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Entrepreneurial opportunities, implicit contracts and market making for complex consumer goods

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Godley, A. C. (2013) Entrepreneurial opportunities, implicit contracts and market making for complex consumer goods. Strategic Entrepreneurship Journal, 7 (4). pp. 273-287. ISSN 1932-4391 doi: https://doi.org/10.1002/sej.1167 Available at http://centaur.reading.ac.uk/29536/

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ENTREPRENEURIAL OPPORTUNITIES, IMPLICITCONTRACTS, AND MARKET MAKING FORCOMPLEX CONSUMER GOODS

ANDREW CHRISTOPHER GODLEY*Centre for Entrepreneurship, Henley Business School, University of Reading,Reading, U.K.

This article extends the theory of entrepreneurial opportunity exploitation, outlining how undercertain conditions, opportunity exploitation is dependent on market making innovations. Whereadverse selection and moral hazard characterize markets, consumers are likely to withdrawregardless of product quality. In order to overcome consumer resistance, entrepreneurs mustsignal credible commitments. But because consumers purchase without fully specifyingrequirements, entrepreneurs’ commitments take the partial form of implicit contracts, creatingstrong mutual commitments to repeated transactions. These commitments enable novel marketsto function, but introduce additional costs. This article illustrates the theory with the historiccase of Singer in sewing machines. © 2013 The Author. Strategic Entrepreneurship Journalpublished by John Wiley & Sons Ltd on behalf of Strategic Management Society.

INTRODUCTION: ENTREPRENEURIALOPPORTUNITIES ANDMARKET MAKING

Scholarly research in the domain of entrepreneurshipresearch has increased substantially in the lastdecade or so, since Shane and Venkataraman’s(2000) call for researchers to identify from whereentrepreneurial opportunities come. Much of thisrecent conceptual development has focused on thecreation, discovery, and development of entrepre-neurial opportunities. Relatively few articles havefocused on better understanding the concept ofentrepreneurial exploitation (Short et al., 2010).Indeed, Short et al. (2010) show that whereopportunity exploitation is a focus, it is largely onassociated personality characteristics not processes(important exceptions would include Sarasan, Dean

and Dillard, 2006; Lee, Peng, and Barney, 2007;Witt, 2007; Choi, Levesque, and Shepherd, 2008;Wood and McKinley, 2010; Schindehutte andMorris, 2009). Such focus on developing the sepa-rate conceptual elements of entrepreneurial opportu-nities is understandable, as the concept has matured,but it should be remembered that the ‘only reliableconfirmation that a previously unseen or unknownvaluable opportunity in fact exists occurs when amarket has been created for the new item’ (Eckhardtand Shane, 2003: 339). Market creation is, therefore,ultimately central to any empirical assessment ofany aspect of entrepreneurial opportunities. Yet theprocess of market making has received relativelylittle attention in the entrepreneurship literature inrecent years.

This omission from the scholarly literature isdoubly curious because while so much of the empiri-cal literature has focused on high technologyentrants, for many of these entrepreneurs, theirprimary concern is not new technology creation,but the uncertainty surrounding market reception(Christensen, 1997). The seeming relative absenceof much consideration in the entrepreneurial

Keywords: entrepreneurial opportunities; opportunity exploita-tion; implicit contracts; credible commitments; market making;price rigidity*Correspondence to: Andrew Godley, Centre for Entrepreneur-ship, Henley Business School, University of Reading, ReadingRG6 5UD, U.K. E-mail: [email protected]

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© 2013 The AuthorStrategic Entrepreneurship Journal published by John Wiley & Sons Ltd on behalf of Strategic ManagementSociety.This is an open access article under the terms of the Creative Commons Attribution License, which permitsuse, distribution and reproduction in any medium, provided the original work is properly cited.

opportunity literature of market reception may havearisen because of the widespread assumption thatconsumer behavior is economically ‘rational.’ Yetin his presidential address to the American Econom-ics Association, Daniel McFadden, Nobel Prize-winning behavioral economist, highlighted oneimportant conclusion of years of behavioral econom-ics research, that this textbook assumption may needto be moderated, ‘Homo economicus . . . is a rarespecies’ (McFadden, 2006: 10). Experimental datafrom behavioral economics research, supported bysimilar outcomes from cognitive psychology andbiology researchers, suggests that consumers do notalways follow conventional norms of self-interestand rationality. In particular, experimental datasuggest that consumers are most unlikely to showtextbook style ‘rationality’ in the face of novelty(McFadden, 2006). An exaggerated awarenessamong consumers of the risk of adverse selection onoutcomes under conditions of novelty means there isan increased risk of consumer withdrawal.

Consumer overreaction to novelty, therefore, has adirect bearing on the domain of entrepreneurship. Inparticular, this implies that entrepreneurs who havecreated new products and services may need to gobeyond product innovation to market making inno-vations to secure successful market reception. Thisarticle, therefore, seeks to separate product innova-tion from market making innovation and show how,in certain markets, successful entrepreneurial entrydepends on market making innovation as well assuccessful product development.

The article proceeds by developing some of theinsights of information economics. These have beenapplied successfully to other economic contexts, butnot to entrepreneurship (Stiglitz, 2000). The articlebegins by describing the uneven impact of informa-tion asymmetries, notably the effects of moralhazard and adverse selection on different kinds ofconsumer goods markets, showing why implicitcontracts between producers and consumers haveemerged as a solution to overcome the threat ofconsumer withdrawal. The article then explains whythis poses particular problems for new entrants insuch markets, and why entrepreneurs need to giveadditional consideration to market making innova-tions. This, in turn, has important implications forpricing strategies and the provision of marketsupport services. The article then goes on to illus-trate the existence of implicit contracts, showinghow they dominated the structure of the market forthe world’s first mass produced, mass marketed,

complex, and high tech consumer durable, thesewing machine.

