Toward a new model of consumer protection: the problem of inflated transaction costs.

Author:Sovern, Jeff


Contrary to the predictions of conventional economic theory, firms often benefit by increasing consumer transaction costs. Firms do so by, for example, obscuring contract terms in a variety of ways, such as providing them after the contract is agreed to, enclosing them with other more interesting information, using small print, and omitting important terms such as arbitration fees from the written contract. Firms also benefit by taking advantage of predictable consumer behaviors, such as the tendency of consumers not to seek rebates, to overload when provided with too much information, and to ignore dull information when overshadowed by vivid information. Using behavioral law and economics, this Article provides examples of practices that inflate consumer transaction costs, explains why firms benefit from such practices, and describes the conditions giving rise to such practices. This Article also explains why inflated consumer transaction costs are objectionable and explores the law's response to the problem. Finally, the Article argues that lawmakers should adopt a norm barring the unnecessary inflation of consumer transaction costs and describes tests that lawmakers can employ to implement such a norm.

TABLE OF CONTENTS INTRODUCTION I. EXAMPLES OF INFLATED CONSUMER TRANSACTION COSTS A. Definition 1. Transaction Costs as Roadblocks 2. Brower v. Gateway 2000, Inc 3. Interlocking Ways To Inflate Transaction Costs 4. Externalities and Internalities 5. Internalities and Rebates 6. Small Print (and the Internet's Equivalent) as a Transaction Cost 7. Use of Transaction Costs To Conceal Changes in Contract Terms II. CONDITIONS FOR INFLATION OF CONSUMER TRANSACTION COSTS A. Lack of Competition To Reduce Transaction Costs in the Marketplace B. Why the Market Fails To Create Competition for Reduced Transaction Costs C. Other Limits to Schwartz and Wilde's Theory D. More on Internalities E. Other Reasons Why Firms Might Not Compete To Reduce Transaction Costs III. WHY INFLATING CONSUMER TRANSACTION COSTS IS OBJECTIONABLE IV. CONSUMER PROTECTION LAW AND INCREASED CONSUMER TRANSACTION COSTS A. Legislation and Regulation B. Case Law V. ADOPTING A NORM CONCERNING INFLATED TRANSACTION COSTS A. Tests of When To Outlaw Practices That Inflate Transaction Costs B. Implementing the Norm CONCLUSION INTRODUCTION

This Article contends that another norm should be added to the pantheon of consumer protection: merchants should not increase consumer transaction costs without good cause. While many existing consumer protection rules can be explained by this norm, the law's failure to adopt such a policy explicitly has damaged consumers. This principle should be embraced and used to formulate consumer protection rules. After supporting these claims, this Article offers guidance for implementing such a norm.

At first glance, such a norm may seem unnecessary. In many contexts, contracting parties have no incentive to increase transaction costs unnecessarily. (1) They obviously do not gain by inflating their own transaction costs for no purpose. They often will not benefit by unnecessarily increasing the transaction costs of those entering into contracts with them either. Conventional economic wisdom suggests that if people unnecessarily increase the costs incurred by their contracting parties, those parties are likely to find it cheaper to do business with a competitor. (2) The practice may also generate ill will.

Consumer transactions, however, do not always follow this general rule, if indeed it is a general rule. In many circumstances, businesses benefit by increasing consumer transaction costs to the detriment of consumers. Indeed, some practices are profitable largely because they inflate consumer transaction costs. Accordingly, firms increase consumer transaction costs because doing so enriches them. Although these practices reduce the surplus from exchange, firms find that acceptable because they maximize their individual gains from the transaction. (3)

An example that will be used throughout this Article is mail-in rebates. Mail-in rebates increase the costs consumers must incur to obtain the reduced price; instead of simply paying less for the item from the beginning, as would be true with a sale item, consumers must fill out a form, gather proofs of purchase, and send them to the manufacturer. (4) The result is that only a handful of consumers obtain rebates; estimates range from a low of less than three percent, (5) to five to ten percent, (6) to forty to fifty percent. (7) Some purchasers never send the rebate form in, while others mail the form to the manufacturer but are denied the rebate because they did not comply with the stated requirements, by, for example, omitting the product's serial number. (8)

