Consumers today have easy access to a wide range of products and services. The task of choosing between hundreds of products or packages each having dozens of different fees however, is the opposite of easy.
Picture: Getty Images/Don Arnold
Product and price variety gives consumers with varying tastes and usage patterns choice. But the overwhelming complexity of markets may have an anti-competitive effect: competition between firms is weaker when consumers are confused. Recent economic theory recognises the possibility that companies might have incentives to intentionally confuse their consumers by spuriously differentiating their products or by using complex price schedules.
There is also an increasing amount of empirical evidence that documents consumer biases such as myopia in decision making, choice overload and status-quo bias, that can potentially be taken advantage of by companies. In the market context, my own research shows that price and product complexity can be used by firms to soften the level of price competition in markets. Obfuscation leads to both frustration and mistaken choices at the consumer level and overall higher prices at the market level.
Although some instances of complexity can be identified as misleading conduct, such as the Nurofen spurious product differentiation case brought by the ACCC, in many instances it is difficult to distinguish genuine price/product variety from obfuscation.
Acknowledging that complexity in markets constitutes a market failure the regulator's task is to rectify the market failure, but how? Unlike the cases of misleading conduct, complexity and choice abundance is a fuzzy and moving target that is difficult to regulate.
One increasingly popular option is to help consumers deal with the complexity. Behavioural economics provides several potential remedies, for example by designing optimal defaults in case the consumer fails to make a choice, or standardising services to increase comparability. These are commonly referred to as "nudges", which do not restrict choices but simplify them for some people.
Many studies examine the effectiveness of such nudges in helping consumers make better decisions. But we don't yet understand the possible unintended consequences of these nudges and how markets would respond to them. The first problem is the difficulty for the regulator to determine the optimal default option. Defaults are very powerful, and a mistakenly chosen default can be extremely bad for the consumer. With great power comes great responsibility.
Another potential problem is that optimally designed default options might in the long run make consumers dependent and reduce their incentives to shop around and switch between companies, which in turn might lead to softer competition between companies. There is a need for both theoretical and empirical research on these issues.
Solutions to a market failure often come not from the government but from the market, through new technologies and new types of businesses. For example, third party comparison sites sometimes help consumers deal with the difficult task of evaluating multiple options. Although such sites have worked for some services, such as hotels and restaurants, others failed to provide a solution. And some created new problems. Recognising the failure of these services in private health insurance, the Australian government started a comparison service of its own.
For other markets, there is hope that soon a virtual robot assistant will track our behaviour, measure our preferences, scrape the web for offers and recommend the optimal product. Until then immediate action from regulators is likely to be necessary and useful. It is also essential to test the effectiveness of these actions through randomised control trials and other careful evaluation methods.
Law and regulation can also help change social norms. We don't accept being charged seperately for cutlery, salt, pepper, chairs and visits to the restroom in a restaurant but we do accept multiple fees in health, finance and telecommunication services. Regulations encouraging all-inclusive fees help consumers demand single and simple quotes for services.
In the long run, solutions will require consumer adaptation and consumer activism. Ultimately, consumers are the best judge of what they want and prefer to make their own decisions even when these are often the wrong decisions. Which is why the most attractive solutions will empower consumers rather than make the choice for them.
Kenan Kalaycı is Lecturer in Economics at The University of Queensland.