Bryan Caplan  

Stumped

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My NPR Debut... Less Stumped...

A dead 80-foot tree was leaning precariously toward our house, so my wife asked three tree-cutting firms to submit bids. The spread was absurdly wide: $1900, $875, and $3200 for the same job.

How is this possible? The quality and safety of the work couldn't be too different, because the $875 firm did a fine job, and took plenty of precautions. The only way the $3200 firm could stay in business, it seems, is if a high fraction of customers are too lazy to get a second opinion.

Is that the real story, or am I missing something?


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COMMENTS (18 to date)

Your hypothesis seems very likely. Information is a very sexy thing.

Even so, we can imagine other alternatives:
- Maybe they have too many jobs and this is their way of letting you know they can't do it, and in the case you do say yes they could bump another client and collect the big prize.
- The firm in question has a sort of monopoly (think Mob-supported) in one area but quotes the same prices everywhere.

Anyway, life is really expensive in the US!
For 875 USD you could get 2 Master degree graduates to do quantitative methods, regression testing and spellchecking on thousands of pages or wash your laundry for a whole month. (440 USD would be a good deal for a fresh graduate entering the corporate world in Romania) ;-) ;-) ;-)

Dr. T writes:

Why are you stumped? This type of practice is common with contractors. I've seen 2-4 fold estimate spreads for landscaping, home remodeling projects, tree removal, pool installations, etc. The high-charge contractors can do well if only 25-30% of potential customers fail to get bids from any of the low-charge contractors. When medium-charge contractors see that high-charge contractors do less work but make more money, they jack up their rates. Then, when one bid seems remarkbly low, the high-charge contractors tell the customer that no one can do the work that cheaply unless they are cutting corners or cheating customers.

I live near Memphis, Tennessee, and this practice has gone on so long that the majority of contractors charge ridiculously high rates. For example, interior house painters are quoting $25-30 per hour and estimating 2-3 times as many hours as needed. (I used to work as a painter, and I know how much work a productive painter can do. I also know that painting requires minimal skills. $10 per hour seems right to me.)

JR writes:

How about a few more details??? I have had bids like this and that informs these questions.
Was the 875 bid from a guy with a truck and a buddy?
Was the 3200 bid from a firm with staff and overhead?
Did the 3200 firm have a large truck with a crane & bucket?
Did you check for their permits to do this work in your town and county?
Did they have liability Insurance?
Did the haul the stuff away? to a LEGAL dump or down a side road somewhere?
Did they remove the stump?

Naveen writes:

Is there a market for low-cost private/household bidding?

Michael Stack writes:

Did you have the stump removed? That's often a large percentage of the cost of a job like that. Also, the insurance folks like that can carry can account for a large percentage of the cost.

Robert Schwartz writes:

Maybe that the high bidder was too busy to take the job, and too cowardly to to say so.

Matthew Cromer writes:

I would have cut the tree for free, and gotten free firewood to heat my home. I've got a wonderful soapstone stove that heats my entire house, and it's great not spending $250 a month on propane.

Matt writes:

I will add my $.02 that this scenario is common. When we had guttering work done there was at least a 2x spread in bids, likewise when we had our trees trimmed.

Like the other guy said, carrying insurance may be part of it. Having better salesmen (and spending more money on them?) might also make a difference. In general, a polished image definitely correlated with a higher rate. I have heard that tree trimming and similar work has a lot of business churn; perhaps guys getting started, or starting to fail, account for some of the lower rates.

Silas Barta writes:

Prof. Caplan: yes, I think that is the real story. Although you might phrase it more rigorously: "There are high (perceived) search costs in finding a contractor, and lots of room for contractors to charge extra for those who perceive the costs as high."

Mike Moffatt writes:

It's not just in contracting where this happens. I've asked companies to submit bids for a large scale translation job and the prices ranged from 7K to 21K. I have no idea why either - it may be due to differences in quality, but all of these firms have good reputation and I have no reason why ex ante to believe that any firm is better than any other.

