INSTITUT Veolia Environnement

  • Home
  • Report n°2: An integrated approach to economic and social contestability in business

Report n°2: An integrated approach to economic and social contestability in business

The recycler's credibility and the collector's efforts

When an asymmetry of expertise prevails between the recycler and collectors, it apparently, on first glance, allows the recycler the opportunity to practise abusive pricing: when evaluating the batch; the buyer can announce a quality inferior to the quality effectively seen to a collector who is not fully aware of the nature of the materials he is collecting and delivering.

The recycler's dilemma: combining an ambiguous pricing structure and a credible commitment
The first effect of asymmetric expertise is to place an inexperienced supplier in a weak position. The supplier whose knowledge is limited is unable to distinguish whether the prices announced by the buyer are based on a fair pricing strategy adjusted to take into account the real quality of the batch or an abusive pricing strategy. If a collector expresses doubts about the price announced by the buyer, the latter can use his expertise to justify the contested evaluation. Having superior knowledge of the qualities, he can easily advance reasons to justify classifying the batch in a particular grade.

Because of this, the recycler's commitment to correlate the observed quality to the announced quality and pay the supplier the "right price" tends to suffer from a lack of credibility. This is a direct consequence of the collector's lack of expertise, since he is unable to detect the recycler's deviations from the pricing rule according to which the real quality and the price are systematically correlated. A second consequence derives directly from the asymmetry of expertise: the price differences between the various batches from one and the same supplier or the differences observed from one supplier to another can be interpreted in two ways. They can be perceived as the signal of an abusive pricing strategy or as discrimination (or as popular parlance would have it "here, we pay what we think the customer will agree to") or as the result of a carefully adjusted price structure intended as an incentive to collectors.

That the quality of the proposed batches depends on the effort produced from the outset by the collection operators is a factor that will cause the recycler to take into account the credibility of his commitment. The need to encourage the suppliers to make an effort on collection and sorting is the reason why maintaining differential expertise is to be said at first glance unfavourable to both parties to the transaction.

when collection efforts are at stake: the threat of contestation through defection
It would be detrimental to the recycler if the collectors were to reduce their collection efforts. This, however, is what they might be encouraged to do if they felt there were not being paid the right price for the batches they bring in. At the very least, the collectors might collect only low qualities, preferring to opt for quantity rather than quality. The nature of the flows collected and delivered would suffer: the majority of the scrap collected and offered for sale by the collectors would consist of low quality easily identifiable scrap available at reduced cost. In addition to reducing their search and collection effort, suppliers might also decide to make less effort to sort the materials, leaving abnormal waste in the batches delivered, in the opinion that "they had already paid for the waste".

If he anticipates less effort in sorting and more waste being left in the batches, the buyer might choose to include a risk premium in his pricing system, thereby marking down the prices he offers. The scrap metal recycling market would then develop similarly to the situation studied by Akerlof, but the suppliers would to some extent feel to be caught in a hold-up, their performance not being paid at true value. The suppliers would then propose for exchange only low quality batches from which they would not have removed the abnormal wastes, resulting in an under-optimal equilibrium on the market, with less remuneration for suppliers who in return would provide low quality batches with a high coefficient of risk for the safety of the recycler's activity, nuisance to local residents and environmental risks for the community.

If this prediction aptly describes a scrap metal recycling market, the consequences for the recycling branch generally would be fairly considerable: reduction in input quality directly impacts output quality (i.e. the processed scrap metal) and subsequently the quality of the consumer or other goods made from the secondary raw material. The risk of damage to the recycler's industrial equipment and for operators further down the chain would increase, as would the environmental risks. To put it succinctly, asymmetry of expertise can have a very negative effect on the smooth progress of transactions on the input market.