Friday, August 04, 2006

Free Lunch (except for the lunch part): Caveat Emptor or Morally Empty?

Flew cross-country a couple weeks ago and found that certain airlines no longer provide food on long trips -- now you can purchase a bad meal for $7 or a cheesy adolescently stocked snack box for $5. Then we took our kids to an amusement park that charges no entrance fee, but did charge for everything else -- including $.15 for the single slice of tomato and $.10 for the piece of wilted iceberg lettuce on my sandwich at lunch. So it was with fascination that I read a great piece by Christopher Shea called "Living in a hidden-fee economy: Things seem cheap until you tack on all the extra costs." He considers the hidden-fee ploys so frequent in today's marketplace and the economics of it all.

You know the move,

The printer. It's one of the most common peripherals in the computer age and so cheap -- at first blush, anyway -- that stores often give them away when you buy a PC. Yet how many people realize, when they walk out of CompUSA, a nice $99 inkjet model tucked under their arm, that it's likely they've just committed themselves to spending nearly $1,500 on ink cartridges over the next four years?
What seems like a caring, thoughtful act is really a back door to your wallet. It's an old trick used by construction companies trying to get government contracts -- charge pennies for extremely expensive one time items and grossly overcharge and underpurchase things like road cones that you will later have to buy more and more of. That way, the bid is lower than anyone else's, but the real pay out, once you get the contract, is huge.

The seemingly obvious countermove by the competitors of such companies, say the makers of other printers, would be to expose these sorts of tricks. By doing that and informing the consumers, they would not only neutralize the advantage that the extra add ons or fake cheaper rates give to the hidden-fee using competition, but also earn PR points for looking like "the honest company that really cares."

Trouble is, an informed consumer is also a self-interested consumer and armed with the knowledge you just provided, he can now avoid the hidden-fee land mines set by the competition and get an even cheaper deal than you are offering.

Imagine two hotel chains. The first, Hidden Price Inn, has a very low room rate of $80 a night, but makes liberal use of high "shrouded" fees: Three bucks for a minibar Coca-Cola, $25 for parking, $12 for eggs at breakfast. The unsophisticated traveler cheerily (if unwittingly) forks over the fees, all the while patting herself on the back for getting a cheap room.

Now imagine a second chain, Straightforward Suites. It charges much more reasonably for the extra costs ($1, say, for that Coke), but because it makes less on the extras, it has to charge slightly more for the room -- $95, instead of $80. Even an unsophisticated traveler can tell $95 isn't as good as $80.

Through an aggressive ad campaign, Straightforward could try to point out how devious the approach of Hidden Price Inn is and how much less deceptive its own prices are. But Laibson and Gabaix show that there's a catch in this strategy: Hidden Price Inn actually has two key types of customers. Yes, there are the clueless consumers (the economists prefer to call them "myopic"). But there are also the sophisticated ones, who know that if they avoid the hotel restaurant, take a taxi instead of using the parking garage and call home with a cell phone, they'll actually get a better deal at Hidden Price than at Straightforward.

By not playing the hidden-fee game, a business hurts itself by not attracting customers. By not playing the hidden-fee game and exposing it in others, a business also hurts itself by driving away customers.

The lone response that Shea quotes to this approach is
Barry Nalebuff, a professor of business strategy at the Yale School of Management and author of "In Praise of Honest Pricing," which appeared in the MIT Sloan Management Review in 2003, says Laibson and Gabaix's article fails to consider that annoying consumers has a cost: It drives them away. "In the end, you don't fool the customers with the hidden price," he says. "They know they've paid it even if they didn't know they were going to pay it." And if they feel ripped off, they won't come back.
While I feel some sympathy for this response, I'm wondering whether the feeling of being ripped off is moral, psychological, or merely pragmatic. When we get taken advantage of, we feel insecure and angry. When we are looking for the best deal and after thinking we've found it, we feel suckered. But is there anything morally wrong here?

Certainly, there is the question of omission. "I haven't told you anything false, I just haven't told you everything you need to know to make a rational choice." There is a grey line between omission and lying. This is why the oath requires not only "the truth" and "nothing but the truth" but also "the whole truth." We've all approached uncomfortable situations by selectively reporting facts. The question is when that lapses into lying.

Someone lies when she tries to get you to believe something she doesn't believe herself (notice that the usual definition of lying as "not telling the truth" isn't enough because if I am mistaken about something I believe, I could tell the truth AND be lying at the same time). The question is whether the hidden-fee folks are doing that. In a certain sense, the hidden fees do seem like tricks of exactly that sort. The very act of hiding the fees is a clear attempt to get you to believe that the end price you will pay is cheaper if you go with them than the competition. In that way, there does appear to be a moral problem here.

In the case of the printer, there is an interesting double deception. The usual assumption on the part of the consumer is that the free printer is not just a nice gesture, but a pot sweetener. They'll take the hit to their margin by adding in the printer I would have bought anyway -- it saves me $100 retail, but only costs them what they pay wholesale. In the end, they make a little less money on each system, but make more money overall by selling more systems. We think we're sophisticated, we think we've seen through the ploy when we believe that they are throwing in the printer, not to trap us into buying ink cartridges, but as an extra incentive from high volume sellers to lure us away from competition. They use misdirection by not only hiding the fee, but doing in such a way that we think we've figured them out.

BUT...the moral question may be different because it is a marketplace transaction. When we are just having a conversation, the assumption is that anything I tell you seriously is true. But in different contexts, that assumption of truth disappears. No one leaves a play angry because it turns out "that actress wasn't really Lady MacBeth, how dare she try to make me think she was." There is a suspension of belief as part of seeing a play. Similarly, when you see a magician, you know that he is fooling you so the assumption of truth is not there. It could be argued that the slight of hand from the illusionist is not unlike that of the used car salesman. Just as you know that the magician is setting you up, so too you should know that the used car salesman is setting you up and that puts the onus on you to not be fooled.

Is this the case with all financial dealings? Does omission in the case of hidden fees fail to be morally problematic here because, unlike in normal conversations where you passively listen and assume that you are not being misled, in negotiation the basic stance is to always assume that you ARE being misled and if you allow yourself to be taken, it is your fault for being a bad negotiator. Boxers can't charge their opponents with battery -- getting brutally beaten is part of the game and by stepping into the ring, they have agreed to the rules. Isn't providing partial information part of the sales game and if you are buying something, haven't you implicitly agreed to the rules of slimy trickery? Doesn't the consumer have some responsibility to be informed and not have to have everything laid out and spoon fed to him? Why blame the salesman for your own ignorance?

But are the rules themselves morally problematic? Is there something wrong with the game? Is this a case where deceit is accepted because it is normal, even though the norms are wrong? How much is a salesperson morally required to tell you when he is selling and how much is on the consumer? Whatever the right answer, hidden fees still piss me off.