
example, a haircut. Also, a car, a computer or computer software and a
basic service, like a catering or cleaning service.
Credence goods goods and services whose quality cannot be fully
evaluated even after they have been purchased and used. Examples are
management consultancy services and legal services and the reason is
the existence of multiple variables and an absence of a counterfactual.
CBSP, The University of Birmingham, 2005/2006.

The adverse selection problem

This classification is important to the problem of adverse selection a

key hazard for purchasing managers.
This is because if a good or service is hard to evaluate, a situation
exists where there is private as well as public information surrounding an
exchange.
If one party to a contract has private information at the time of contract
negotiations that potentially reduces the value of the contract to the other
party, we say that the situation is one of adverse selection.
This notion was first put forward by Akerlof in his 1970 paper The
Market for Lemons a paper eventually appreciated by the academic
community.
CBSP, The University of Birmingham, 2005/2006.

The adverse selection problem: example

In the context of business to business relationships, adverse selection

concerns the supplier selection part of the purchasing process.
An example of adverse selection can be seen in the selection of ICL
Fujitsu by the Lord Chancellors Department, a UK central government
department, as its supplier for the Libra IT project a case from week 1.
ICL Fujitsu claimed during the pre-contract negotiations that it could
develop a system that would integrate all of the different agencies of the
British legal system and do it for a certain price. It made these claims
during its pre-contract pitch.
It became clear after the contract had been signed that ICL Fujitsu had
no such capability. Eventually, the LCD had to re-structure its supply
arrangements.
CBSP, The University of Birmingham, 2005/2006.

The adverse selection problem: example

A further example concerns management consultancy. An NHS trust

contracted with a niche consultancy for a project concerning supply
chain efficiency that is, the way in which the trust understood its
demand for medical consumables and maintained appropriate stocks.
The MD of the consultancy was highly able and put together a very good
pitch as to how his organisation would undertake the project, provided
projects done in the past, etc.
However, the team that implemented the project did not include the MD.
Over the previous year, he had stepped back from involvement in project
delivery and had focused on sales activities.
The team that was assigned to the trusts project was poor and
produced a poor report, offering little insight. Indeed, part of the brief was
parceled off to another organisation.
CBSP, The University of Birmingham, 2005/2006.

The adverse selection problem: potential solutions

There are a number of classic ways of trying to manage adverse

selection:
Adverse selection can often be bad for suppliers (bad crowds out good).

- Signaling: suppliers often use signaling as a way of demonstrating

quality. Certain desirable characteristics are shown to the other party.
Adverse selection is always bad for buyers, as it affects VFM
- Screening: a re-numeration schedule based upon performance, for
example.
- Warranties and Trial Periods
- Short initial contract terms
- Identify service delivery team
CBSP, The University of Birmingham, 2005/2006.

The adverse selection problem: potential solutions

- Contingent renewal: the idea that future business can affect current
actions. Suppliers may not risk adverse selection in key accounts.
- Benchmarking: buyer compares supplier against other suppliers.
- Third party evaluation
- Reputation: On some occasions, the risk of losing reputation will in any
case be sufficient to dissuade suppliers.
Potential Problems with Potential Buy-Side Solutions
- Benchmarking exercise may be affected by unwillingness of others to
admit to mistakes.
- Contingent renewal may be affected by absence of future business.
One-off transactions tend to be more beset by adverse selection.
- Principal-agent problem within supplier can affect impact of many of the
mechanisms, especially contingent renewal and reputation.
CBSP, The University of Birmingham, 2005/2006.