Transparent Operations: The Financial Impact of Social Impact

Tim Kraft and Carlos Santos ,

In 2007, Patagonia launched “The Footprint Chronicles,” a website dedicated to disclosing its business practices to consumers, including the network of suppliers it uses and their treatment of workers who make its outdoor gear. Patagonia says the website’s mission is to use “transparency about our supply chain to help us reduce our adverse social and environmental impacts — and on an industrial scale.”

The company details, for example, how it has switched to organic cotton over chemically intensive cotton, works to promote fair labor practices — especially among one of the groups it calls the most vulnerable to exploitation, migrant workers — and uses only “traceable down,” which can be traced back to birds that were never force-fed or live-plucked.

Other major companies, such as Nike and Nestlé, have followed the trend in transparency. The movement piqued the interest of Darden Professor Tim Kraft, who wanted to determine whether transparency really mattered to the consumer.

“Ten or 15 years ago, these companies treated their supply chains like intellectual property. Nobody disclosed supply chains,” says Kraft, who teaches operations management at Darden.

Then Nike came under heavy criticism in the late 1990s and early 2000s for using child labor to produce its sportswear products. Then-CEO Phil Knight said at the time: “I truly believe the American consumer doesn’t want to buy products made under abusive conditions.”

“It was a different way to think, and it started a trend,” says Kraft. “And that change of mindset is what interests us. Does this transparency actually have an impact? Do people care about this?”

Kraft and his colleagues León Valdés and Yanchong Zheng from the Sloan School of Management at MIT used behavioral experiments to investigate.

“With behavioral experiments, we’re one step deeper than traditional marketing experiments. We don’t have an actual product we use in the experiment. Instead, it is all about the interaction between players. We’re trying to get to the underlying behavior, the psychology of it,” says Kraft. “We want to know what is driving the consumer’s decision. Our hope is that once we understand this deeper root cause of what’s driving the decision, then we can use these theoretical findings to better inform our tests and experiments in applied settings with actual products.”

To understand consumers’ behavior toward transparency, Kraft used an incentivized game in which the motivation for participants was to make money. The games involved three players interacting over decisions. The players, who played the role of either a firm, a worker or a consumer, were paid real money. How much of that money they took home depended on their decisions. How much would the consumer pay for a product so the worker is better paid?

“In these types of experiments, we just want participants to react,’’ says Kraft. “We wanted to know how much money they’d be willing to give up to benefit another.” He specifically wanted to know whether consumers would reward a firm for its socially responsible efforts — known as indirect reciprocity — and how the differences in consumers’ prosocial orientations — the willingness to sacrifice one’s own benefit to help others — impact the roles transparency and indirect reciprocity play in consumers’ valuation.

The answer in the study, titled “Transparency in Social Responsibility: Investigating Consumers’ Behaviors and Motives,” was that “consumers are willing to pay more for a product when a company demonstrates higher visibility into the social responsibility practices of its supply chain. This is particularly true if the improvement is from a nontransparent state, as the incremental increase in consumers’ willingness-to-pay diminishes as the level of transparency further improves.”

In the study, Kraft and his colleagues report that “consumers are willing to pay a higher price under a higher level of transparency. In addition, there exists an important interplay among transparency, indirect reciprocity and consumers’ prosocial orientations. High prosocial consumers do not exhibit indirect reciprocity. Their valuations are primarily driven by the social outcome, such as the worker’s pay, and the level of transparency, rather than by the knowledge about the firm’s effort. In sharp contrast, indirect reciprocity has a strong positive effect on low prosocial consumers’ valuations when transparency is high. However, as transparency decreases, we first observe a negative effect of indirect reciprocity on low prosocial consumers’ valuations, and then indirect reciprocity disappears.”

“The idea is that when you have high prosocial people, they don’t demonstrate indirect reciprocity, in which they reward a company because of the company’s efforts to do good,” says Kraft. “That doesn’t mean though that high prosocials don’t give a lot. They give more than the low prosocial people. It’s just that their decisions are being driven by something else. It’s not reciprocity. They’re not saying, thanks for making this effort. They’re doing it because of something else like altruism or because they feel bad for the worker or they want to correct the inequality between themselves and the worker. But they’re not rewarding that intermediary player, the firm. That’s the key.”

“People who are low prosocial give less overall, but they’re the ones we can identify with the idea of indirect reciprocity,” says Kraft. “But it only occurs when things are highly transparent. They’re very conservative with money, but if you show them what’s going on — both the effort and the outcome — then they’ll reward the firm player for helping the worker.”

Kraft’s findings will be useful to companies debating if they should take the costly step of making their supply chains transparent.

And there’s more research on the subject to come from Kraft. “We’re working on a new paper, similar in setup, but instead of looking at indirect reciprocity, we’re looking at trust. Does transparency actually build trust with consumers?”

Tim Kraft co-authored “Transparency in Social Responsibility: Investigating Consumers’ Behaviors and Motives” with León Valdés and Yanchong Zheng, both of the MIT Sloan School of Management.

About the Faculty

Tim Kraft

Kraft’s expertise is in distribution and logistics, supply chain management and sustainable operations. His research focuses on the impact of environmental and social responsibility issues on supply chain management decisions. Topics he has worked on include firms’ and non-governmental organizations’ decisions regarding potentially hazardous substances in product lines, developing collaborative methods... Learn More