Using The Profit Motive To Curtail Bad Business Behavior

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By David Grace (

I recently wrote a column* listing the many situations where market forces do not deter shoddy products and abusive terms, thus leaving regulation as the principal tool to protect the public.

(* The Market: The Other God That Failed)

One reader took the position that regulations are costly and are not 100% successful and that therefore they should never be imposed.

That’s an unwarranted conclusion. Everything is always a cost/benefit analysis. But maybe there is an alternative to some regulations. Exploring that alternative is the subject of this column.

The Lesser Of Two Evils

While regulations created to protect against shoddy and dangerous products and abusive terms of service can be complicated and expensive to enforce and only partially effective, it’s always a fact question which alternative, (1) the damage to the public from the abuses practiced by an unregulated industry or (2) the cost of enforcing the regulations, is the lesser of two evils.

The determining factor on whether to use any tool is not if that tool works perfectly. Everything really useful is also dangerous and, in one way or another, costly.

The question isn’t, “Does this tool have drawbacks?” but rather “Do the benefits of doing this outweigh the costs?”

Residential gas service does a lot of good, but it also results in fires and explosions. Private automobiles are of great value, but their use is also expensive, toxic and damaging. The same is true with the Internet and free speech.

The civil-court system is terrible. Super inefficient. Super costly. It often yields bad results. We could go on and on about all the negatives of the civil-court system. But does that mean we should have no civil courts?

Someone might say: “The government already regulates food safety. Those regulations cost a lot of time and money to administer and enforce. Yet, in spite of all those laws, companies sometimes still sell contaminated products, so what’s the point of having those laws at all?”

That’s equivalent to saying: “It’s illegal to rape women. Enforcing the rape laws costs a tremendous amount of money. Yet, in spite of rape being illegal, men still rape women, so what’s the point of making rape illegal at all?”

That’s an incredibly stupid argument.

Laws against rape, murder, and drunk driving are costly and never 100% effective, but only a total fool would conclude that because those laws are not 100% effective we should repeal them, save the money we spend on the police and prisons, and make rape, murder and drunk driving legal.

In many situations the Market doesn’t protect consumers. In fact, in many situations the Market’s profit motive makes the abuse of consumers more, not less, likely because in many situations it is more profitable in the short term to deliver bad products than good ones.

This fact brings us back to the imperfect, inefficient, expensive, lesser-of-two-evils mechanism of protecting consumers with regulations.

Other than the two choices, do nothing or regulate the industry, is there another way?

Bad Behavior Is Profitable

The prime reason for the ubiquitousness of bad business behavior is that it is profitable in the short term. If people know that there is a bar of gold sitting out there, some of them are going to try to cheat to get it.

It’s how some people are built. For a certain percentage of the population, if they think that in the short term they can get money by stealing, lying and cheating, that’s what they will do.

The Lure Of Present Profit Is Stronger Than The Fear Of Future Loss

Consumer-protection laws rely on the concept of punishment as a deterrent. The problem is that people are more likely to engage in bad behavior in the hope of a quick profit than they are to avoid bad behavior because of the fear of a future punishment.

Why? Well, for one thing they feel that their chances of profiting in the short term from bad behavior are higher and offer a greater reward than their chances of getting caught, convicted and penalized at some date years in the future.

The expectation of an immediate benefit is a more powerful lure than the possibility of a long-delayed punishment is a deterrent.

Can We Make Good Behavior More Profitable?

The most effective way to encourage good behavior is to make the desired behavior more profitable in the short term than bad behavior. That’s not always easy or even possible, but if you can create a system that motivates good behavior through the lure of short-term gain it’s likely to be effective.

Using The Profit Motive Instead Of Regulation To Improve Trade Schools

For example, for many years people have been getting cheated by for-profit trade schools. You can impose all kinds of regulations on these schools, but they continue to rip people off because they can charge desperate, often unqualified people thousands of dollars and deliver a crappy product that is difficult to prove is defective.

That problem can be solved by changing the trade-school compensation system to one that uses the profit motive to encourage the delivery of a good product.*

(*How To Train Americans For Good-Paying Jobs Without Rip-off Schools, Without Student Loans & Without Spending Taxpayer Money)

Specifically, you make it illegal for any trade school to charge a fixed-fee tuition. Instead, you limit the school’s method of compensation to only receiving a capped percentage of the student’s take-home pay earned from a job in the field that the school trains him/her for.

When the school is only paid if the student succeeds then it becomes in the school’s financial self-interest to accept good students with high aptitude and train them well. Under this system the profit motive fixes the problem instead of causing the problem.