SETTING OUT THE PROBLEM OFINFORMATION ASYMMETRIES:MORAL HAZARD AND ADVERSESELECTION EFFECTS IN CONSUMERMARKETS

The transactional relationship under considerationis between entrepreneurial firms and consumers;firms sell novel products to consumers, consumersbuy from firms. Under such conditions of uncer-tainty, consumer purchases are decisions made onthe basis of crude estimates of expected futureutility.1 There is a risk such estimates may turn outto be wildly inaccurate. Consumers, in fact, acquireonly sufficient information to make an informedjudgment about the utility of a purchased novelproduct at some point after formal completion,meaning these transactions share characteristics ofincomplete, open-ended contracts and their associ-ated risks. Producers may seek to disseminate infor-mation to overcome such risks, but consumers areunlikely to take such information at face value, asproducers may be less than fully transparent inorder to complete the transaction. In this setting,consumers face similar adverse selection effects asbankers facing would-be borrowers. Simply alteringthe price—banks increasing interest rates to poten-tial borrowers or consumers insisting on lowerprices from producers—does not screen out the badrisks (Stiglitz and Weiss, 1981; Grossman and Hart,1986; Godley and Ross, 1996; Stiglitz, 2000).

This is not the case for all novel consumer goods.For many new products, consumers are well placedto be able to test the firm’s claims because for manyproducts (‘search goods’ in Nelson’s terminology(Nelson, 1974)), consumers can sample or test goodsbefore purchase. Nelson differentiated search goodsfrom others—which he called ‘experience goods’—that are sufficiently complex in nature and for whichconsumers are unable to gain sufficient information

1 For the purposes of theory building, I am ignoring state inter-vention, warranty provision, comparison Web sites or otherinstitutional innovations to overcome the threat of opportunisticbehavior in open-ended contracts in this section (although seeDiscussion and Conclusion below). Equally the focus is ongoods rather than services, where consumption is mostlysimultaneous with production, and, so, where transactions aremostly spot rather than sharing the open-ended characteristicsemphasized here.

2 A. C. Godley

© 2013 The AuthorStrategic Entrepreneurship Journal published by John Wiley & Sons Ltd on behalf of Strategic Management Society

Strat. Entrepreneurship J., ••: ••–•• (2013)DOI: 10.1002/sej

prior to purchase,. These transactions do possesssimilar characteristics to open-ended, incompletecontracts because these novel products are taken onin faith by consumers. It is only through actuallyexperiencing them after purchase that the consumeris genuinely able to judge whether the product hasmet ex ante expectations. For consumers likely toexaggerate the risks of adverse selection under con-ditions of uncertainty, there is a greater risk of with-drawal from such novel and complex experiencegoods.

For some quasi open-ended transactions, there isalso the additional risk of moral hazard, where con-sumers face not only the risk of adverse selection,but vulnerability to producer opportunism. Thisleads to what Akerlof described as the ‘lemons’problem (Akerlof, 1970). In markets for experiencegoods characterized by information asymmetry,where the seller possesses more information than thebuyer and where the buyer suspects that the sellermay act opportunistically, the buyer will insist on adiscount in the price to reflect the cost of insuringagainst the transaction going wrong or of the pur-chase turning into a ‘lemon’ (the American slangexpression for dud cars). In some markets, like sec-ondhand cars, this reduction in price may be easilyabsorbed or passed on to suppliers. But in marketscharacterized by very high sunk costs, producersmay not be able to pay the consumers’ implicit insur-ance premiums. To overcome such a strong propen-sity to consumer withdrawal producers must investin developing communication channels not only todisseminate relevant information about the productitself, but also to convince consumers of their trust-worthiness. The penalty of continued consumer sus-picion of producer opportunistic behavior is lowerprices.

The threat of moral hazard varies for differentkinds of experience goods, however. For example,there are several kinds of experience goods for whichdemand is repeat demand—the products are con-sumed, typically shortly after purchase, leading tofurther repeat purchases—subject to some satisfac-tion threshold being met. Consumers here are neitherable to consume at the point of purchase (like mostservices) nor to sample before purchase (like searchgoods), but they are able to benefit from the infor-mation generated by previous purchases. The risk ofnovelty and the dependence on the producer’spromise is not eradicated, but it is modified to onewhere producers commit to ensure future purchasesare consistent with previous ones.

For novel durable goods, however, consumers aremore dependent on an entrepreneur’s promise—firstbecause they are not repeat purchases (and so theypossess no information from previous purchases),but also because once a durable good has been pur-chased, consumers have less incentive to continuesampling and testing alternatives. Consumerdurables like computers or smart phones might betypical of these products (e.g., Kay, 1993). Further-more, consumer durables are typically more expen-sive and treated as quasi investment goods. Thepossibility of a bad purchase, therefore, represents ahigher long-term risk to consumer utility because ofthe time required before the expense can be fullyamortized and the product replaced.

Table 1 summarizes this first step of setting outthe problem posed by information asymmetries. Itillustrates that many transactions for novel goodsand services are unaffected by either moral hazard oradverse selection effects, and so face minimal risk ofconsumer withdrawal. For example, when bothadverse selection and moral hazard effects are low,in Box 1 (with novel search goods like clothing,perhaps), consumers are sufficiently informed topursue their own self-interest and fully commit totransactions. In Box 2, low product complexitymeans minimal risk of adverse selection effects, butthe open-ended nature of the contract exposes con-sumers to the risk of moral hazard. Entrepreneurialentry into these types of markets (domestic construc-tion services, perhaps) would have to devise contrac-tual strategies to avoid consumers insisting ondiscounts to insure against poor quality (throughstage payments, perhaps).

