Wednesday, December 13, 2006

The Economics of Hidden Fees

The NY Times has an article on hidden fees, where the stated price of the good does not reflect the full cost. Examples are ATM surcharges that you may not know about when you open your bank account, expensive minibars in hotels where you don't know that you are paying $4 for a Coke until you get the hotel bill, or expensive printer cartridges you have to buy every month for a printer that you got on sale.

The main question the article asks is: why don't firms compete to offer low ATM surcharges or low printer cartridge prices? A firm could offer their printer cartridges or minibars at lower prices and advertise those lower prices to increase their business.

The article references a paper by two economists that argue that it is a form of price discrimination (even though they don't use that term in the article):

Their argument assumes the existence of two kinds of consumers — sophisticates and “myopes.” Sophisticates play the hidden-fee game well. They seek out low advertised rates and whenever possible avoid or find substitutes for the hidden fees, using cellphones at hotels, steering clear of the minibar and setting their printers to draft mode. Myopes, by contrast, obliviously sip $5 Cokes.

Now ask yourself: what would happen if some business tried to blow the whistle on hidden fees in its sector? Consider a hotel chain that wants to expose the use of hidden fees by, say, the Hilton chain. Because Hilton makes so much on the extras, it can charge a low, even a loss-leader, price (say, $80) for its rooms. The other chain might charge more (say, $100) as it hits the airwaves with ads saying: “Watch out for our competitor’s hidden fees. We charge fairly for breakfast and local phone calls.”

But now ask yourself: whose behavior would such an ad change? Sophisticates already know about the hidden fees. All that the ads will do, Laibson and Gabaix contend, is turn some myopic consumers into sophisticates. And in turn these newly wised-up consumers will spend less on extras at both hotels — indeed, at any hotel they use from then on. Unshrouding hidden fees is “good for the consumer and bad for both firms,” Laibson and Gabaix conclude. “Neither firm has an incentive to do it.” Multiply the hotel example by a thousand, across all sorts of industries, they say, and you see how we got the countless deceptive price structures we have today.

Any other examples of hidden fees? What do you think of the author's argument? Are you a "myope" or a "sophisticate"?

(Source: Marginal Revolution)


Anonymous said...

Another example of a hidden fee would be cell phone usage. Most people just think that they will pay a certain predetermined amount. You do not realize how much you are going to have to pay until you get to the end of the month and see the added overages for going over on your minutes, making long distance phone calls, or sending too many text messages. This could also be true when you sign up for a credit card. Many credit card companies can lure in college students by selling them on the fact that they only have to pay a certain amount to get almost unlimited spending power. They are probably shocked when they see the bill filled with late fees and interest. I think that the author makes a good point in the sense that neither of the firms will gain from letting this knowledge out. It would be smarter for them just to keep their mouths shout and their hidden fees high. I believe that my dad has taught me well because I am a sophisticate. My family knows not to open the minibar, order movies from the hotel TV, or make long distance phone calls from the room. I think people will get wise to this eventually and it really should only take this happening once for someone to figure out what is going on. Until everyone catches on, I think hotels and other industries will keep up their trickery on the consumer for as long as they can.

Anonymous said...

I believe that there are many hidden fees in buying a new car. You see the price displayed on the car, but then when you enter the office to sign all the bills and contracts. You see how many extra taxes and cost that come with buying this new car. My dad and I once bought an ATV from a store that sold ATV's, GoKarts, etc.. We went in to sign all the paperwork, and my dad realized that we were charged a fee for actually having to talk with the dealer and sign all the bills and contracts. So this is an example of a hidden fee. My dad has tried to teach my sister and I to be sophisticates. He has succeded in turning me into a sophisticate, but my sister on the other hand is much more of a myope. I dont think she even thinks of the hidden cost that come with raiding the minibar in a hotel room, or going over the limit on her phone bill and text messages. I agree with Natalie when she says that industries will keep trying to scam people with hidden fees until everyone becomes sophisticates and starts to realize they are being ripped off.


Anonymous said...

another example of hidden fees would be college tuition. When you agree to go to a school, you can't pay just the tuition costs alone, you are also forced to buy a meal plan pay for housing or a meal & housing combo, books and a computer, all in addition to the cost of any other supplies that you might need and the cost of living. People end up paying much more for one year of college than colleges advertise with their tuition price. Industries will never advertise high hidden fees of their competitors because then they too will lose extra revenue from those hidden fees. Industries will always continue to have hidden fees because not everyone will try to be a sophisticate simply because some people don't care and others don't know. With six people in my family, my parents have tried to teach us to be sophiticates. My parents even bought an RV, so we don't even stay in hotels anymore--now we just have to watch out for hidden fees in campgrounds, such as charging extra if you have two air conditioners, charging for cable tv, etc.
~Emily S.