Nondisclosure Agreements Are Actually Pricing Tools

Saturday, July 2, 2016

A recent article described Tesla's use of nondisclosure agreements to silence unhappy customers. In the article, a company spokesman explained that these NDAs were intended "to protect itself from potential lawsuits," but I think there's another reason.

NDAs can boost a company's pricing power.

The way this works is rather insidious and (in the eyes of this non-lawyer) fairly unique for a civil contract. While most contracts involve two parties who benefit from an exchange of value, nondisclosure agreements implicitly include a third party who is always harmed but has no ability to voice an objection. You probably wouldn't find this upsetting, if not for one surprising fact. The person who is harmed is almost certainly you.

As I have stated many times, a price can be modeled on two customer characteristics: willingness to pay and ability to pay. NDAs have the potential to artificially inflate a customer's willingness to pay to the extreme. As negative information about an item is restricted, but positive information continues to flow freely, customers will overestimate the value of that good.

One of the most accepted theories in mainstream economics is the efficient-market hypothesis. It states that relevant information is always available and will guide the prices toward optimum efficiency. As NDAs become more prevalent, relevant information will disappear, and larger pricing distortions will become commonplace. Products that should succeed against lesser competitors will fail.

Amazed that the actions of others might affect your bottom line? Welcome to the world of externalities.

Need some help understanding your pricing environment? Why not contact me for a consultation or read my book on software pricing. No NDA required!