ANALYZING MANAGERIAL DECISIONS, Ebay – Case study

Task summary:Please follow the instructions/questions attached to write the case study about Ebay. Reference the attached sources at least twice and use another outside source.

? MAIN DETAILS: eBay operates the world’s largest online auction. It is a multi-billion dollar business, which in 2018 generated nearly $11 billion in revenue from its operations in about 33 countries. Sellers pay a small fee to eBay to list their items. They provide a description of the item, photographs, the minimum acceptable bid, accepted forms of payment, and other relevant information. Items can be sold at a fixed price or through an auction. In an auction, bidders submit electronic bids over the Internet. After the auction closes (auctions usually last several days), the high bidder receives an e-mail. The high bidder must contact the seller within three business days to claim the item and arrange payment and delivery. eBay provides other support services: The Feedback Forum is a place where eBay users leave comments about each other’s buying and selling experiences. If you are a bidder, you can check the seller’s Feedback Profile easily before you place a bid to learn about the other buyers’ experience. If you’re a seller, you can do the same thing to check out buyers. Each participant is given a Feedback Score based on the number of positive and negative ratings they have received. Participants with sufficient positive ratings are flagged by colored stars. The highest rating is the “Red shooting star.” eBay has created a set of policies to guard against “feedback manipulation” and “feedback abuse.”eBay users are encouraged to settle transactions through PayPal. PayPal provides free insurance of up to $2,000 on some items to protect buyers in cases where they do not receive the item or it was less than expected. Participants sign user agreements that specify the trading rules and expectations. eBay’s safety staff investigates alleged misuses at eBay such as fraud, trading offenses, and illegally listed items. Potential resolutions include such things as banning a person from future trading on eBay.

1. How does eBay create value?

2. What potential contracting problems exist on eBay?

3. How does eBay address these problems?

4. What are the contracting costs at eBay?eBay claims that it has only a small problem with fraud and misuse of the system. Does this imply that it is overinvesting in addressing potential contracting problems? Underinvesting? Explain.

