Loss-leader Economy

Loss leaders might conceal punishing fee traps for the unwary myopic consumers.

The market is full of attractive deals that offer price discounts on sought-after items. But if you are not careful about some hidden fees, these good deals could quickly turn costly. For example, an overdraft of $1 in your free checking account could easily cost you $30. Late credit-card payment on your low-interest credit card account could trigger high late fees and much higher interest rate for the rest of your life. A heavily-discounted $100 hotel room could suddenly become $150 if you use the room phone, drink a bottle of water from their mini-bar, or use the internet connection. The attractive monthly rates on cell phones could be offset by punishing "overage" charges.

In all these cases, the cheap loss-leaders are prominently publicized. But the hidden fees are harder to find out until you are saddled with them. If you are a sophisticated consumer who is careful to avoid the hidden fees, you are living in hog heaven. But if you are somewhat careless, you are better off patronizing businesses who price each of their items based on individual marginal cost.

In a competitive market with mature products, however, transparent pricers that price everything based on its marginal cost will be at a disadvantage compared to those who offer loss leaders. First, the sophisticated consumers would buy mostly loss leaders. So the transparent pricers are powerless to attract them. Second, the careless consumers may be too myopic to ignore the loss leaders even though they are better off with the transparent pricers. So the transparent pricers are powerless to attract their business either. As a result, the competition boils down to who can offer more attractive loss leaders and better conceal their hidden-fee traps.

Transparent pricers might have an advantage if the service package is standardized and all the fees must be included. But the ingenuity of the loss-leading pricers knows no bound. And there will be ever newer generations of myopic consumers for their target practices.

References:
  • Xavier Gabaix, David Laibson. "Shrouded attributes, consumer myopia, and information suppression in competitive markets." Quarterly Journal of Economics May 2006, Vol. 121, No. 2: 505-540.
  • Boston Globe. 6/25/2006. "The hidden economy."
  • New York Times. 7/22/2006. "What the na´ve consumers don't know, can help you."
  • WSJ 7/12/2001. "The little extras that count (up)."

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