Friday, March 27, 2009

Travel Expenses and Price Discrimination

Last week I gave two talks in Oregon for the Federalist Society; I now have to send them documentation for my expenses--a motel, a rental car, and airport parking. I have not done so yet, but it did start me wondering about why that particular arrangement, a fixed payment plus expenses, is so common.

The argument against it is obvious. Paying me a fixed sum instead would make it in my interest to minimize expenses—find an inexpensive motel, shop around online for the best available car rental deal. Billing them for a luxury hotel might have undesirable consequences—I have never tried the experiment. But short of that, it is much easier for me to monitor myself, make sure I am getting the best available deal, than it is for them to monitor me.

In other contexts, one argument against a lump sum contract is that it gives the recipient an incentive to reduce costs not only by careful shopping but also by producing a lower quality product, using low quality construction materials to build a house, for instance. Similarly, someone flying me to Europe to give a talk may be reasonably concerned that a lump sum payment instead of an honorarium plus expenses will result in my getting a cheap tourist class flight, perhaps even a red-eye. Buying me a business class ticket instead—a pleasant luxury, but one I have never purchased with my own money—may result in a more rested speaker and a better talk.

It is hard to see how that applies here. The inexpensive Motel 8 I actually stayed at—I approve of the Federalist Society and so am willing to make some effort to save them money even if they don't structure their contract with me to give me a financial incentive to do so—gave me as good a night's sleep as a more expensive motel or hotel would have. The rental car I located via got me from the Portland airport to Eugene and back with no difficulty. So why is an honorarium plus expenses the usual arrangement for speaking fees?

To see one possible answer, imagine that the Federalist Society wants me to give two talks, one at Stanford and one at Harvard. I live in San Jose, so a lump sum payment sufficient to get me to Cambridge will have to be enough to not only buy my time but also pay the cost of a trip across the country. That same payment is considerably more than they need to get me to give a talk at Stanford, which is about a half hour drive from my house. By instead offering a fixed honorarium plus expenses they get what they pay closer to the minimum amount they have to offer me to get me to give each talk.

They are, in other words, engaging in price discrimination—by a buyer not, as in the usual textbook examples, a seller. They could do the same thing by offering a lump sum, but one that varied according to some estimate of transport costs, thus retaining the advantage of giving me an incentive to hold down expenses; perhaps I should suggest it to them. But if transport costs vary a good deal by where you are going, when you are going, how far in advance you buy your ticket, and the like, their method may be easier.


Lord of the Snowmonkeys said...

I like the zen-ish quality of this post.

David Friedman said...

I suspect complicit read the post after I accidentally posted the beginning, with title unfinished, and before I replaced it with the current version.

Anonymous said...

From my experience, the labor savings decrease costs. There's no detailed analysis for the fair cost of each trip. There's no haggling over the possible contingencies due to unforseen events. It's the actual cost, with records. You eliminate the expertise of a professional for doing the analysis. All you need is someone to process the information for the accountant.

I'm sure some speakers pursue luxury, but they price their services at that time. Future engagements will have this cost as a consideration. The speaker is given the option of pricing their service beyond what the market will bear.

Anonymous said...

Suppose that the Federalists invite a speaker every month. They offer every speaker the same honorarium, plus the expenses necessary to get them there. It minimizes negotiation time to do this, and to trust that a speaker who wants to be re-invited will not claim excessive expenses. It also minimizes jealousy among speakers.

dimakor said...

May be the money for your talk and for your expenses comes from different budgets?

gcallah said...

Taxes, man, taxes! You don't get taxed on your expense re-imbursements, but you do on your honorarium.

gcallah said...

And yes, I know you can deduct your own expenses, but then you have to document them, save receipts, are open to charges as to whether or not they are reasonable, etc. -- if you just get paid expenses, it never shows up on your returns at all.

David Friedman said...

Gene thinks the explanation is taxes. As he mentions, however, I can deduct my expenses. And while that requires me to keep track of receipts and such, so does the honorarium plus expenses alternative.

