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October 2001
Volume 19, Number 10

The Economics of Bad Service
William L. Anderson

Everyone complains about bad service. From the airlines to telecommunications, we hear of the increasing number of consumer complaints. Diane Brady, a writer for Business Week, believes that she has the answer to why some of us might believe service is bad. Last year, she informed BW's readers that, once again, capitalism is running amok and now needs the hand of government more than ever to force businesses to properly serve their customers. "Why Service Stinks" told of unfairness abounding as firms go overboard to keep "good" customers and do everything they can to get rid of "bad" ones.

Brady writes, "Companies know just how good a customer you are--and unless you're a high roller, they would rather lose you than take the time to fix your problem." Brady notes that the biggest-spending customers of many firms, including banks, retailers, and utilities, are able to have their complaints quickly and thoroughly addressed. Those who spend less, she notes, must wait in line. "Welcome to the new consumer apartheid," she says.

Brady's words carry serious charges. In fact, she does not stop with those accusations. She continues: "Increasingly, companies have made a deliberate decision to give some people skimpy service because that's all their business is worth."

Given the anticapitalist sentiments that regularly appear in Business Week (once labeled by the Heritage Foundation as the "anti-business business magazine"), such words are hardly surprising. Yet, while all of us have experienced bad customer service, the whole concept of service is badly misunderstood by most people.

Brady perpetuates the misunderstanding by complaining, "That's a far cry (the push for customers to engage in self-service) from the days when the customer was king. In the data-rich new millennium, sales staff no longer let you return goods without question while rushing to shake your hand."

In other words, we are supposed to believe that, once upon a time, the customer was always right and business owners would immediately and ceaselessly work to fully satisfy every customer regardless of their stature, wealth, or size of bank account.

For those of us old enough to remember the experiences of banking, shopping, and working in the pre- high-technology days, the author's stereotype of "how things used to be" is a bit off the mark. Furthermore, the implication of the article is that producers in a free-market economy do not serve their customers well, especially since their final goal is making money and not serving people in an egalitarian manner.

This is not to deny that service can be sloppy or incomplete. Many readers no doubt have experienced some of the customer service problems that Brady describes. Furthermore, I would not disagree that many firms will favor large-volume customers over those who spend less. Brady, after all, did not make up her examples out of whole cloth.

But even if many of her "horror stories" are true, Brady absolutely has missed the mark in understanding the role of customer service and, more importantly, the economics of service.

Most people, including many economists, misunderstand the role of both consumption and business in the economy, believing that there exists an ideal standard to which all producers should be held by force of law. Specifically, many people deem that legitimacy of a free market rests on whether or not consumers are properly satisfied with products they have purchased and the way they received services.

"Mainstream" economic theory does not address this situation well because of the inadequacies of how it often is presented. Teachers of economics often begin with the concept of perfect competition, which is an imaginary state of things in which tiny producers have an insignificant amount of market share. Furthermore, all players in this system have perfect knowledge, which means there is no need for customer service, as the customer already has all of the necessary information.

While such a state of analysis is useful in describing some economic phenomena, many economists have made the error of declaring that such a state of being is necessary for an economy to work efficiently. However, should firms in an industry hold a large market share or, to be more specific, not operate in a state of "perfect competition" (which actually describes the market conditions of the vast number of business firms), then all bets are off and imperfect competition exists. These conditions require government intervention, since "consumer sovereignty" and competition no longer hold true, according to many mainstream economists.

Since most firms have "market power" to one degree or another, that places them at an advantage in their dealings with consumers, mainstream economists say. The only way to "level the playing field" for consumers, then, is to force regulations upon businesses to make them act in the "public interest."

The concept of "consumer sovereignty" is well known to those familiar with Austrian economics. Ludwig von Mises describes it in Human Action. However, it is important to differentiate between the Austrian and mainstream views of "consumer sovereignty," as the definitions are not only different, but also lead to very diverse conclusions.

In the Austrian view, "consumer sovereignty" individuals who purchase goods and services in a free market "are at the helm and steer the ship," writes Mises. He goes on to say, "The consumers determine ultimately not only the prices of the consumers' goods, but no less the prices of all factors of production."

Mises is not presenting a picture of an ideal society. Rather, he is saying that in a free-market setting, the choices of consumers will ultimately determine the choices of producers. Since consumers are free to purchase what they like and cannot be forced to do otherwise, it would be foolhardy for producers to create goods that people are not willing to purchase.

Further understanding of this concept is gained from Carl Menger in his pathbreaking 1871 book, Principles of Economics. In his examination of what determined the value of something, Menger broke with the standard classical tradition that, in the long run, the price of something was simply the summation of the "costs of production" of the factors of production. To put it another way, to the classical economists, beginning with Adam Smith, the value of the final (consumers') good was determined by what it cost to make it.