In some markets for complex experience goods,consumers face the risk of adverse selection (it is toocomplex for them know ex ante whether the productwill meet expectations), but consumption is so coin-cident with purchase that there is little risk of moralhazard. These Box 3 markets might be composed of

Table 1. Moral hazard and adverse selection and the riskof consumer withdrawal

+ 2. Open-endedincompletetransactions

4. Novel complexconsumer durables

Moralhazard

1. Novel searchgoods

3. Complex nondurables(repeat goods)

−− Adverse selection +

Entrepreneurial Opportunities and Implicit Contracts 3



nondurable goods and services. In order to overcomethe risk of complexity, entrepreneurs may seek tobuild incrementally on existing products and ser-vices and, therefore, enable consumers to draw com-parisons either from their own or others’ previoustransactions. Or for more complex goods, specialistintermediaries might emerge to offer authoritativeinformation.

As a set of transactions relating to repeat goods,the threat of producer opportunism facing consumersis restricted to the secondary threat of the price-quality mix changing in favor of producer interests atsome later stage. This has implications for firm stra-tegic behavior rather than strategies of entrepreneur-ial entry, which I will return to later. But for presentpurposes, the important result from Table 1 is toidentify that for entrepreneurs engaged in Box 4 typemarkets, where entrepreneurs are introducing novel,complex, nonincremental durable goods, their targetmarket possesses little relevant information and haslittle prospect of independently accessing such infor-mation so as to make an informed decision. There is,therefore, a high risk of adverse selection effectsinfluencing consumer reception. Moreover, becauseconsumers have to pay up front but will have open-ended requirements, there is a strong risk of moralhazard. Such markets, often for high-tech durableproducts with high intellectual property content forinstance, are a common feature of the entrepreneur-ship literature (Dushnitsky and Lavie, 2010; Enderset al, 2008; Pollock, Fund, and Baker, 2009;Woolley, 2010). Yet focusing on the characteristicsof such markets from the consumer’s perspectiveshould lead to the conclusion that without appropri-ate market making innovations, these are marketswith a high risk of consumer withdrawal and so highrates of entrepreneurial failure regardless of themerits of the novel product itself.

ENTREPRENEURIALRESPONSE—MARKET MAKINGINNOVATION AND IMPLICITCONTRACTS

Nelson’s (1974) focus on the different properties ofconsumer goods is helpful because it indicates howproducers might respond with different advertisingstrategies when engaging with risk-averse consum-ers in transactions characterized by varying degreesof information asymmetries. While this was anadvance on Akerlof (who, as Stiglitz [2000] reminds

us, ignored the desire of producers to supply moreinformation), for the purposes of this article,Nelson’s (1974) typology does not go far enough inexplaining the difficulties facing entrepreneurs inresponding to such information asymmetries. Indeedthere is nothing in Nelson’s (1974) analysis thatnecessarily leads to an entrepreneur having to investin a market making response; alternative institutionalsolutions could easily be envisaged (standards, regu-lations, independent arbiters, etc. (Langlois, 2003;Kleinschmidt, 2010). To understand why in mostconsumer goods markets it is producers who reducethe risk of consumer withdrawal from the threats ofadverse selection and moral hazard rather than anyother actor, the complexities associated with con-sumer demand specification need to be explained.

OVERCOMING COSTLYPRE-PURCHASE SPECIFICATIONWITH CREDIBLE COMMITMENTSAND IMPLICIT CONTRACTS

Another way to conceptualize Nelson’s (1974)demarcation between experience and search goodsis to understand that when consumers are unable tospecify their requirements pre-purchase, they willbe able to make an informed judgment of its utilityonly after experiencing it. It is this inability tospecify requirements pre-purchase that so power-fully demarcates consumer demand from businessdemand for novel, complex products. Businessestypically have much greater understandings ofthe specification required for any particular newproduct required, so business-to-business (B2B)markets are often characterized by tendering andother procurement techniques to ensure bettermatches between buyer and seller.2

In the absence of clear specification from consum-ers, producers engage in guesswork to more exactlyidentify what it is consumers desire but are unable toarticulate. Such guesswork may be informed bymarket research, but in the end, producers have toopt for a particular product or design with less thanperfect information about consumer desires (Orme,

2 Obviously these are points on a spectrum rather than separatecategories of behavior. IBM’s position of dominance in thebusiness machine market for decades was based on the tagline,‘No one was ever fired for buying IBM,’ indicating that whereinformation asymmetries arise in B2B markets, a similarpattern of behavior to that described here for consumer marketsemerges.

4 A. C. Godley



2006). An entrepreneur making investment decisionsin the face of such an absence of consumer specifi-cations is what Casson describes as exercising entre-preneurial judgment (see Casson, 1982, 2005, andCasson and Godley, 2005, for a historical applica-tion). Having made their decision, producers thenhave to communicate with their target audienceabout their novel product. But given that the realunderlying consumer demand factors remain inar-ticulate, producers engage in communicating tacitas well as nontacit information with consumers,through advertising, sponsorship, public relations,and so on, with the aim that such investments inintangible information will lead consumers to recog-nize congruence between their own inarticulatedesires and the offering from the firm.

The need for innovation in market making is,therefore, the outcome not of information asymme-tries per se, but rather the evidently very high coststo consumers of articulating more clearly theirrequired specification pre-purchase. If producersfound market making more costly, then consumerswould have a stronger incentive to specify their ownrequirements and then invest in a search for the mostsuitable providers. Such a market, like most B2Bmarkets, would involve much reduced marketingcosts, but much greater specification and searchcosts. Given the expense of market making innova-tions like brands and reputations, it is reasonable toinfer that consumers find it very costly to engage inany rigorous specification processes. Firms, there-fore, provide sufficient relevant information to con-sumers more cheaply than consumers can discover itthemselves.3 Moreover, it is firms that typically havethe stronger incentive to resolve the risk of consumerwithdrawal rather than consumers, because firms’investments in sunk costs associated with productionare significantly greater than any individual consum-er’s search cost. When consumers typically do investin pre-purchase specification (for example in self-designed house construction), there is much lessincentive for producers to invest in brand creation(house builders, to continue the example, merelytender bids on price and quality).

