The advantages of cooperation

Economic models assume that we are driven above all by self-interest. However, recent behavioural economics suggest that people care about fairness, reciprocity, good relationships, group identity and, conversely, status, for their own sake and for more than self-interest.

by Christoph Loch and Yaozhong Wu
Last Updated: 23 Jul 2013

Two experimental studies by Christoph H. Loch, professor of technology and operations management at INSEAD, and Yaozhong Wu of NUS Business School, Singapore, investigate whether such social preferences influence supply chain transactions.

In the first study, 100 French undergraduates were given scenarios for a one-shot transaction, and a short questionnaire to test for the influence of social preferences. For example, when participants could choose between the same economic conditions while being seen as a 'winner', even if it meant financial loss, rather than being seen as being outsmarted although gaining financially, 27% chose to act for status rather than economic gain.

These findings show that people may deviate from the profit-maximising agent model in predictable ways: perceived relationships and group identity foster cooperative behaviour rather than economic benefit, while salient status induces uncooperative actions, even when losing economic benefit.

To test the robustness of their findings, Loch and Wu designed a second study with real payoffs and repeated transactions. In a sequential mover game, two players interact in an experimentally controlled way through computers, making decisions about profit margins that jointly determine consumer demand. This represents a supply chain structure, similar to a supplier and retailer, with a simple wholesale price contract.

The two partners react over multiple rounds, with A choosing a profit margin, then B choosing a profit margin to determine the market price. In the control condition, the players are anonymous and have no relationship. In the relationship condition, the players are briefly introduced by name and shake hands. In the status condition, one partner would be declared the winner in each round (by a simple announcement on the computer screen), although the status had no economic benefits.

The results showed that both players deviate significantly from purely economic rationality. In the status condition, both act aggressively (setting a high price, which forces the other side to "give in" or accept a lower profit), and as a result, everybody's profits per round diminish.

In the relationship condition, player A offers a lower price, and player B, rather than exploiting the offer by grabbing profits with a high price, also sets a lower price. As a result, both sides are actually better off per round. Participants respond in this manner because they react emotionally to social interactions: we are driven by what happens in the recent past, not only by our calculation of future benefits.

The experimental evidence therefore suggests that social preferences systematically influence behaviour in supply chain transactions, as distinct from economic incentives. In positive relationships, concern for others' welfare promotes cooperation, individual performance and sustained high-system efficiency, while desire for status results in tough actions and reduces system efficiency and individual performance. Our good relationships are our best financial drivers.

Social preferences and supply chain performance: An experimental study

Professor Christopher H Loch, GlaxoSmithKline chaired professor of corporate innovation and professor of technology and operations Management at INSEAD and Yaozhong Wu of the Department of Business Studies at NUS Business School

INSEAD 2007

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