Promise, Trust and Betrayal: Costs of Breaching an Implicit Contract

Levy, Daniel and Young, Andrew (2019): Promise, Trust and Betrayal: Costs of Breaching an Implicit Contract.

Abstract

We study the cost of breaching an implicit contract in a goods market, building on a recent study that documented the presence of such a contract in the Coca-Cola market, in the US, during 1886‒1959. The implicit contract promised a serving of Coca-Cola of a constant quality (the “real thing”), and of a constant quantity (6.5oz in a bottle or from the fountain), at a constant nominal price of 5¢. We offer two types of evidence. First, we document a case that occurred in 1930, where the Coca-Cola Company chose to incur a permanently higher marginal cost of production, instead of a one-time increase in the fixed cost, to prevent a quality adjustment of Coca-Cola, which would be considered a breach of the implicit contract. Second, we explore the consequences of the Company’s 1985 decision to replace the original Coke with the “New Coke.” Using the model of Exit, Voice, and Loyalty (Hirschman 1970), we argue that the unprecedented public outcry that followed the New Coke’s introduction, was a response to the Company’s breaching of the implicit contract. We document the direct and quantifiable costs of this implicit contract breach, and demonstrate that the indirect, although unquantifiable, costs in terms of lost customer goodwill were substantial.

• Item Type: MPRA Paper
• Language: English
• Keywords: Implicit Contract, Cost of Breaching a Contract, Cost of Breaking a Contract, Invisible Handshake, Customer Market, Long-Term Relationship, Price Rigidity, Sticky Prices, Nickel Coke, Coca-Cola, Secret Formula
• Subjects: A - General Economics and Teaching > A1 - General Economics > A14 - Sociology of Economics; E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E12 - Keynes ; Keynesian ; Post-Keynesian; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; K - Law and Economics > K1 - Basic Areas of Law > K10 - General; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L14 - Transactional Relationships ; Contracts and Reputation ; Networks; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L16 - Industrial Organization and Macroeconomics: Industrial Structure and Structural Change ; Industrial Price Indices; L - Industrial Organization > L6 - Industry Studies: Manufacturing > L66 - Food ; Beverages ; Cosmetics ; Tobacco ; Wine and Spirits; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M3 - Marketing and Advertising > M30 - General; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M3 - Marketing and Advertising > M31 - Marketing; N - Economic History > N8 - Micro-Business History > N80 - General, International, or Comparative

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