To summarize, in some consumer goods sectors(typically complex durable goods) where repeat pur-chases are rare, amortization costs are high, and con-sumers find pre-purchase specification very costly,producers face the strongest incentive to provide

product-specific, intangible information to consum-ers. If consumers believe this intangible information,the risks and, hence, the costs to contracting arereduced.

In intermediate product markets exhibiting hightransaction costs, firms face the alternative strategyof internalizing the relevant economic activity(Coase, 1937; Williamson, 1981, 1985; Buckley andCasson, 1976). But firms cannot internalize consum-ers. There have to be alternative institutional solu-tions to such high risk-related transaction costs inconsumer goods markets, and it is entrepreneurs whoface the strongest incentive to find solutions.

Such market making solutions involve, by defini-tion, the ability to meet a consumer’s inarticulateand open-ended requirements, and they requirea firm to go beyond the explicit contract ofexchange—transferring the rights to a good for agiven price—to an implicit contract, where the pro-ducer communicates to the consumer that it willmeet all their product-associated demands, whetherunderstood at the moment of transaction or not,whether codified or not, and until some point in thefuture where consumer uncertainty falls awayapproximately to zero. Such a commitment tounspecified consumer requirements, therefore, rep-resents unfunded guarantees to future expectations.Implicit contracts are costly but necessary marketmaking innovations.

Okun defined implicit contracts as ‘invisiblehandshakes’ or ‘arrangements that are not legallybinding but that give both sides incentives to main-tain the relationship’ (1981: 49–50). Substantialanecdotal or partial evidence of the pervasiveness ofimplicit contracts can be drawn from a variety ofcontexts where relationship is preferred to contract.Examples occur in the business history literature oncomplex infrastructure projects (Mata, 2008) or inthe international management literature on Germanand Japanese corporate governance systems(Jenkinson and Mayer, 1992), or in the cross-culturalmanagement literature on Chinese managers’ deci-sion making (Graham and Lam, 2003), to list but afew.

The economic literature on implicit contracts is,however, clear that markets so characterized are ableto function only in the presence of supportive socialnorms. The most significant norm to be observed inexperimental data is reciprocity (Axelrod, 1984;Fehr and Gachter, 2000; Gachter and Herrmann,2009). Reciprocity’s importance in the behavioraleconomics literature is that it enables markets

3 Firms obviously gain from economies in pooling commoncharacteristics of consumer demand specifications.




characterized by implicit contracts to function. Itovercomes what Avner Greif has called ‘the funda-mental problem of exchange’ (Greif, 1994, 2000).But this implies that a transactional relationshipbetween entrepreneurs and consumers based onimplicit contracts exhibits more similarities with aprisoner’s dilemma view of the world than theconventional understanding of price-taking freemarkets. Credible and long-term commitments torepeated exchange, therefore, introduce significantconstraints on both parties’ freedom of action.

Implicit contracts have been particularly influen-tial in the economics of the labor market, where theempirical observation of lower than expected levelsof volatility in employment and wages over thecourse of a business cycle has been explained by ‘thehypothesis that contract wages embody implicit pay-ments of insurance premiums by workers in favor-able states of nature and receipts of indemnities inunfavorable states’ (Rosen, 1985: 1145; Azariadisand Stiglitz, 1983). The equivalent of this wagerigidity in labor markets is price rigidity in consumermarkets. The literature here emphasizes that risk-averse consumers interpret any change in price orquality that appears to favor producer interests asproducer opportunism, so producers face strongincentives to maintain price and quality to avoidconsumer boycotts (Renner and Tyran, 2004). Once‘the firm draws a clientele with attractive implicitcontracts, any deviation unfavorable to consumers isseen as a violation of these contracts’ (Okun, 1981:154).

The strongest empirical support for this is pro-vided by Young and Levy’s (2010) excellent analysisof Coca-Cola’s 70 years’ persistence with pricerigidity. The significance of implicit contracts inCoca-Cola’s market is underlined by the consumerresponse to the firm’s first formula change—thedisastrous introduction of ‘New Coke’ in 1985,which led the then-CEO to reflect on the consequentrestrictions on managerial authority, observing that it‘was then we learned that if the shareholders thinkthey own this company, they are kidding themselves.The reality is that the American consumer ownsCoca-Cola’ (Tedlow, 1990: 60).

Coca-Cola is a repeat good. The principal asym-metry in this and other repeat good markets is one oftime inconsistency (Young and Levy, 2010). Implicitcontracts signal a commitment by producers to mini-mize any change over time that is not in consumerinterests. In terms of Table 1, this particular producerpromise simply changes the transaction characteris-

tics of Box 3 goods more toward those of Box 1 byreducing the threat of adverse changes to future priceand quality. But for this article’s purposes, the focusis on Box 4-type transactions, not Box 3. BecauseBox 4 goods are durable goods, entrepreneurs haveto convince uninformed and inarticulate consumersto buy their novel products without the prospect ofrepeat purchasing. The market making solution ofprice and quality rigidity alone is insufficient to over-come the risk of consumer withdrawal in Box 4-typemarkets.

Alternative strategies available to entrepreneursoutside price and quality rigidity are a scarce featureof the literature. The wider economics of incompletecontracts emphasizes the importance of periodicallyrevisiting the explicit contracts in order to betterreallocate residual rights (Holmstrom and Tirole,1989). But such recommendations are hardly likelyto assist entrepreneurs aiming to elicit consumertrust at the point of market entry. As noted earlier,Okun (1981) simply assumes such relationshipshave begun. Renner and Tyran (2004: 578) simplystate that such long-term relationships ‘endog-enously form’ without any indication of what kind ofmarket making innovation might elicit consumertrust in markets for novel, complex durable goods.The approach adopted here is to return to the two keyfeatures of Box 4-type transactions which hindermarket reception. If these have been correctly iden-tified, then entrepreneurial entrants are best advisedto create market making innovations to solve eachspecific problem in turn.

