May 17, 2005
At any price
The New York Times discusses the à la carte economy:
The practice of luring customers with a low list price is an old one - it’s how television pitchmen get you to buy the Veg-O-Matic - but recently it has come to dominate many areas of the modern economy. The value of being a smart consumer, like the cost of being a naïve one, has risen sharply.
A room at the Marriott may cost only $150, but the final bill looks a lot different once you have handed your car keys to the valet, used the high-speed Internet connection and eaten the $11 oatmeal. Late fees on credit cards have jumped. So have many mutual-fund fees.
Two young economists, Xavier Gabaix and David I. Laibson, have come up with a name for this practice: shrouding. Once you start to think about it, you notice shrouding almost everywhere, like the features that add to the price of a new car, the warranty from Best Buy, the burgers at the ballpark and the surcharge Ticketmaster puts on concert tickets. The price you hear is not the price you end up paying.
Gabaix and Laibson (their paper is here) believe that shrouding is primarily a consequence of choice. In the old days when the phone service came only from AT&T, movies could be rented only from the local video store, and cars offered just a handful of options, shrouding was impossible—even the most naïve consumer could spot a rip-off. It was also unnecessary, because with few competitors most businesses could afford to price transparently.
Today, with near-infinite choice in almost every sector, businesses need to lure consumers with “loss-leader” base pricing. Once a customer is signed up, through the door, or behind the wheel, extra charges can be piled on:
Mr. Laibson, a professor at Harvard, has his own favorite example of shrouding: Hewlett-Packard’s inkjet printers. The advertised price is as low as $35, but it includes no ink cartridges or paper, two necessary items for printing.
“Here’s my challenge to you,” he said. “Go to the H-P Web site and pretend to be an individual purchaser of a computer, not a business. Go to the deskjet printers. See if you can find the cost of printing on a per-page basis. That is the most important information.”
Although choice is a key driver of shrouding, commoditization is perhaps more important. The most heavily shrouded goods and services are those that have become highly commoditized—such as computer printers, credit cards, phone service, basic hotels and mass-market cars.
Move upmarket, and shrouding loses its grip. Buy an Acura, and the price you’ll pay is completely transparent. Swallow the $395 annual fee for an Amex Platinum, and you’ll find it far more accommodating about late payments than a Capital One card. Stay at Morgans Hotel in New York, and the high-speed Internet comes free.
Price transparency, then, comes at a price. But not as high a price—in relative terms—as that paid by the naïve consumer who believes the loss-leader price he sees is the price he’ll actually pay. Moreover, in highly commoditized markets, competition is unlikely to erode shrouding, because base margins are already wafer thin. In such cases, think Gabaix and Laibson, regulators may have to step in and compulsorily unshroud the market.
Posted by Stephen at 1:40 PM in Economics | Permalink | TrackBack (0)
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