Consumer obfuscation by a multiproduct firm

• Published date: 01 March 2018
• Author: Vaiva Petrikaitė
• DOI: http://doi.org/10.1111/1756-2171.12225
• Date: 01 March 2018

RAND Journal of Economics

Vol.49, No. 1, Spring 2018

pp. 206–223

Consumer obfuscation by a multiproduct

firm

Vaiva Petrikait˙

e∗

This article shows that a multiproductfirm has incentives to obfuscate its products by using search

costs to induce consumers to search through its products in a particular order. The consumers

who draw high valuations of the first product terminate their search earlier than the consumers

who draw low valuations. Thus, the firm has incentives to raise the price of the earlier searched

product. The optimal search cost for an obfuscated product is such that consumers inspect the

product only if the match values of the previously searched goods have been very poor.

1. Introduction

Knowledge of individual customer preferences and the ability to set personal prices allow

firms to collect higher sales revenues. However, such marketing approaches may not be feasible

in some markets due to the cost of data gathering and consumer privacy concerns. In these cases,

firms need to apply other customer screening techniques.

This article provides a formal analysis of one such technique, whereby a multiproduct firm

can imperfectly screen its customers’ preferences by obfuscating its products. In particular, the

article considers a model where consumers have unit demand and differin their random valuations

of products, as in Perloff and Salop (1985). The firm chooses a set of prices and may obfuscate

its products by setting product-specific search costs. To learn the prices and match values of

the products, consumers must then engage in a costly sequential search process, as in Wolinsky

(1986) and Anderson and Renault (1999). This article shows that, in equilibrium, a multiproduct

monopolist sets positive search costs for some products, and thereby makes a consumer sample

the products in a particular order by starting with the less obfuscated goods. This ordered search

encourages consumers to self-sort according to their valuations. The average valuation of a

∗Instituto de An´

alisis Econ´

omico (CSIC) and Barcelona GSE; asvaiva@gmail.com.

I want to express my enormous gratitude to two anonymous referees and the Editor for their patience, comments,

additional questions, and suggested examples. I am also extremely grateful to Jos´

e Luis Moraga-Gonz´

alez for his advice

while writing this article. Additionally,I thank Marco Haan, Shu Yu, WimSiekman, Dominic Hauck, Christopher Wilson,

Irina Stanga, Saara H¨

am¨

al¨

ainen, Andrew Rhodes, Michalis Zaouras, Gianni de Fraja, Francesc Dilme, Vincente Cu˜

nat,

Michael Waterson,Sandro Shelegia, Aidas Masili ¯

unas, Sjaak Hurkens, Roberto Burguet, the participants of the seminars

at Universit¨

at D¨

usseldorf (DICE), Pompeu FabraUniversity, the Insitute of Economic Analysis (CSIC), the University of

Lancaster, the University of Cardiff, the Universityof Durham, the VthConsumer Search and Switching Workshop, and

EARIE-2013, for their helpful comments and suggestions. The author acknowledges the financial support of the Spanish

Ministry of Economics, grants no. ECO2014-59959-P and ECO2015-74328-JIN (AEI/FEDER/UE).

206 C2018, The RAND Corporation.

PETRIKAIT˙

E/ 207

product by consumers who buy the good decreases in the search order. Thus, the monopolist sets

higher prices for products searched for earlier and lowers the prices for those searched for later.

In reality, firms are obliged to inform consumers about their products before purchasing.

However, they are relatively free in choosing the way in which they provide this information. As

a result, obfuscation often appears in practice. For instance, supermarkets do not create artificial

search frictions but exploit limited shelf space in placing products with different profit margins.

According to Derbyshire (2004), products that are placed at eye level are more expensive than

those that are at the bottom or at the top of a shelf. Similarly, Mannino (2012) observes that

“[retailers] know shoppers want to easily find the size, price, and item neatly displayed. So, they

purposely create the frustration of the poorly marked and poorly organized clearance area to

tempt you toward the beautifully displayed and perfectly organized full-price merchandise.”1In

her book, Mitford (1963) describes how coffin sellers lead their customers to more expensive

items first, and later they introduce the consumers to cheaper options. Additionally, online retailers

often put special links to their new arrivals on the first pages of their online shops during regular

seasons, as these new arrivals provide higher profit margins,and consumers obser ve themsooner

and more easily than other products. Further, Anagol, Cole, and Sarkar (2013) and Bergstresser,

Chalmers, and Tufano (2009) show that insurance agents and financial advisors often offer their

customers products that have higher commission fees and do not necessarilysatisfy best the needs

of a customer, in which case the customer has to put additional effort into learning more about

the alternatives.

Besides the main analysis with symmetric products, this article also studies how a multiprod-

uct firm obfuscates goods that differ in quality or design. Tomodel quality and design differences,

I adopt the method of Johnson and Myatt (2006) and Bar-Isaac, Caruana, and Cu˜

nat (2012) based

on the rotation of distribution functions. The analysis shows that the monopolist obfuscates the

product more that attracts fewer consumers absent obfuscation. Thus, if twoproducts are differen-

tiated vertically,the monopolist obfuscates the good of lower quality. Meanwhile, whether a mass

or a niche market product is obfuscated depends on the distribution of the products’ valuations.

Additionally, the article covers a couple of extensions of the basic model, which consider

observable prices and differences in production costs. It is shown that price observability does

not eliminate the incentives to obfuscate. In the case of different production costs, the seller sets

a higher search cost for the product that is chosen by fewer consumers absent obfuscation, which,

given identical distributions of the valuations, is a product with higher marginal production costs.

This article contributes to the recent economics literature on obfuscation by studying the

subject within a multiproduct firm as a mechanism for screening consumer preferences. So far,

existing studies have focused on obfuscation as an instrument employed to decrease competitive

pressure among firms (Wilson, 2010; Ellison and Wolitzky, 2012). In those models, firms sell

homogeneous products. Consumers incur search costs when learning about prices, and the degree

of obfuscation is either unobservable (Ellison and Wolitzky, 2012) or known (Wilson, 2010) to

consumers apriori. Both Wilson (2010) and Ellison and Wolitzky (2012) find that obfuscation

decreases competitive pressure; and therefore, firms earn more profits if they follow this strategy.

Other articles consider intrafirm obfuscation by a multiproduct firm. Closest to that of the

present article are Gu and Liu (2013), Gamp (2016), and Salop (1977). Gu and Liu (2013) show

that a monopolist retailer may use obfuscation in the retail market to make the manufacturers pay

for prominent positions. In that study, the retailer charges the same price for all the products and

focuses on the upstream market.2In the model of Salop (1977), a multiproduct monopolist screens

consumers according to their valuations by using their differences in search costs. Gamp (2016)

1The same was found in the experimental study of Dr´

eze, Hoch, and Purk (1994) and by BBC Watchdog,who drew

consumers’ attention to the fact that supermarkets placed cheaper options in less prominent positions that required addi-

tional effort to find them (source: www.bbc.co.uk/watchdog/consumer_advice/supermarket_psychology.shtml; accessed

July 2013).

2Iyer and Kuksov(2012) observe that firms never overinvest in shopping experiences that decrease the search costs

of consumers compared to the social optimum, when the shopping experience is a substitute for price advertising.

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The RAND Corporation 2018.