When consumers fail to obtain rebates, manufacturers retain the funds involved, making rebates particularly valuable to manufacturers, especially when compared to coupons or sales. Manufacturers apparently employ rebates chiefly because they increase sales by creating an illusion of a lower price, while the transaction costs generated by rebate offers permit manufacturers effectively to charge the unrebated price to most consumers. (9)

Commentators claim that some manufacturers, in an effort to make rebates even more profitable, impose time-consuming requirements as a part of rebate applications largely to discourage consumers from submitting them. (10) For example, one manufacturer required consumers to mail in the end panel from a box, a dated cash register receipt, and a form on which the consumer had to write five words of four or more letters that can be formed by using the letters from the phrase "full prescription strength." (11) Similarly, when one seller offered a computer system for $300 after rebates, consumers had to submit four different rebate forms to four different firms, each with a different set of rules. (12) As the head of one company offering rebates explained, "We're not trying to make it easy." (13) Companies that administer rebate programs are reported to "frequently tout their ability to run rebate promotions with a large face value but a low redemption rate." (14)

Some sellers have gone even further. One manufacturer required consumers to send in the price code from the product's carton, even though the carton did not have a price code. (15) Another manufacturer instructed consumers to hold a bottle under boiling water for five minutes to remove the neck label so it could be submitted to the manufacturer. (16) Still another seller limited the rebate in fine print to those who had purchased the item on one of two days in July and required applications to be postmarked by the end of July. (17) Consumer Reports warns readers, "[h]iding important details is all part of the rebate game." (18)

Given the profitability of rebates, their swelling popularity is hardly surprising. (19) Estimates of the total number of rebates offered in 2003 (excluding car sales) are as high as six billion dollars (20) with one chain alone reportedly having offered rebates on 217 different products. (21) In some sectors of the economy, rebates are ubiquitous. (22) But the practice of offering rebates that manufacturers know will not be redeemed because of transaction costs is arguably fraudulent. Rebates also share a quality with the widely banned practice of bait and switch (23): consumers are baited by the rebate and effectively switched to a different transaction. Though in some cases that is because of the consumer's own behavior, manufacturers understand that many consumers act in such a fashion; indeed, manufacturers depend on it. Manufacturers do have an alternative that eliminates consumer transaction costs: they could replace the rebate with a lower price. In short, manufacturers find rebates attractive precisely because they generate consumer transaction costs.

One way to address rebates is to see them as a particular species of fraud and deal with them through existing common law deceit claims and deceptive trade practices legislation. (24) Certainly some rebate practices violate these rules, and perhaps all do. Another way to respond to the rebate problem is to adopt legislation outlawing or regulating rebates. (25) This might force manufacturers to offer their products at a lower price to all consumers or perhaps to sell at the actual price without misleading consumers into erroneously thinking they will obtain a rebate. In either case, many consumers would benefit. (26) By and large, consumer protection law has responded to individual examples of firms increasing consumer transaction costs in just such an ad hoc fashion: by barring the objectionable practices or attempting to subsume them under existing norms. Although helpful, such an approach leaves intact the ability of merchants to increase consumer transaction costs in other ways. This Article contends that in addition to adopting or adapting rules to respond to specific acts, consumer protection law should embrace a general norm that unnecessarily increasing consumer transaction costs is itself objectionable and the idea that such a norm should serve as a basis for both legislation and case law. (27)

While some practices that inflate transaction costs are also deceptive, such as rebates, many are not. The current debate regarding the relative merits of the opt-in and opt-out approaches to personal privacy provides an illustration. (28) Many companies profit not only from selling goods to consumers but also from selling to other businesses the names and addresses of consumers who have purchased particular goods. Consequently, firms may be reluctant to trim the names of consumers from their lists; in general, the fewer names, the less valuable the list. The law, however, requires some businesses to notify consumers of their right to opt out of the trade in their personal information. Businesses in this situation often maximize the...

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