Let others pay for add-ons while you ride free

I snagged this from Book of Joe. Drop by and tell him I sent you over. He has some good material.

Damon Darlin’s July 22, 2006 New York Times story about letting other people do your heavy lifting got my undivided attention.

Here’s his piece.

    What the Naïve Consumers Don’t Know, Can Help You

    “When Xavier Gabaix and David Laibson open a hotel room minibar, they see among the tiny liquor bottles and European chocolates a perpetual battle between companies charging hidden fees and the sophisticated consumer trying to avoid them.

    The two economics professors — Mr. Laibson at Harvard and Mr. Gabaix at the Massachusetts Institute of Technology and Princeton — have looked at how companies hide fees and costs. They found that sophisticated consumers have somehow learned how to game the system by having enough naïve consumers around to subsidize them.

    The smartest strategy, they say, is for the sophisticated consumer to choose the service with the most hidden charges and highest add-on prices, but then avoid paying those added costs. ”The sophisticated consumer takes advantage of that,” Mr. Gabaix said. ”The naïve pay all the fees.”

    Companies hide add-on costs, of course, because it is lucrative. Hewlett-Packard sells inexpensive printers and makes its profit on high-margin replacement ink cartridges that can cost half as much as the printer. The fastest-growing segment of Wells Fargo’s banking business is income from fees, up 14 percent in the latest quarter.

    Consumers see fees everywhere, in their cellphone and credit card bills, mail-order invoices, mutual fund statements, car rental and hotel charges. Actually, most consumers (particularly those who do not start their Saturday mornings reading financial advice) do not see them or they spot them too late. And that myopia perplexed the two professors.

    Economic theory says shrouded fees should not happen. A competing company should come along and tell consumers just how bad its competitors are for extracting those fees. Epson should be telling the world how much Hewlett-Packard charges for ink. Marriott should be pointing out Hilton’s parking fees and phone surcharges. But that rarely happens, and Mr. Laibson likens that to the dog that did not bark for Sherlock Holmes.

    ”My view of the world is that people usually make smart choices, but sometimes they make mistakes,” Mr. Laibson said. ”Why doesn’t the market fix the problem?”

    In a paper appearing in The Quarterly Journal of Economics with the academic title of ”Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets,” the professors say that price-cutting and educational advertising do not always benefit the bargain-seeking consumer. A company would hurt itself if it described how its competitor loads on the fees, they said.

    They argue that drawing attention to the rivals’ fees just alerts the sophisticated consumer that the rival is actually offering a better deal. Transparent Hotel could advertise a no-added-fees $100 room and point out that Nontransparent Hotel really charges $145 for its $70 room. If a consumer goes with Nontransparent and avoids the add-on fees, he ends up paying less, the economists said. He would advise going to the hotel with the lowest room rate and avoid any fees, assuming — which economists love to do — that factors like location and safety are equal.

    The result for the well-meaning company is harsh. Its advertising might hurt the rival in the sense that consumers pay fewer fees there, but it is increasing the number of sophisticated consumers and teaching them to choose the other guys. It is unlikely to draw in the sophisticates. ”That business won’t make much money once you understand how the world works,” Mr. Laibson said. ”What’s the benefit to the company?”

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