Choosing not to compete: Can firms maintain high prices by confusing consumers?

• Published date: 01 December 2017
• DOI: http://doi.org/10.1111/jems.12212
• Date: 01 December 2017

Received: 3 July 2015 Revised: 2 May 2017 Accepted: 8 May 2017

DOI: 10.1111/jems.12212

ORIGINAL ARTICLE

Choosing not to compete: Can firms maintain high prices

by confusing consumers?

Paolo Crosetto1Alexia Gaudeul2

1GAEL, INRA, CNRS, Grenoble INP,

Univ.Grenoble-Alpes, Grenoble, France

(Email: paolo.crosetto@inra.fr)

2Chair of Microeconomics, Georg-

August-UniversitätGöttingen, Göttingen,

Germany (Email: alexia.gaudeul@wiwi.uni-

goettingen.de)

FundingInformation

Thisresearch was funded by the Max Planck

Instituteof Economics in Jena and was pre-

sentedat t he Universityof Rennes, France,

att he 2014 workshopon “Industrial Organi-

zation:Theor y,Empirics and Exper iments”

inAlberobello, Italy, at the 2014 ESA Euro-

peanmeeting in Prague, Czech Republic, at the

2015Maastr ichtBehavioral and Experimen-

tal Economics Symposium in Maastricht,

Netherlands,at the 2016 conference of

the EARIE in Lisbon, Portugal,and at t he

2016Annual Conference of the Verein für

Socialpolitikin Augsburg, Germany. We

thank Igor Asanov,Iván Barreda Tarrazona,

MelanieDunger, Stéphane Lemarié, Florian

Schuett,Stefania Sitzia, Theodore L. Turocy,

andBor is Vallée,as well as our coeditor and

twoanonymous referees for their comments.

Allremaining er rors and omissions are our

own.

Abstract

Firms with very similar products often present their products in different ways. This

makes it difficult for consumers to find out whichproduct fits their needs best, or which

one is the cheapest. Why is there no convergence toward common ways to present

products? Is it possible for firms to maintain high prices by confusing consumers? We

run a market experiment to investigate those questions. In our market, firms choose

how to present their products in addition to choosing their price. We find that firms

maintain different ways to present their products and that this allows them to main-

tain high prices. This behavior is not consistent with competitive behavior, such as

when firms adopt best responses to each other, imitate the most successful firm, or

learn the best strategy over time. Rather, our results are only consistent with coop-

eration between firms. Firms cooperate by not imitating the way other firms present

their products. Cooperation is maintained by the threat of tough competition if a firm

makes its product easy to compare with others. Firms are all the more likely to main-

tain such cooperation if their products do not actually differ much. This is because in

that case, maintaining differences in the presentation of their products is the only way

to maintain profits.

1INTRODUCTION

Firms compete not only in terms of price and product quality but also in the way theypresent t heir productand pr ice to consumers.

Prices may be set per kilogram, per pound, or per liter. Users maybe offered subscr iptions or chargedon a per-usage basis. After-

sale services, insurance, and extended guarantees may be included or sold as add-ons. Firms can use different package shape and

size, different metrics in describing the product, different locations on supermarket shelves, and different categories in online

listings. All those different pricing schemes and different presentations can reflect real differences in their products. However,

they may also not reflect any real underlying differences in what is being offered.

In an ideal world, firms would adopt common ways to present their products and their prices. Consumers would then make

accurate comparisons and select the best product. They would not have to do complicated calculations and search for infor-

mation to find out how to compare products accurately. However, firms as a whole may want to prevent easy comparisons.

Indeed, buyer ignorance—in the inability to judge the quality of a product by its intrinsic merit—is a source of oligopoly power

(Scitovsky, 1950). Imperfect consumer information allows firms to maintain prices above marginal costs (Stiglitz, 1989).

J Econ Manage Strat. 2017;26:897–922. © 2017 WileyPeriodicals, Inc. 897wileyonlinelibrary.com/journal/jems

898 JOURNAL OF ECONOMICS & MANAGEMENTSTRATEGY

Spurious differentiation can work as well as real product differentiation in helping to maintain high prices and a profit mar-

gin (Perloff & Salop, 1985, section 6).