And, if I really don't like keeping track of things or am too disorganized to manage it, the cost to me of not deducting is considerably lower than the cost to me of not claiming expenses.

Paul Birch said...

I agree with Gene. Usually you only have to keep your expense receipts a short time, handing them over - in exchange for cash - when you turn up for the lecture. If the expenses are modest, or sufficiently predictable, they may not bother to ask for receipts at all. By contrast, your fee may arrive, as a cheque, only some weeks (or months!) later, with tax already deducted. On one occasion I got my expenses in cash on the day, but had to write directly to the head of the BBC before they'd finally disgorge my fee.

Daveon said...

There are two issues here. The first is the tax issue of reimbursed expenses verses a self managed approach. Even if you accept responsibility for paying and claiming business expense related deductions, there is a potential risk for the person paying you.

The second often comes down to internal accounting practice inside the organization. One of my clients, a major US corporation, will always pay expenses separately at cost because their internal accounting system pays these from a different capital budget to actual engineering project work. So it's common for us to have a fixed price for the engineering work with a variable expense paid at cost.

There's also a cultural component. Our UK based consultants tend to work of an expense account whereas our European and Asian Consultants work from a Per Diem which gives them a fixed daily allowance, which can be paid tax free, and is used for all out of pocket expenses.

That's quite rare in the UK for senior consulting engagements but extremely common in hourly paid engineering positions such as fitters, electricians or welders, where they'll be given a daily allowance which can be used on anything they like.

This, typically, translates to staying in as cheap accommodation as they can possibly find and spending the balance on beer.

That's a cultural thing too I guess.

Daveon said...

however, I can deduct my expenses. And while that requires me to keep track of receipts and such, so does the honorarium plus expenses alternative.

Based on the problems I've had negotiating Per Diem arrangements with US companies I think there's also an external tax problem. Many US based businesses don't like paying lump sums in lieu of expenses to individuals in case the individual doesn't correctly report the amounts to the IRS. I'm told, but have no data either way, that in theory this can end up as a tax liability for the organization.

Hence keeping them separate and accounting for them separately.

Personally speaking: I used to like Per Diems until I started traveling pretty much all the time, and my expectations and desires for comfort increased to the point where the Per Diem, and the potential to save money, stopped being of interest. While making Expense Claims is a nightmare, I prefer the upside of the improved quality of hotels and restaurants I use.

gcallah said...

"Gene thinks the explanation is taxes. As he mentions, however, I can deduct my expenses. And while that requires me to keep track of receipts and such, so does the honorarium plus expenses alternative."

Yes, except the first alternative requires me to keep my receipts somewhere I can find them for a year, in the second I hand the host my receipts the day of the talk.

Bob Murphy said...

In terms of a single explanation, I think Gene's is right.

However, I also wonder if it's partly to push the uncertainty onto the host, and that makes negotiations quicker.

E.g. suppose I have an offer for two different talks on the same day, so I have to choose. Ones in Boston and the other is in some podunk town in Minnesota.

If I'm just offered a lump sum, I have to do a bunch of research to figure out what my net pay is.

In contrast, the people at Boston know how much the hotels in the area are, how much the cab fare from the airport will be, etc.

I always ask the organizer where I should stay, too. So to avoid getting fleeced the organizer could even offer to book the room directly (which often happens), so you just use your credit card for incidentals.

Ed Kless said...

Sorry so late to the game, but perhaps there is a different explanation namely, prices do not come from costs.

Price is primarily based on the perceived value of the customer. David people pay you for your knowledge not your time.

I was most concerned by this statement, "a lump sum payment sufficient to get me to Cambridge will have to be enough to not only buy my time but also pay the cost of a trip across the country."

This implies an agreement with Marx' Labor Theory of Value. In short, your honorarium should be a fixed price set commiserate with the value.

Best idea, offer each host three options. Something like:
a) Speech only
b) Speech plus a Q&A or book signing
c) All of b + follow up phone call with participants