To Menger, such a view made no sense, as such a point of view leads only to an endless regression, since if "costs begat costs," one would then have to discover the "cost" of the "first" item, but determine it in a different manner. This was obviously an impossible--and ridiculous--task.

Instead of continuing the classical fiction on value, Menger reversed the order of causality. Moreover, Menger pointed out that value of the factors of production comes from the value individuals place on the final product or consumers' good, which amounts to a backward imputation of value for those factors.

For example, early settlers in western Pennsylvania did not value petroleum, although they knew it was in the ground. In fact, petroleum was a nuisance, as it fouled wells with something for which there was little or no use. It was not until someone discovered that one could derive a useful fuel called kerosene from petroleum that petroleum itself became in demand. Soon after the oil boom began during the 1860s, land that had sold for a few dollars an acre before the advent of kerosene suddenly became worth a few thousand dollars per acre.

It was not the value of the land, labor, and machinery to drill, refine, and transport oil and oil-derived products that made kerosene valuable. Rather, it was the fact that consumers valued kerosene--which produced light at a fraction of the cost of whale oil, the previous fuel of choice--that gave value to those factors of production that went into making kerosene.

Government often intervenes in a free economy in order to change the arrangements that consumers and producers have already created. Mises holds that while such intervention may be done in the name of helping consumers, in the end, consumers actually are harmed. Unfortunately, in this age of regulation and intervention, "consumer sovereignty" has actually been negatively affected even as those engaging in the government intervention claim that their only purpose is to help consumers.

The prevailing view, however, as articulated in the Business Week article, is that consumers constantly are victims of producers who, unhampered by government regulation, use their market powers to constantly harm their customers.

This is the viewpoint that constantly classifies the consumers as victims, not sovereign individuals who are free to make choices that please them. In this way of thinking, the consumer is almost always deserving of better treatment than he or she receives from producers, which means that government must intervene on behalf of consumers if things are to be set right.

In using words like "force" and "control" to describe business activities, we do injustice both to consumers and the English language. For example, take Wal-Mart and sales of color television sets through its retail stores and Sam's Club outlets. Assume that Wal-Mart sells about 70 percent of all color TVs sold in the USA each year.

The typical economics textbook would say, "Wal-Mart controls 70 percent of the color television market in this country." The word "control," of course, assumes coercion. Another way of saying that statement is, "Wal-Mart Stores, Inc., forces 70 percent of color television buyers in the country to purchase TVs at either Wal-Mart or Sam's Club." This obviously makes no sense. Wal-Mart does not have such powers.

One can accurately declare, "Seventy percent of people who purchase color television sets in the United States choose to purchase them from Wal-Mart." In fact, if one were to query those purchasing televisions from Wal-Mart, most likely none of them would say that the nation's largest retailer was coercing them into buying televisions.

What, then, does one say about what people perceive to be miserable customer service? What about flight delays and other service problems dealing with airlines? To answer such questions and others raised by the Business Week article, we go back to Mises and apply his reasoning to computer purchases.

In less than a decade, we went from purchasing computers at high-priced specialty shops where we had high expectations of service to buying directly from larger outlets with the implication that we were trading service for lower prices. In fact, one of the most important aspects of selling computers at lower prices with more user-friendly platforms was that individuals could more easily work their computers and, thus, not be so dependent upon service personnel.

To put it another way, consumers have preferred lower-priced computers and less-accessible service to higher prices and more service, or at least that is what their buying habits in the free market have indicated. In Misesian and Mengerian terms, consumers determined that customer service would have less value to them as long as computers were relatively cheap and user-friendly. This does not mean that consumers disregard customer service altogether, but rather that it ranks lower in their preference orders now than it did when computers were more complicated to operate.

In general, the retail sector of our economy has moved toward more self-service, as consumers have demonstrated time and again that they prefer lower prices for goods and services. From self-checkout counters at supermarkets to outlet malls, consumers have strongly spoken. (I don't deny that all of us like to have someone wait hand-and-foot on us, but it is not possible to have both massive discounting and "Can-I-get-you-another-grape-ma'am?" service simultaneously. Consumers have clearly demonstrated that they prefer lower prices.)

Despite what Business Week and others claim, consumers are hardly victims of rapacious producers in our modern economy. Actually, the opposite seems to be true. Never before have consumers faced such a wide array of affordable choices, something that people who have languished for years in "planned" economies have only been able to imagine from a distance.

Service does not "stink," as Brady and others claim. If we look at the entire picture, we would have to conclude, instead, that we never have had it better.

William L. Anderson teaches economics at Frostburg State University ( Further Reading: Diane Brady, "Why Service Stinks," Business Week, October 23, 2000, pp. 118-28; and Carl Menger, Principles of Economics (New York: New York University Press, 1976).


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