Imagine a bargain-hunting antitrust professor, excited about an upcoming trip, going online to book his hotel. After spending an hour or two searching various sites for the best hotel offer, he finds what he thinks is a great value. Triumphantly, he proceeds with the booking. Vegas, baby!
As he clicks through on the website, getting ever deeper into the complicated reservation process, other pressing needs, like picking the kids up from school, loom. With only fifteen minutes until he has to leave to get them, he realizes he has to finish this reservation fast.
Wait . . . little fees keep being tacked onto that offer he thought was so great.
Does he ignore the additional credit card fee and city tax? Yes, he does. Time’s a-wasting, there are now only ten minutes until he has to leave, and besides, there’s nothing to be done about these fees. Ready to hit confirm, he sees yet another fee—something called a “resort fee,” which is quite hefty—being added into his total. Does he finish the reservation or decide to start over later with another website—which is likely to be doing the same thing?
As though sensing his hesitation, the hotel website now starts its own countdown. It informs him that ten other customers are also looking at the exact same room. If he waits until after school pickup, the deal on the room might vanish.
Wait . . . suddenly it’s twenty-three people who are now looking at this room. How did that happen? A red signal flashes: “In high demand!” The pressure is mounting, and it’s now only seven minutes until he has to leave for school pickup—and another kind of countdown starts, because if he’s late, the school will charge for aftercare.
The digital clock on the screen now provides an apocalyptic countdown—the discount is seemingly on life support. He’s seen this happen before and knows that if the clock winds down, he’ll get a message like this: “You just missed it! Our last room sold out a few seconds ago. Your dates are popular—we’ve run out of rooms at this property! Check out more below.”
With a sense of resignation, rather than his initial triumph, he hits the purchase button. A pop-up window congratulates him for grabbing the discount over his tardy rivals. It reassures him that he saved 45 percent in comparison to the list price. Great—it seems that all turned out well in the end.
Until the day he reaches the hotel on the Vegas Strip and reality begins to set in. Smiles greet him at the reception desk where he’s told about some minor issues that need to be addressed. No, sir, the resort fee does not include fast Wi-Fi connection or access to the spa. Nor does the resort fee cover parking—by valet or by himself. Actually, he has no idea what the resort fee is supposed to cover because it’s not spelled out anywhere. But he’s here to have a good time, he reminds himself, as part of his stress-reducing program, so he goes with the flow and hands over his new credit card.
The card offer came with a very low annual interest rate. It was surprisingly low, in fact—far better than what the other card companies seemed to be offering. Sure, it was a temporary teaser rate. Probably somewhere way down there in the fine print there’s something about when that rate expires and also something about overdraft fees. But he was too busy to take the time to read it. And besides, those charges are irrelevant to him. He intends to pay in full and on time. He’ll never carry a balance.
Five days later his vacation is over. He enjoyed himself in Vegas and liked his hotel, but as he is checking out, he sees a few other unanticipated charges on the bill. Twenty bucks for extra towels? That $100-a-night room has ended up costing double what he’d expected. But there’s no time to argue. His plane is leaving soon, and the rescheduling fee is more than the airfare. Later that month, another surprise awaits him. His new credit card apparently has a higher interest rate than he expected and sky-high late fees, too, which he discovered after he overlooked his bill because so much work had piled up on his desk while he was on vacation. His assumption that he would always pay on time has already been proved wrong.
Astonishingly, all of this takes place in two intensely competitive markets—hotels and credit cards—where, in theory, the power of competition will mean that we consumers can expect to get great deals, where our interests will reign supreme as the merchants fight tooth and nail for our business. And yet, even in an environment where competition is so rich, we can still receive less than we bargained for—a lot less.
We’ve already seen toxic competition among helmetless hockey players. We’ve seen toxic competition as a steam engine spewing horsemeat. Now, imagine competition as a turquoise sea. Its waves, cooling our toes and inviting us to take the plunge, call us seaward. We accept the invitation. We go with the flow and with every stroke we glide farther from the security of our beach towels.
As we frolic in these waters, enjoying ourselves, something tells us we should turn around. But our strokes are slackening and we are carried farther into the sea. Swimming harder to try to return, we are caught up in rip currents we hadn’t seen, which pull us seaward at eight feet per second, and the beach keeps receding. We’re in over our heads and can’t seem to get ourselves back to shore. We’re drowning!
Welcome to our Third Overdose—where on the surface competition appears to be to our advantage. But appearances are deceiving, and it’s easy to end up struggling to come up for air. The hotel, car rental, and airplane booking sites are all in a fierce competition for our business. But this is not a competition that operates by finding more and more ways to please its customers, as we might expect; instead it funnels the companies’ ingenuity into finding ways to drag us ever farther out to sea. The rivals offer promotions that drain our wealth. They outmaneuver each other to find our weaknesses, and they draw us unsuspectingly into debt.
We swim against a rip current of late fees, of automatic enrollment in programs we don’t want that charge us even more fees, of misleading and deceptive information about terms, prices, or payments. If we slacken even briefly, we are carried deeper into debt. Some of us make it to shore. Yet, embarrassed by our failure to do due diligence, by our gullibility, we don’t speak up.