Brabantia celebrated its 100-year anniversary in 2019 as one of Europe’s leading manufacturers
of household products such as ironing boards, waste bins, food storage canisters, kitchen tools,
and mailboxes. Headquartered in the Netherlands, the family-owned company employs around
1,000 people and has offices and production facilities at various locations worldwide, including
marketing/sales offices in 23 countries (it is “active” in many more countries).
Through the 1980s and 1990s, Brabantia faced increased competition for its products. With the
creation of a “single market” within the European Economic Union, other European companies
entered Brabantia’s local markets. As Europe’s population growth slowed, the household utensil
market became saturated. And large, mass-marketing retailers entered the European market,
driving out many of Brabantia’s traditional outlets—small household specialty stores.1
Brabantia required new products and new channels of distribution. It had to become more
efficient. It had high rates of rework and scrap, low levels of productivity, and high rates of
employee absenteeism. The firm was organized quite centrally with traditional formal
hierarchies, task specialization, and a functional structure. New products and programs were
“top down” in nature and usually excluded input from lower-level operational staff. The firm
assessed its performance based on cost, margins, and meeting output goals—not on measuring
quality or customer satisfaction. Pay increases were based on seniority and companywide pay
settlements.
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To address its problems of increased competition, shrinking channels of distribution, low worker
productivity, and a stale product line, Brabantia instituted a series of organizational changes
that were designed to enhance performance. These changes involved three important aspects
of the organization that we refer to as the firm’s organizational architecture2:
The assignment of decision rights within the firm.
The methods of rewarding individuals.
The structure of systems to evaluate the performance of both individuals and business units.
Senior managers set the overall policies of the firm, including its organizational architecture.
One change involved giving lower-level managers greater control over their work and
substantial authority to make and implement decisions. Semiautonomous work teams were
given considerable freedom in ordering raw materials, scheduling production, and recruiting
new team members. All employees participated in writing a new mission statement that
emphasized Brabantia’s unique product designs and their usability. In other words, Brabantia
decentralized the assignment of decision rights within the organization.
The company began to focus on innovation, or new-product development, rather than cost or
output. It changed how employees were rewarded, placing greater emphasis on rewarding
teams and individuals. It also restructured its information systems to monitor performance
using a broader range of objectives, such as quality and customer satisfaction. Employees were
trained to work in groups and to apply continuous improvement techniques with an emphasis
on staff involvement. Formal policy statements were drafted to explain the new organizational
architecture and mission statement to all employees.
The results have been impressive. The time to develop new products was reduced 20 percent.
Quality and productivity have improved. Scrap and rework rates have fallen. And, employee
satisfaction has improved.
This example of Brabantia illustrates that organizational architecture is an important
determinant of the success or failure of firms. The purpose of this chapter is to introduce the
concept of organizational architecture and provide a broad overview of the factors that are
likely to be important in designing the optimal architecture for a particular organization.
Understanding organizational architecture provides managers with powerful tools for affecting
their firm’s performance. As we shall see, managers must be careful and thoughtful in their use
of these tools, or the results can be counterproductive. This book presents material designed to
help managers employ these tools more effectively.
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We begin by discussing the fundamental problem facing firms and markets. We then examine
how structuring of the firm’s organizational architecture can help to resolve this problem.3
The Fundamental Problem
The primary goal of any economic organization is to produce the output customers want at the
lowest possible cost. The challenge of discovering customer demands while reducing costs, both
for economic systems and within individual firms, is complicated by the fact that important
information for economic decision making generally is held by many different individuals.
Furthermore, this information often is quite expensive to transfer (e.g., the information is
specific as opposed to general). For example, a scientist is likely to know more about the
potential of a specific research project than are executives higher in the firm. Similarly,
individual machine operators normally know more about how to use their particular machines
than do their supervisors. In both cases, communicating such information to headquarters for
approval prior to acting on the information is likely to be cumbersome, resulting in many lost
opportunities.
A second complication is that decision makers might not have appropriate incentives to make
more effective decisions even if they have the relevant information. There are incentive
problems. For example, a scientist might want to complete a research project out of scholarly
interest, even if convinced the project is unprofitable. Similarly, machine operators might not
want to use machines efficiently if this would mean additional work for them.