The following example illustrates why firms may prefer to adopt different ways to present their products. Suppose two com-

peting sodas are alike in every respect except the color of their packaging. “Red” is sold in a red package and “Blue” is sold in

a blue package. Some consumers only buy “Red,” others only buy “Blue.” A third producer, with essentially the same product,

wants to enter the market. He has to choose the color of his packaging. If he chooses red, then “Red” consumers will not see

the difference with the existing red product and will then simply choose the cheaper of the two red products. This will lead to a

downward price spiral. Therefore, the third producer may prefer to choose green, for example, in order to avoid direct competi-

tion with either of the two incumbents. Another example illustrates the same principle: Two yogurt manufacturerswit h identical

products have to choose whether to market their product as a health product or a dessert. If they choose the same category,t hen

their products are direct competitors. If they choose different categories, then they do not have to compete as hard.

Such spurious differentiation can be difficult to maintain however.Any one firm can profit by lowering its prices and making

it easy for consumers to compare its product with the competition. This attracts “savvy” consumers, that is, those consumers

who, whenever possible, compare products by their objective characteristics. However, if a firm does this, then other firms will

start price wars in order to regain savvy consumers. In the long term, this leads to lower profits. Anticipating this, firms may

choose not to compete for savvy consumers in the first place.

Price wars are all the more costly when real product differences are minimal. This is why such markets can paradoxically

exhibit the most spurious differentiation and the highest profit margins (Møllgaard & Overgaard, 2001). For example,most par-

ticipants in blind tests cannot perceive the difference between Coca-Cola and Pepsi. However, the two companies havebeen able

to maintain profit margins by choosing different logos, colors, bottle sizes, advertising, marketing campaigns, and distribution

channels. This has reduced the share of consumers who choose between the two based on prices.

In this paper, we present experimental evidence that firms can cooperate in maintaining high prices and different ways to

present their products. We find that this happens if firms are well informed about the behavior of their competitors. Rather

counterintuitively, an increase in the share of savvy consumers—who choose based on price if products are presented the same

way—does not lead to lower prices and profits. Indeed, our experimental markets with full marketinformation and many savvy

consumers were the ones with the highest prices and the least uniformity in the presentation of products. The presence of savvy

consumer discourages firms from making their products easy to compare, as this leads to tough competition. However, we find

that such cooperation is maintained only if firms are well informed about the behavior of their competitors. If firms cannot

observe each other, then they cannot deter imitation by others. The presence of savvy consumers then encourages firms to

choose common ways to present their products. This is why our experimental markets with no market information and many

savvy consumers were the ones with the lowest profits.

1.1 Literature

Our results are interesting because economists have long asserted that savvy consumers force firms to keep prices low

(Armstrong, 2015). This is because competition for savvy consumers drives prices down (Salop & Stiglitz, 1977; Varian, 1980).

Furthermore, competition becomes tougher as consumers learn to avoid products that are presented in unusual ways (Gaudeul

& Sugden, 2012). Finally, if some firms try to confuse consumers, then new firms with more transparent offers enter the market

(Wenzel, 2014).

Recent work challenges the faith in those assertions. A developing theoretical literature in behavioral industrial organization

deals with firms that exploit the cognitive limitations of consumers to establish market power. Markets in which firms evade

competitive forces by confusing consumers have been called “confusopolies” (Adams, 1997). In such markets, firms make it

difficult for consumers to consider all options. They use complex price schedules, hide some of the costs of using their product,

or make it difficult to compare products (Bar-Isaac, Caruana, & Cuñat, 2010; Carlin, 2009; Chioveanu & Zhou, 2013; Ellison,

2005; Ellison & Wolitzky, 2012; Gabaix & Laibson, 2006; Heidhues, Kőszegi, & Murooka, 2017; Piccione & Spiegler, 2012;

Spiegler, 2006).

Empirical evidence shows that intentional obfuscation does occur (Célérier & Vallée,2013; Ellison & Ellison, 2009; Hossain

& Morgan, 2007; McDonald & Wren, 2013; Muir, Seim, & Vitorino, 2013; Wenzel, 2013; Woodward & Hall, 2010). Books,

reviews, and policy papers explore how firms manipulate and deceiveconsumers who “search too little, become confused com-

paring prices” and fail to switch from their default options (Akerlof & Shiller, 2015; Beales, Craswell, & Salop, 1981; Garrod,

Hviid, Loomes, & Price, 2009; Grubb, 2015; Spiegler, 2015). Indeed, “the common use of tariff proliferation (...) is collusive

in nature” according to Siciliani (2014). Competition and market authorities in the United States, United Kingdom, Australia,