Using A Different Pricing System Instead Of Criminal Laws To Eliminate Ticket Scalpers

Here’s another example of fixing a problem by adopting a different system: Middlemen grab up concert tickets then sell them at a huge markup. That deprives fans of access to the artist and it diverts money from the artists to the middlemen.

All kinds of regulations have been proposed to deter this practice including laws making it illegal to “scalp” tickets. None of them have worked particularly well. But there is a fix that doesn’t require complicated regulations.

Instead of legislating punishment for scalpers, the artists can sell tickets in a reverse auction where the price declines over time.*

(* How To Stop Event-Ticket Rip Offs. More Money For Artists, Free Tickets For Fans, Nothing For Scammers)

Several weeks or months in advance of the concert the tickets are freely available for $10,000 each. Every three days the price declines by $1,000 until it reaches $1,000. Every three days after that it declines by $100 until it reaches $100 then every three days after that it declines by $10. This continues until it bottoms out at $10 or all the tickets are sold.

Under this system all the money goes to the artists and the scalpers have no way to profit from the concert.

The point is that if you can find a mechanism that employs the short-term profit motive to promote good behavior you can reduce bad behavior with minimal government regulation.

So, our question then becomes:

  • What mechanism might we use that will give a business more short-term money when it treats consumers well and less short-term money when it treats consumers poorly?
  • How can we change the business-compensation system so that in order to make bigger profits in the short term a company has to deliver better products under better terms?

Reducing Bad Corporate Behavior By Directly Tying Corporate Profits To Customer Satisfaction

I have one idea. I won’t say it’s the best answer or that it is certain to work, but it’s something to think about.

Instead of a fixed corporate tax rate suppose we had a variable rate of between 20% and 30%. The actual rate would depend upon the customers’ satisfaction with the company and its products.

The default tax rate would be 30%. Each customer would have one vote for every dollar of product they purchased during the previous twelve months. The customer would be able to multiply his/her number of votes times a customer-satisfaction score of between -5 and +5.

If I paid a company, for example United Airlines, $1,000 over the previous calendar year I could give them a score of between 1,000 X -5 (-5,000) and 1,000 X +5 (+5,000). The scores from all of the voting customers would be totaled.

If customers who had paid United $1 billion in sales participated in the voting, then the range of possible scores would be between -5,000,000,000 and + 5,000,000,000.

If all the negative votes offset all the positive votes and United’s net score was 0 (zero) then their corporate tax rate would be halfway between 20% and 30%, namely 25%. If their score was minus 5,000,000,000 their tax rate would be 30% and if it was +5,000,000,000 it would be 20%, with the actual rate being proportional to the actual score within that range.

In short, United’s customers would be able to materially and directly affect United’s short-term, after-tax profits depending on how happy or unhappy they were with United’s services.

Of course you would need to set a minimum number of votes that would need to be cast, a minimum level of participation, for the vote to be considered valid, perhaps at least 25% of the total possible votes. In this example, if United’s gross revenue was $4 billion then customers who spent at least $1 billion would need to cast votes. If fewer than that voted then United would pay taxes at the 30% default rate.

This would give United a strong incentive to get their customers to participate.

Motivating Customers To Vote

Why would customers take the time and trouble to vote? Because the companies would pay them to vote with vouchers, discounts and coupons. For example, United might offer a flight voucher equal to 1% of your number of votes with a $25 minimum and a $250 maximum, so if I had spent $1,000 on United flights in the previous year I would get a $25 voucher/credit if I voted. If I had spent $10,000 my voucher would be $100 and if I had spent $100,000 on United flights the voucher would be $250.

Obviously, these are numbers I picked out of the air but the principle is the same — give your customers a sufficient incentive so that you obtain votes from customers representing some minimum percentage of your gross sales OR pay a default corporate tax rate of 30% instead of possibly reducing that tax rate down to 20%.

How much less likely would United be to lose your bags and cancel your flight if the executives knew that a low level of customer satisfaction could cost the company tens of millions of dollars in additional taxes?

An Idea, Not A Cure

Would this solve all problems with bad business behavior? Of course not. A company might decide to totally screw over a relatively small number of customers in the pursuit of a large amount of money and live with those few negative scores.

For example, several insurance companies materially short-changed many of their policy holders after Hurricane Sandy. Even if this system had been in place it likely would not have deterred that bad conduct by the insurance companies.

But experimenting with a system like this would be a start.

– David Grace (

To see a list of my other columns, go to:

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