In sum, the principal challenge in designing firms (as well as entire economic systems) is to
maximize the likelihood that decision makers have both the relevant information to make good
decisions and the incentives to use the information productively.
There are many alternative ways of organizing economic activity to try to achieve these
objectives. Economic transactions can occur within markets or firms. Firms can be organized as
corporations, mutuals, partnerships, supplier cooperatives, employee-owned companies, or
sole proprietorships. In each case, there are many different possible organizational
architectures. All these alternatives involve costs as well as benefits. As we have discussed in
previous chapters, individuals have incentives to select value-maximizing forms of organization.
By maximizing the “size of the pie,” there is more value to share among the parties to the
transaction. To achieve this objective, it is important to have a detailed understanding of the
architectures of both markets and firms.
Architecture of Markets
The price system helps resolve information and incentive problems in markets. As we discussed
in the first half of this book, in market economies, individuals have private property rights. If
Jorge Ortega owns a building, he decides how it will be used. If Aldo Deng knows how to make
better use of the building, Aldo can bid more for the building than it is worth to Jorge. Jorge can
sell it and pocket the proceeds. Aldo has strong incentives to use the building productively
because he bears the wealth effects.
ANALYZING MANAGERIAL DECISIONS: eBay.com*
eBay operates the world’s largest online auction. It is a multi-billion dollar business, which in
2018 generated nearly $11 billion in revenue from its operations in about 33 countries. Sellers
pay a small fee to eBay to list their items. They provide a description of the item, photographs,
the minimum acceptable bid, accepted forms of payment, and other relevant information.
Items can be sold at a fixed price or through an auction. In an auction, bidders submit electronic
bids over the Internet. After the auction closes (auctions usually last several days), the high
bidder receives an e-mail. The high bidder must contact the seller within three business days to
claim the item and arrange payment and delivery. eBay provides other support services:
The Feedback Forum is a place where eBay users leave comments about each other’s buying
and selling experiences. If you are a bidder, you can check the seller’s Feedback Profile easily
before you place a bid to learn about the other buyers’ experience. If you’re a seller, you can do
the same thing to check out buyers. Each participant is given a Feedback Score based on the
number of positive and negative ratings they have received. Participants with sufficient positive
ratings are flagged by colored stars. The highest rating is the “Red shooting star.” eBay has
created a set of policies to guard against “feedback manipulation” and “feedback abuse.”
eBay users are encouraged to settle transactions through PayPal. PayPal provides free insurance
of up to $2,000 on some items to protect buyers in cases where they do not receive the item or
it was less than expected.
Participants sign user agreements that specify the trading rules and expectations. eBay’s safety
staff investigates alleged misuses at eBay such as fraud, trading offenses, and illegally listed
items. Potential resolutions include such things as banning a person from future trading on
eBay.
1. How does eBay create value?
2. What potential contracting problems exist on eBay?
3. How does eBay address these problems?
4. What are the contracting costs at eBay?
eBay claims that it has only a small problem with fraud and misuse of the system. Does this
imply that it is overinvesting in addressing potential contracting problems? Underinvesting?
Explain.
*To obtain more detailed information, go to www.ebay.com.
The purchase of RJR-Nabisco by Kohlberg, Kravis, Roberts & Company was an extremely large
corporate takeover that occurred in 1988. Public accounts report lavish expenditures and
decisions of questionable merit by RJR executives preceding the takeover. For example,
Burrough and Helyar in their best seller Barbarians at the Gate write1,
It was no lie. RJR executives lived like kings. The top 31 executives were paid a total of $14.2
million, or an average of $458,000. Some of them became legends at the Waverly for dispensing
$100 tips to the shoeshine girl. [Ross] Johnson’s two maids were on the company payroll. No
expense was spared decorating the new headquarters, highlighted by the top-floor digs of the
top executives. It was, literally, the sweet life. A candy cart came around twice a day dropping
off bowls of bonbons at each floor’s reception areas. Not Baby Ruths but fine French
confections. The minimum perks for even lowly middle managers was one club membership and
one company car, worth $28,000. The maximum, as nearly as anyone could tell, was Johnson’s
two dozen club memberships and John Martin’s $105,000 Mercedes.
In addition, it appears that major investment decisions at RJR often were driven not by value
maximization but rather by the preferences of managers. For instance, Ross Johnson, the CEO of
RJR, reportedly continued to invest millions of dollars in developing a smokeless cigarette long
after it was obvious that the project would never be profitable.
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There are many more examples of potential conflicts of interest between corporate executives
and investors.2 In some cases, these have even led to charges of criminal misconduct. Consider
Elizabeth Holmes, who was once touted as being the female counterpart of Apple’s Steve Jobs.
Holmes dropped out of Stanford in 2003 to found the company Real Time Cures, later renamed
Theranos. The company reportedly had developed breakthrough technologies that greatly
reduced the costs of numerous blood tests ranging from cholesterol to cancer. Theranos