The first difficulty facing producers of novel,complex durables is of communicating to inarticu-late consumers that such goods might meet theirneeds. Because most complex durables possessstrong elements of multi-functionality, it is difficultfor producers to signal likely post purchase usage topotential consumers through conventional promo-tion strategies. Product complexity and consumerinability to prespecify requirements suggest that anappropriate market making solution to overcome therisk of adverse selection would be for an entrepre-neur to invest in signaling mechanisms to dissemi-nate information that allow consumers to judge howthey might use the product. Partial responses heremight range from conventional branding strategies tostrategies popular in the customer relationship man-agement literature (such as firm-specific interactiveWeb sites) to engaging with customer review Websites, and so on. But perhaps the most completeresponse would be to invest in a fully comprehensive

6 A. C. Godley



pre-sales demonstration and after-sales service ableto advise customers on their individual usage.

The second difficulty relates to the open-endednature of transactions. The explicit contract is a spottransaction (or a near-spot transaction in cases ofinstallment purchases). But consumers will be awareof the risk of moral hazard, as producers simply maynot keep promises. For novel durable goods, produc-ers may offer initially attractive servicing and repairterms, but may subsequently change terms, forexample. Entrepreneurs seeking to overcome con-sumer propensity to withdraw because of the risk ofmoral hazard would, therefore, need to make cred-ible commitments not to change service conditionsin ways that might adversely affect consumers. Butbecause consumers’ future requirements remainunspecified at the point of transaction, such a com-mitment must be made through an implicit contract.

It follows that if implicit contracts are the pre-ferred solution to overcoming the threat of consumerwithdrawal in markets for complex consumer goods,entrepreneurs will need to invest in market makinginnovations that would reduce the risks to consumersof adverse selection and moral hazard. The mostcomplete market making response would be a com-prehensive pre-sales demonstration and after-salesservice that would meet all information requirementsfor consumers of novel durables. Such an investmentwould be very costly for entrepreneurs, but it wouldsignal a credible commitment by an entrepreneur toelicit consumer trust to make the market at the pointof entry.

Given the expense associated with such a marketmaking innovation, entrepreneurs might simply passon the costs of after-sales services to consumers inthe form of an explicit list of prices for a variety ofservices.4 But charging the market rate for after-salesservices opens up the possibility of third partiesestablishing themselves as competing sources ofafter-sales services. In the long run, competition inafter-sales service provision is unlikely to impactfirm strategy, but at the point of market entry wherethe need to elicit trust with consumers is the key tosuccessful market making, competition in after-salesservice may undermine the credible commitmentsneeded for the relationship between entrepreneurand consumer to begin. So entrants will need to

subsidize their market support services to deter com-petitor entry. Because the cost of such a subsidy hasto come from product revenues, premium pricingstrategies have to be employed by entrepreneurialentrants, otherwise the subsidy for market supportservices is not viable. The provision of below-costafter-sales support and advice to consumers ofcomplex durables should, therefore, overcome muchof the risk of potential consumer withdrawal.5 Thecombination of responses has, however, effectivelytransformed a spot transaction of a durable good intoa repeat consumption of market support services,thus changing the transaction characteristics of thegood from its original Box 4 features to somethingmore akin to a Box 3 complex, repeat good.

There remains then the time inconsistencyproblem identified in Box 3-type transactions, over-come most visibly above by the implicit contractoffered by Coca-Cola to keep prices and quality con-sistent. This then implies that for the entrepreneursof Box 4 complex durables who have alreadyinvested in pre-sales demonstration and after-salesservices (or similar devices) to overcome consum-ers’ aversion to complexity, there needs to be afurther market making innovation—that of makingcredible commitments to price and quality rigidity ofboth the product itself and the after-sales services.

IMPLICATIONS

Entrepreneurs entering complex consumer goodsmarkets, therefore, need to elicit consumer trust bymaking credible, yet non-specified, commitments,and they must also be able to anticipate likely com-petitor response. The most comprehensive marketmaking innovations are likely to focus on marketsupport services, as these then solve both the infor-mation problem of selection and the risk of oppor-tunism. There are of course a range of other potentialsolutions, which have already been flagged earlier.But as pre-sales demonstration and after-sales ser-vices are the most complete response, it seems sen-sible to limit discussion to these solutions first. Ireturn to alternative potential responses later in theconcluding section.

These observations lead to two testable proposi-tions that would demonstrate the existence and

4 In principle, the costs of pre-sales demonstration could also bepassed on to consumers in the same manner. But the obviousdesire of producers to induce the transaction here obscures thesame logic.

5 Following from the previous note, the same logic applies inprinciple to pre-sales demonstration services, but is likely to beobscured in practice.




boundary conditions of implicit contract-led marketmaking innovations. First, if producers of novelproducts need to offer implicit commitments to con-sumers mediated through pre-sales demonstrationand after-sales services to secure market acceptance,these market support services will be subsidized. Ifgaining consumer commitment to the future relation-ship is the key to securing the transaction, then thethreat of third-party service provision must beresisted. The greater the reliance on implicit con-tracts, the lower the price of after-sales support toconsumers. Consequently the actual product will bepriced at a premium in order to subsidize the after-sales service. If producers don’t rely on implicit con-tracts, there would be no subsidy for such provision.

Proposition 1: Where consumer acceptance of anovel product depends on entrepreneurs offeringimplicit contracts, market support services will besubsidized by premium product prices.

