Is there some realistic way for customers to figure out if you are telling the truth about what you can deliver?
When customers have a hard time figuring out whether or not you provide a service that’s any better than the next guy’s, is it realistic to think you can push up the price?
It’s not just translators who struggle with these dilemmas and it’s not just translators who have to deal with customers who don’t seem to fully value the skill and effort required to produce better than average work. These sorts of problems have been the subject of much study by economists—and some of them have come up a few tricks that have been good enough to win them a Nobel Prize.
In this post, I look at a Nobel Prize-winning idea known as market signalling and begin to explore how translators might benefit from the insights it provides.
In a recent conversation with Luigi Muzii  we raised the question of how translation providers might more profitably “signal” quality. Here we continue the conversation:
Paul: Luigi, last time we talked we developed a model of the translation industry characterised by information asymmetry—a situation where translators have a profound understanding of what is at stake when trying to communicate across different languages, but people who need the translations—on average—don’t.
We discussed how this produces a market of uncertain product quality where buyers have difficulty differentiating between good and poor quality work.
Luigi: That’s right. Instead of buying what they need, buyers often have nothing better to go on than price to select a provider—and so translation providers end up engaging in destructive price competition. As prices fall, translation providers have little option but to seek cheaper (and usually lower quality) resources to keep their businesses afloat. This triggers a downward price-quality spiral and we see Gresham’s Law in operation—bad quality drives out the good—as we discussed in an earlier post .
Paul: So how can we reverse this situation? Can we imagine a situation where buyers would consider more than just price when looking for a translator, and where LSPs compete with each other to engage the most appropriate (not the cheapest) linguists for the job?
Luigi: Absolutely! We know this because linguists are not the only ones who find themselves in a situation of information asymmetry. Most of us manage to buy services from our lawyers or purchase new refrigerators without having to do a law degree or without studying refrigeration engineering first! Trying to educate the customer is an uphill battle—there are smarter ways to look at the problem.
It was an American economist, Michael Spence, who figured out how we are often able to make good decisions when we are not experts in the subject or have insufficient information. He got the 2001 Nobel Prize for Economics for his ideas.
The idea Spence developed is called market signalling . He looked at what makes signals credible enough for us to choose between alternatives when we really don’t have enough knowledge or information to understand the difference.
Paul: That’s exactly the situation most translation buyers find themselves in!
Luigi: Precisely. If translator A can deliver a better service than a lower-priced competitor B, but a potential buyer is unable to independently check which provider would actually be more advantageous, Michael Spence’s ideas on market signalling provides a way to help us understand on what basis the buyer might choose the better quality service from translator A.
Paul: So how does Spence’s theory work?
Luigi: In a previous conversation we used the second-hand car market to illustrate what can happen when buyers and sellers do not have the same knowledge or understanding of the product they are buying and selling. So let’s go back to second-hand cars to see how Spence’s ideas on market signalling work in that situation .
Imagine that you want to buy a second-hand car and you find two cars you like equally well—but one has a warranty and the other doesn’t. You’d probably prefer the one with the warranty (and if you have the budget for it, the chances are good that you’d also be willing to pay a bit more for it). If something goes wrong with the car, the seller will fix it free of charge.
Paul: Fixing up “bad” translations by the original translator at no cost is no news in the translation industry.
Luigi: Indeed. But getting translations “fixed” (or cars repaired) can be a real hassle!
Paul: Yes. The very thought of a car breaking down is a nightmare. The inconvenience of not being able to use it while repairs are being done would a big consideration for me when buying a car.
Luigi: That’s right! You are probably more interested in getting a quality car—one that won’t break down—than you are in having the dealer pay for any repairs. In fact, you’re hoping that there won’t be any repairs!
The meaning behind the offer to fix the car at the seller’s expense goes way beyond just saving money for the buyer. Spence’s insight was that the potential cost of a warranty to the seller is interpreted by the buyer as a signal about the true quality of the car.
Paul: So what’s the reasoning behind the seller’s strategy in offering a warranty then?
Luigi: As most of us don’t have any special expertise as mechanics, it’s difficult for us to independently verify whether the car with a warranty is any better than the car without one.
Paul: Again, this is the same dilemma that most translation buyers face!
Luigi: Yes. If the seller wants to get a better price for a car which is unlikely to give the buyer any trouble, then he needs an effective method of communicating the truth about its actual condition. His message needs to be one that we are going to take seriously.
If the seller knows that the car has had a good track record (or perhaps he has had it checked out mechanically), then he can be confident about offering a warranty because he knows that the chances that we’ll come back to him demanding costly repairs is quite low. If the car is actually in good condition, then offering a warranty is unlikely to cost him anything.