Stephen W. Stanton writes:

I worked on a tree service crew to put myself through college. Here are the answers

1. Short-term supply and demand. They price jobs higher if they have plenty of work to keep them busy.
2. Perceived gullability. They charge what they can get away with.
3. Skill. Some jobs are too hard for some crews to handle easily. There is a big difference between pruning a little apple tree and taking down a 100' tall half-dead tulip tree surrounded by delicate and expensive stuff (pool, greenhouse).
4. Equipment. Some jobs are much easier to do with a crane and/or bucket truck. Some jobs don't need that equipment, but the crew needs to take the equipment to the job site anyway.
5. Reputation. There are a lot of unknown tree services out there consising of a few ragtag guys with chainsaws. There are some services that have been around for decades and have a sterling reputation.
6. Lousy estimators. Some tree service sales reps are bad at their jobs, overbidding and underbidding.
7. "Legitimate" business practices. Having full insurance and paying all taxes will dramatically raise a company's costs. Hiring illegal Guatemalans is a huge cost advantage.
8. Perceived risk. Removing a tree from a house is risky. You can't know what will go wrong, and what you will get blamed for.
9. Dealing with insurance companies, etc. Some tree companies refuse to do paperwork unless it pays.
10. Perceived difficulty of the customer. If you seem like a jerk, you'll be charged a premium to offset the extra work you'll demand before paying up.
11. Local considerations. Some tree companies have a touch-and-go relationship with to police in certain towns. (usually for minor things, like working past the town's "curfew" of 7 or 8.)
12. Difficulty of dumping and getting rid of the wood. Some companies have dump sites everywhere. Some need to kill hours a day trekking dozens of miles to the nearest spot.

There are other considerations, obviously, but the above represent the biggest.

Aaron Chalfin writes:

My guess is that contractors present high bids if they are currently very busy. Leisure becomes dearer as the contractor has less of it. So to compensate him for his very valuable leisure time, he needs a higher wage.

Karl Smith writes:

My Stepfather is a tree contractor and I pretty much agree with Stanton but "marginal cost" (tree jobs are very lumpy) is probably the dominant factor.

There are very high fixed costs associated with the tree business. Therefore, handling a a job when there are no jobs can be near zero marginal cost, depending on how you pay your workers.

However, handling a job when you are busy means renting out more equipment, which means going to get it, inspecting it, etc. It also means possibly contracting out another site manager if you can't manage all your the sites yourself or with your regular guys.

So, what you are witnessing is actually effeciency in action. You went with the lower priced guys, as you should have, because their marginal costs (at this momement) were lower.

Jav writes:

sort of unrelated, but for some reason i'm itching to claim this absurd spread as proof against efficient markets (shouldn't the company that charges $3,200 be out of business by now?). i know im being simplistic, given my lack of education in economics that's only reasonable. but would really appreciate if someone could poke some big holes in the logic.

William Woodruff writes:

Jav et al,

Absolutely correct. This pokes a giant whole in the efficient market theory. There are however, demanders at all points of the slope and some who are not rational economic actors will choose the $3200 seller.

liberty writes:

Jav, see the post just before yours, it is a good counter-argument. Some of the others help to explain it too. For this kind of work especially the prices can be different based on costs and quality of service, and the price often doesn't stay the same, but changes with volume, etc.

Lord writes:

a high fraction of customers are too lazy

Don't you mean a low fraction? It doesn't take many to make up for the price difference. The problem is having to spend many more hours giving bids but that is much easier. They will also try to infer how price sensitive you are by how expensive the home and surroundings are. Then again the salesperson may have been hard up for money and was trying to make up for slack.

tc writes:

Here's what Hal Varian said in How to Make a Scene:

After I had done a dozen or so after-dinner speeches, I started getting calls from speakers' bureaus. These folks would line up talks, handle travel arrangements, and get you paid. In fact, a particular service they offered was to hand you a check right after you spoke. I found all this appealing, but I wondered if it was really worth the 20 percent cut they demanded.

One bureau bragged that Paul Krugman was one of their clients, so I called him up to ask him what they did for him. Paul said that the main service they provided was chutzpa: they were willing to ask for an amount of money that he would be embarrassed to ask for.

It struck me as phenomenal that Paul Krugman, of all people, would have to pay for chutzpa! I figured that I could swallow my embarrassment and double my asking price all by myself.

I also got some good advice from my brother, who had a heating and cooling business in Ohio. As he said: ``Always bid on a job. If you have a lot of work already, bid high; if you haven't got much work, bid low. But always bid.''

It's good advice-don't say ``no,'' just come back with your reservation price.

It really works. The more I asked for, the more they paid. Of course, every now and then, someone would balk, but that's the nature of pricing. If no one ever says ``no'' you are not charging enough.

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