Premium prices may well attract competitor entry,but if the transaction is bound by information asym-metries leading to implicit contractual solutions,then consumers will opt for high price, high-servicedurables rather than cheap, low-service imitators.

Second, if implicit contracts are required to signalto consumers that producers of novel, complexdurables will commit to continuing to support theirafter-sales requirements, we would expect to seeprice and quality rigidity in the product itself and inthe provision of after-sales services. Furthermore, ifimplicit contract market making innovations are ofgreater importance than the product itself in estab-lishing and maintaining market transactions, then theimplication is that prices and quality would be heldmore rigid in after-sales services than in the productitself.

Proposition 2a: Where consumer acceptance of anovel product depends on entrepreneurs offeringimplicit contracts, price and quality rigidity willbe observed.

Proposition 2b: If the market making innovationis of greater significance in eliciting consumeracceptance than the product itself, then price andquality rigidity will be greater in the provision ofmarket support services than in the product itself.

It must be emphasized that the focus here is on themarket conditions necessary for market entry. Once

a product is established, a producer may feel lessbound by their commitments to consumers. As notedearlier in the case of Coca-Cola, firms that havecreated markets through strong implicit contractsmay discover they have less freedom of movementthan might be imagined. But over time, it is likelythat the costs of a fully comprehensive after-salesservice could be moderated.

DATA: IMPLICIT CONTRACTS IN THESINGER SELLING SYSTEM

Following Young and Levy’s (2010) method of iden-tifying a critical historic case study to evaluate theimpact of implicit contracts, we also adopt a casestudy method (Burgelman, 2011; Jones and Khanna,2006). The focus here on the properties of novelcomplex durable goods means that choosing a repeatgood (like Coca-Cola) is not suitable. Moreover, ourfocus on understanding the fundamental propertiesof such transactions in the absence of warranties andother interventions to overcome such time inconsis-tency and complexity problems implies that the bestcase would be before state mandated standards andminimum warranties were introduced. This leads usto focus on what was historically the first case of amass marketed, mass produced, high tech complexconsumer durable, the sewing machine.

Young and Levy further justify their selection ofCoca-Cola by referring to its economic significance:the company’s 1945 global sales summed to theequivalent of 0.13 percent of U.S. GDP (Young andLevy, 2010). Singer was the dominant producer ofsewing machines before the 1930s, so it is the keycase study among sewing machine producers. Itsrelative significance dwarfed that of Coca-Cola.Between 1868 and 1914, the firm produced 43million sewing machines, more than 90 percent asconsumer goods. As a durable good, these machineswere invariably one-off purchases, and with a verylow depreciation rate, they were almost neverrepeated by households. By the end of World War I,approximately one in every five households in theworld had a Singer sewing machine.6 This vast stock

6 The global population in 1913 was 1.79 billion, somewhat lessafter the 1918 flu epidemic (Maddison, 2007). Assuming amean household size of seven results in about a quarter of amillion households. Adding Singer’s wartime production ofmachines to its pre-war stock sums to something close to a totalstock of 50 million machines; this leads to the assumption ofone in five households with a Singer machine.

8 A. C. Godley



of domestic machinery converts into a notional mon-etary value of 0.57 percent of global GDP in 1913!7

The Singer selling system was based around animplicit contract with uninformed consumers toprovide as much pre-sales demonstration and after-sales services as required, thus reducing consumerrisks of adverse selection and moral hazard sur-rounding the purchase of this novel and, for theperiod, high tech, complex consumer durable. Thesewere features that were not included in the explicitcontract of exchange, which was usually just aschedule of installment payments.

Singer created its novel distribution system inBritain (not in the United States) in the late 1870s. Itsoriginal U.S. sales system was based around retailoutlets. Singer had made a commitment to theBritish market by opening a factory in Glasgow in1865, but this did not initially lead to superior marketshare. But because Singer faced a different coststructure in the British market compared with itsseveral U.S. rivals (none of which had any sunk costsin a British branch factory), it was forced to actearlier and invest in a market making solution—itsnovel selling system (Godley, 1999, 2001, 2003;Godley and Fletcher, 2000a, 2000b).

The innovative British selling system requiredrecruiting and managing many, many thousands ofsales staff, who were instructed to cold call everyhousehold in their territories each year, to collectinstallment payments from all customers in theirhomes and to offer pre-sales demonstration andafter-sales service in customers’ (and for pre-salesdemonstration in potential customers’) houses ondemand. This was as close to a fully comprehensivemarket support service as is possible to imagine.

The sewing machine was invented in the UnitedStates in the 1850s, and it was met with enormoussuccess there in the 1860s and 1870s. It was first sold

in Britain in the late 1850s and 1860s. But sales tookoff in Britain only after the innovative selling systemwas rolled out after 1875. The product innovationwas, therefore, separate from the market makinginnovation. Outside North America and Britain,sales were close to negligible before 1875. Marketpenetration in these emerging markets began onlyonce the new selling system was introduced. AsSinger entered these emerging markets, its sewingmachines met with remarkable levels of acceptance,typically enjoying 80 to 90 percent shares of thesemarkets. This was not because Singer machines werecheap—they were not. They were always priced at asignificant premium. This was not because they wereof a higher quality. Machines made by Willcox andGibb, Wheeler and Wilson, or, later, Pfaff, were con-sidered technologically superior. Rather, it wasbecause Singer entered each new market with a satu-ration sales and market support service that over-came the risks of adverse selection and moral hazardto consumers. Competitors without similar commit-ments to such expensive pre-sales demonstration andafter-sales service either withdrew from the marketor remained low-cost competitors with inferiorservice offerings and only small market shares(Godley, 2006).