Paul: I get it: the seller’s very offer to pay for any repairs is a signal that he knows that the chances of a breakdown are actually low. So that makes me more inclined to believe him because I know that he wants to increase his profit and he will not want to pay my repair bills if he can possibly avoid it!
Luigi: Exactly. It’s the potential loss to the seller that makes his message credible. He’s now in a position to demand a higher price and we are more likely to pay it because we have some confidence that he’s telling the truth. Our payoff is that we will escape the hassle of a breakdown. It’s a win-win situation.
Luigi: If the seller knows that a car is actually in poor condition, he can be pretty certain that if he offers you a warranty it is going to cost him. In theory, he could push up the asking price by offering a warranty on a poor quality car. But that’s risky—he knows that the worse the condition of the car, the more likely he will make a loss from inevitable and expensive repairs later on. As buyers, we’re not so silly, and we know that too!
To make a profit, his best strategy may be to sell cars of lower quality at a lower price – and without a warranty. After all, there’s still a good market for cheap cars, just as there is a good market for lower value translations!
Paul: I can see that just promising quality is not enough. As buyers, we are unlikely to be persuaded by some sign over the car yard which promises that the seller only offers top quality cars. “Talk is cheap,” as they say. I guess a promise to deliver quality becomes credible only when the seller puts his money where his mouth is.
Luigi: Yes. This explains why the offer of a warranty is much more than a simple “added benefit” to induce the customer to buy. A good warranty is a credible signal of the actual quality of the car. Even though we may not be able to verify the quality of the car ourselves, we figure that a canny car salesman wouldn’t volunteer to pay for potentially expensive repairs unless there was a very low chance of things going wrong.
Actions speak louder than words. To be an effective signal, an action should be incapable of being mimicked by a rational liar: it must be unprofitable when truth differs from what you want to convey… 
Luigi: Yes. The salesman with low-quality cars on his lot simply can’t afford to offer the same sort of warranty as a competitor with good quality cars.
Paul: The principle is that it simply doesn’t make economic sense to offer a warranty and then to lie about the quality.
Luigi: Exactly. The seller with high-quality cars can afford to offer a really outstanding warranty because he knows he won’t have to honour it very often. In a situation where the seller knows the truth, but we don’t, we have to read the signals. If a salesman won’t match the warranty of his competitor you can be sure that he’s done his profit and loss calculations and has figured that it is not in his own financial interest to offer it to you. We may not be able to figure out the quality of a second-hand car by looking under the hood, but we can intuitively figure it out by reading the market signals.
When we can see that the seller faces a significant cost or penalty by not telling the truth, then we believe him. That’s the trick!
Paul: So how can we apply this principle to the translation industry? Are you suggesting that good quality translators might earn more if they offered a money back guarantee?
Luigi: Ha, ha! Translations are not cars, and the analogy with the second-hand car market can only be taken so far. Just offering a simple warranty may not be enough. Buyers wanting a “quality” second-hand car might be willing to pay more for one with a warranty because their ultimate payoff is avoiding the inconvenience of a breakdown.
But does the average translation buyer think about “quality” in these terms when she goes out looking for a translator?
Paul: I suspect that most buyers are not really sure about what translation quality actually means—at least not in the same way that translators tend to think about it.
Luigi: Exactly. So why would they want to pay more for some vague notion of “quality”—even with a guarantee? To get a better price for better quality translation work we not only have to make our signalling credible, but we also have to think about what the customer’s payoff is—we have to be able to communicate quality in her terms, not ours…
Paul: These Nobel Prize-winning ideas are all very well, Luigi, but we need to illustrate them with some practical examples. Let’s look at how translators might get a better price by signalling “quality” in a way that is both credible and meaningful to buyers in our next session!
 “Liar, Liar! Pants On Fire!” is a playground taunt that kids shout when they think a playmate is lying. “Pants (or bottom) on fire” is a euphemism for spanking, the expected punishment for not telling the truth. (http://bit.ly/H3HH62). The taunt may be a paraphrased version of William Blake’s 1810 poem “The Liar”, http://yhoo.it/bAkK6X.
 See Luigi’s biography here: http://www.slideshare.net/muzii
 Sulzberger, P. (2012), Are bad translators driving out the good? http://wp.me/p1ptPs-Ag
 Spence, A. M. (1974). Market Signaling: Informational Transfer in Hiring and Related Screening Processes. Cambridge: Harvard University Press.
 The argument here follows the one outlined by Dixit and Nalebuff in Chapter 8 (Interpreting and Manipulating Information) of their book, The Art of Strategy (2008), W.W. Norton & Company, NY.
 Dixit A.K. & Nalebuff B. J. (2008). The Art of Strategy, W.W. Norton & Company, NY, USA, p. 239.