generated significant investor interest, reaching a peak valuation in 2014 estimated at $10
billion. Holmes with a majority stake in the company became famously wealthy.
Things began to go wrong for Theranos in late 2015 after The Wall Street Journal published a
highly critical article in which a former senior employee claimed that the company was actually
using competitors’ equipment to conduct a majority of its blood tests, despite its claims to the
contrary. Increased regulatory and media scrutiny followed. The company ultimately was
liquidated. In 2018, a federal grand jury indicted Holmes and the former president of the
company on fraud charges. The U.S. Attorney’s Office stated that to promote the company, the
two executives had “engaged in a multi-million-dollar scheme to defraud investors and a
separate scheme to defraud doctors and patients.” The trial was scheduled to begin in 2020.
Executive scandals are not limited to U.S. companies. For example, in 2017, the U.S. Department
of Justice indicted the chair/CEO and former CFO of China Medical Technologies Inc. for
defrauding China Medical’s investors of more than $400 million. Allegedly the two executives
had diverted the funds raised through security sales to entities that they controlled.
These examples raise at least four interesting issues:
In previous chapters, we employed standard economics tools, treated the firm as a “black box,”
and focused on first-order conditions. We assumed that managers always maximize profits.
Apparently, they do not. To understand management problems within the firm, we need a
richer characterization of the firm and managerial decision making.
Material conflicts of interest can exist between owners and managers: Shareholders are
interested in the firm’s value, whereas the managers are interested in their own well-being.
What other conflicts of interest exist within firms?
Owner-manager conflicts can result in reduced productivity and waste. Unchecked, such
conflicts of interest can destroy a firm. How do firms limit unproductive actions by selfinterested managers to enhance value and avoid failure?
If techniques to limit unproductive actions exist, why did the owners (shareholders) at scandalridden companies allow the managers to engage in such dysfunctional behavior?
In this chapter, we examine these and related issues. We begin by enriching our understanding
of the definition of a firm. We then use this more explicit understanding to discuss various
conflicts of interest that exist within firms. Thereafter, we examine how contracts help reduce or
control these conflicts. We focus particular attention on the problems created by costly
information. Finally, we discuss how reputational concerns can control incentive conflicts within
firms.
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Firms
In Chapter 3, we characterized the firm in terms of administrative decision making: Markets use
prices to allocate resources; firms use managers. This prompted a discussion of the relative
efficiency of firms and markets. Thus far in the book, we have treated the firm as if it had one
central manager who acts to maximize the firm’s value. This characterization is employed widely
in economics and has proved quite useful in explaining production and pricing decisions.
The actual decision-making process within firms, however, is extremely complex and differs
from this simple characterization in at least three ways. First, there are many decision makers
within firms. In large corporations, the board of directors makes major policy decisions,
including appointing the CEO. The CEO, in turn, retains certain important decision rights while
delegating many operating decisions (for instance, pricing, production, and financing decisions)
to lower-level managers. Even the lowest-paid employee in the firm usually has some decisionmaking authority. Second, the primary objective of most of these decision makers is not to
maximize the value of the firm: The investment behavior of the RJR executives certainly
suggests interests in things other than corporate value maximization. Third, firms often use
internal pricing systems (transfer prices) to allocate internal resources.
Definition
The firm is a focal point for a set of contracts.
Analyzing organizational issues within the firm requires a richer concept of the firm. Several
useful definitions have been developed by economists.3 We focus on one definition that is
particularly useful for our purposes4: The firm is a focal point for a set of contracts. This
definition focuses on the fact that the firm ultimately is a creation of the legal system; it has
been granted the legal standing of an individual (it can enter contracts, sue, be sued, and so on).
The term focal point indicates that the firm always is one of the parties to each of the many
contracts that constitute the firm. Examples of these contracts are employee contracts, supplier
contracts, customer warranties, stock, bonds, loans, leases, franchise agreements, and
insurance contracts. This contract view of the firm is depicted in Figure 10.1.
Figure 10.1 The Firm as a Focal Point for a Set of Contracts
The firm is a creation of the legal system that has the standing of an individual in a court of law.
The firm serves as one party to the many contracts that make up the firm.
Some contracts are explicit legal documents, whereas many others are implicit. And even within
a relationship that has been formalized with an explicit contract, there is a broad array of
aspects of the relationship that are not spelled out within the written agreement—they are
implicit. An example of an implicit contract is an employee’s understanding that if a job is done
well, it will result in a promotion. Implicit contracts are often difficult to enforce in a court of
law. Later in this chapter, we discuss how reputational concerns can help ensure that individuals
honor implicit contracts.