By contrast, Singer never attained such domi-nance in its domestic U.S. market. There the demandfor sewing machines had already matured before themid-1870s, and market saturation had already beenreached by the time of Singer’s innovation in selling,so there were fewer information asymmetries, neg-ligible novelty, and alternative actors were alreadycompeting to provide after-sales service (Chandler,1977, 1990; Godley, 2006; Casson and Godley,2007; Williamson, 1981).

Evidence to support Singer’s relative success inoverseas markets can be seen from Figure 1, whichcompares the diffusion of Singer machines from thelate 1870s in several key overseas markets with thediffusion of sewing machines produced by all manu-facturers in the United States (where the Civil Warhad acted as an artificial brake on consumption until1866). Allowing for differences in levels of percapita income, the figure shows how the new sellingsystem enabled Singer to enjoy greater success inemerging markets than any of its competitors.

It has already been noted that the explicit contractwas a cursory affair. But was this success based onoffering attractive implicit contracts to Singer’s con-sumers as it entered these emerging markets? Thefirst proposition detailed earlier suggests that where

7 Converting the total stock of machines into a monetary valuein 1913 requires a depreciation rate to be applied to the machinesale prices. There is no single measure for a worldwide depre-ciation rate for 1913. Gregory (1985) estimates a depreciationrate for pre-1914 Russia (Singer’s biggest market) to have been2 percent. A similar rate is conventional for pre-1914 U.K.(Matthews, Feinstein, and Odling Smee, 1982). By contrast,Feldenkirchen (1982) assumes a depreciation rate for Germanindustrial goods to have been a relatively high 6 percent. I havetaken the figure of 3 percent as the depreciation rate for domes-tic Singer sewing machines. The mean price paid per machineover the period 1880 to 1914 was $38. The net effect is toproduce a a value on the depreciated 1914 stock of Singermachines of just under $1.4 billion, which was 0.57 percent ofworld GDP, estimated to have been $2.733 trillion in 1913(Maddison, 2007).




implicit contracts are important in overcoming con-sumer resistance to complex consumer durables, themarket support services offered would need to besubsidized. Godley (2006) reports the cost of theselling system in each of Singer’s overseas markets,reported here in Figure 2.

This shows that the cost of selling occasionallyvaried from 30 percent to 200 percent of any single

market’s gross income for that year. But the overallmean cost of selling was 60 percent of gross rev-enues across all markets and over the entire period. Itis impossible to disaggregate with any accuracy thecost of selling from the cost of market support ser-vices, indeed they were commingled deliberately.Where national markets reached saturation, such asthe U.K. from 1905 onward, sales costs did not

Britain

Ireland

BelgiumCH

Spain

Portugal

Italy

Australasia

South Africa

India

Philippines

Japan

D

Russia

Scandinavia

NL

Ottoman Empire

USA - All industry diffusion (for comparison)

0

20

40

60

80

100

120

140

Figure 1. Diffusion of Singer sewing machines (aggregate machines sold per thousand of population) in the leadingemerging markets from 1870 to 1920, compared with all industry diffusion in the United States from 1858 to 1880

Source: Adapted from Godley, 2006.

Figure 2. Singer’s sales expenses as a percentage of gross income in leading emerging markets, 1880 to 1913Source: Adapted from Godley, 2006.

10 A. C. Godley



decline (compare the U.K. in Figures 1 and 2),perhaps suggesting market support costs dominatedtotal sales costs.8 Clearly this is noisy data, but itseems entirely reasonable to deduce that the cost ofmarket support services was a substantial share oftotal sales costs.9 Yet other than charging for thecosts of spare parts, Singer made all its marketsupport services free of charge. This represented anenormous subsidy—one that was made possible onlyby premium pricing. Singer, with its expensivemarket support service, had to charge the highestprices in the market. In most overseas markets, itsnearest competitors charged a third less for nearidentical machines, in some less than half (Godley,2006; Casson and Godley, 2007; Gordon, 2011).

The second proposition considers whether evi-dence of price rigidity might indicate the use ofimplicit contracts and, further, whether prices for theproduct or for market support services were more orless rigid, indicating relatively greater or lesserdependence on implicit contracts in the two activi-ties. As Young and Levy (2010) have documentedfor Coca-Cola, the general price environment overthe period was one of very low inflation and occa-

sional deflation. But individual commodities experi-enced different price trajectories.

The most important commodity for sewingmachines was iron. Direct evidence of Singer’s pricerigidity emerges in Figure 3, where price volatility iniron prices is compared with Singer’s pricing inoverseas markets from 1880 to 1914.10 The evidencesuggests that Singer’s machine prices were far lessvolatile than the single most important input cost; thestandard deviation in sewing machine prices wasalmost one-third that of iron prices. This relativeprice rigidity is suggestive of Singer using implicitcontracts in its product offerings. But the price formarket support services remained at zero through-out. Given that there was some (albeit small) changein product pricing over the period, price rigidity inSinger’s market support service was, therefore,greater than that in its product offering. If price rigid-ity is positively correlated with the significance ofimplicit contracts, then Singer’s offering of innova-tive market support services depended even more onimplicit contracts than its success arising from aninnovative product in emerging markets.

Such results are only suggestive. of course.Explicit evidence of an implicit contract is, asYoung and Levy (2010) remind us, difficult to find.Nevertheless, anecdotal support from documentary

8 The obvious counter argument is that the marginal cost ofselling increased beyond the point of saturation.9 Occasional breakdown of the different roles of employees inthe selling organization suggest that around 40 percent ofemployees were engaged in sales, the rest in support services.But, as explained, the actual role of sales staff also included aconsiderable amount of market support activities.

10 We focus on price rigidity rather than quality rigidity simplybecause it is far more observable.

SD iron 16.2SD Singer 6.0

0

20

40

60

80

100

120

Mean unit $ price

Mean-SD

Mean+SD

Scottish iron

Figure 3. Price rigidity in sewing machines? Singer’s global pricing compared with iron prices, 1880 to 1918(sewing machine and iron prices in current £)

Source: Adapted from Godley (2006) for Singer and Mitchell (1962) for Scottish iron. Iron prices indexed1918 = 100.




sources within the Singer archives suggests that thecompany increasingly understood the nature of itscommitment to its consumers. By 1918, the head ofthe strategically important U.K. sales office (whichoversaw most international sales) stated in thecompany magazine that ‘It is as a MaintenanceOrganization, however, that the Singer Companiesachieve their greatest value’ (Godley, 2006: 295),indicating clearly to all employees in the interna-tional sales organization that the implicit contractswith consumers mediated through the marketsupport services were the reason consumers hadbeen so willing to commit to Singer rather thancheaper competitors.

DISCUSSION AND CONCLUSION

The entrepreneurial opportunities literature has, it iscontended here, declined to give opportunity exploi-tation the emphasis it deserves in recent years. In anattempt to outline why opportunity exploitation is sosignificant, this article has attempted to separatemarket making from product innovation and has doneso by deliberately focusing on the most complexmarkets—those where the characteristics of the trans-action are most likely to lead to consumer withdrawalregardless of the merits of the actual product.

Insights from the economics of information andbehavioral economics suggest that consumers areless accepting of novelty than conventional theoryimplies. Consumers, therefore, are likely to with-draw from transactions when faced with the risks ofadverse selection and moral hazard. Such conditionsare most acute in markets for novel, complex, andhigh tech consumer durables. Because of consumerinarticulacy, entrepreneurs need not only to makecredible commitments to elicit consumer trust, butalso to do so via tacit information—commitmentsthat, therefore, go far beyond those enshrined in theexplicit contract. As depicted in Young and Levy’s(2010) case of Coca-Cola and the case of Singersewing machines outlined here, the presence ofimplicit contracts governing market transactionsintroduces significant constraints on producers’freedom of action. In addition to credible commit-ments to future price and quality rigidity, the focushas been on outlining why entrepreneurs must offeradditional market support services to convey neces-sary information.

The focus in this article has been on exploringhow the most complete response to reducing con-

sumer uncertainty might well involve a fully com-prehensive pre-sales demonstration and after-salesservice. At the point of market entry, service require-ments cannot accurately be forecast, so commit-ments are implicit and open ended. Because elicitingconsumer trust at the outset is so important, competi-tor entry into market support services must bedeterred, meaning that market support services aresubsidized and, hence, the novel product itself musthave a premium price. In these markets, ‘price mustexceed marginal cost’ (Stiglitz, 2000: 1460). Butunlike in conventional markets, cheap competitorspose less of a threat.

Over time, of course, conditions of uncertainty arelikely to diminish and consumers become morefamiliar with their complex durables, their require-ments become more predictable, and their sensitivityto price competition increases. Producers are likelyto be able to move progressively more towardexplicit contracts for their market support services,which may relax the constraints of mutual commit-ment on firm strategic behavior in time. But forentrepreneurs wanting to launch such kinds of novel,complex durable goods, the important conclusionhere is that they need to be aware of the likely addi-tional costs involved in a successful product launchof offering a suitable market making solution touninformed consumers. Business models that fail totake such consumer risk aversion fully into accountare likely to overestimate consumer acceptance.

The case of Singer in its international marketshighlights how this market making innovation wasmore significant to that company’s fortunes than theproduct innovation itself. But successful entry intoother complex consumer goods markets need not bebased on such comprehensive and expensive com-mitments to implicit contracts as seen in the Singercase. Alternative entrepreneurial responses thatreduce risks of adverse selection and moral hazardhave already been indicated here, but might alsoinclude encouraging early adopting consumers topost reviews on comparison Web sites or to giveprominence to endorsements from independent advi-sors or intermediaries, for example. Indeed, thenumber of theoretically possible solutions is verylarge.

The theory developed here may, therefore, have alarge number of applications in the field of entrepre-neurship research. For example, the identification ofthe necessity of market making innovations for suc-cessful entry into such markets may also helpexplain one of the curious outcomes in the recent

12 A. C. Godley



literature. Ireland, Hitt, and Sirmon (2003) haveshown that while small firms are relatively superiorat opportunity discovery and development, largefirms are much better at opportunity exploitation.Over and above the advantages size gives in distri-bution channels, the results above suggest that largerfirms find it easier to offer attractive implicit con-tracts to consumers, perhaps because their commit-ments are more credible, or perhaps because theirprevious experience means that their development ofadditional implicit contracts is simply an extensionof existing relationships. Completely new entrantsby contrast simply do not have existing customerrelationships from which to build.

One possible application of the theory developedhere may, therefore, be that new start-up firms inhigh tech sectors currently underestimate the hurdlesthey face in successfully bringing their products tomarket. Before developing such a possible applica-tion further, however, it is necessary to model theentrepreneurial response of engaging in implicit con-tracts with consumers more formally. Developingsuch a concept into a more formal partial equilib-rium model should ‘fully confront the inadequacies’of the currently proposed theory, so it must be themost sensible next step (Stiglitz, 2000: 1456). Thiswould enable future entrepreneurship scholars toassess which kind of market making innovationwould be the most suitable entrepreneurial responseaccording to which set of market conditions.

ACKNOWLEDGEMENTS

This article has benefited enormously from comments byseminar participants at the Wharton School, Universityof Pennsylvania; the Centre for Corporate Reputation,Said Business School, University of Oxford; Depart-ment of Marketing, Lancaster University ManagementSchool; and Henley Business School, University ofReading. I am grateful in particular to Nicholas Alexan-der, Mark Casson, Dan Levinthal and Dan Raff, andespecially the two anonymous referees. All errors remainmy own. I gratefully acknowledge the support of theEconomic and Social Research Council, grant RES 062-23-1272.

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