How does this overdose differ from the other two? Unlike our First Overdose, with the helmetless hockey players and entice-and-reject universities, the competitors’ collective and individual interests are aligned—against us. They achieve their profits by exploiting us.
Unlike our Second Overdose of horsemeat scandals, quality isn’t degraded. We actually got a nice suite at Caesars Palace. It just ended up costing about double what we expected because we didn’t know about all the fees that were going to be added to the base price—and didn’t protest them once we became aware of them. And our credit card works perfectly well—that is, it allows us to buy what we want when we want it without much concern about how we’re going to pay for it, which we enjoy a lot—until we come face-to-face with the high interest rate and late fees that were hidden in the fine print. But since we can keep making just minimum payments, we can keep closing our eyes to the real cost.
As a measure of how topsy-turvy these competitive markets are, the credit card industry has turned the definition of deadbeat upside down. Credit card deadbeats are customers who successfully avoid the hidden fees because they pay in full and on time, and live within their means. This deprives the industry of the fees, where they make most of their profit. “Star” customers, by contrast, are those who can’t avoid the exploitation.
Are You Calling Me Irrational?
On paper, competition works well. Assuming that we generally know what serves our own interest, and that we have the time, judgment, mental energy, and willpower to ensure that we get it, competition can indeed deliver what we want at a fair price. In their full-throated defense of competition, most economists, for decades, did make these assumptions. The term homo economicus has been used (often mockingly, sometimes earnestly) to refer to these specimens of supreme rationality, who are believed to be always capable of acting in their own self-interest. Objective and deliberative, they seek out the optimal amount of information, readily and continually update their beliefs with relevant and reliable data, and choose the best action according to stable preferences. As homo economicus obtains new facts, it revises its beliefs and modifies its behavior. With its admirable rationality and willpower, the homo economicus can shop, save, exercise, eat, and drink appropriately, resisting temptations that undermine its well-being and always following practices that maximize it.
However, in the real world, few if any of us are perfectly rational. As Fyodor Dostoyevsky remarked in Notes from the Underground, “[t]he trouble with man is that he’s stupid. Phenomenally stupid.”
Maybe “phenomenally stupid” is too harsh. But our intelligence and rationality are constantly being tested in the marketplace, and we often fail the test there.
Suppose Lavazza and illy coffee are both on sale at your local supermarket. For both, the standard price per pound is $9.00. However, right now illy is offering a discount of 33 percent on its one-pound bag, bringing the price down to $6.00. Lavazza hasn’t lowered its price, but is offering 1.33 pounds for $9.00. Assuming you like both brands equally, which option is better—a 33 percent reduction in price, or a 33 percent increase in quantity? Or are they the same?
Suppose Bloomingdale’s has a sale—slashing 40 percent off a $1,000 Ralph Lauren jacket. The Ralph Lauren outlet shop has that same jacket, but has marked it down twice: first by 20 percent and then by an additional 25 percent. Which one offers the better deal?
When we each asked our children, they began crunching the numbers on their calculators. Who shops with a calculator? we responded. Few of us take the time to compute these math problems, and even fewer of us can do the math in our heads. We rely on intuition.
So, for the first problem, most shoppers generally opt for the 33 percent extra, the Wall Street Journal reported, even though the discount is the better option. For the two deals to break even, the price discount of 33 percent would have to be matched by an offer of 50 percent more quantity, not 33 percent.1
Likewise, the double discount (20 percent and then an additional 25 percent off) seems like the better deal, but it is the same as the 40 percent off offer.
Now put yourself in the seller’s position. Why offer the better bargain (33 percent off) when many would choose the inferior option (33 percent more coffee)? Why offer a steep discount, when you can entice more consumers by discounting the items twice?
Here’s another example—in this case one that doesn’t turn on our math abilities but our basic psychological makeup.
Suppose you are offered $100 today or $120 next week. Which would you choose?
Many choose the $100, despite the fact that the better choice is, of course, to delay gratification in order to net an additional $20.2
Now suppose you are offered $100 in fifty-two weeks from now or $120 in fifty-three weeks from now. Many now choose the $120.
Neurological research has examined why this is the case. The discrepancy between our short-run and long-run preferences could reflect which part of our brain’s neural system is activated.3 The research suggests that choices that involve an immediate reward (such as $100 today versus $120 next week) can disproportionately activate the impulsive part of our brain (the limbic system), which goes for the short-term benefit. Like Veruca Salt in Willy Wonka and the Chocolate Factory, we want it, and we want it now. But when the rewards are in the relatively distant future, they activate the brain’s more deliberative part (the lateral prefrontal cortex), which engages in long-term cost-benefit analyses and encourages us to make the better choice to wait the additional week.
These examples give us just a glimpse of when and why our own fallibility encourages competition to turn toxic. To understand this better, we can look at this and the three other conditions that characterize markets in which our Third Overdose is likely to flourish.
FIRST, as we’ve been discussing, in all these markets consumers are not the rational superhero homo economicus. They are human and have human weaknesses that get in the way of their deliberative reasoning and willpower.
Many consumers rely on intuition rather than deliberative reasoning. They succumb to the temptations of instant gratification, misjudge the strength of their willpower, and overestimate their ability to detect manipulation and exploitation. As anyone who has ever overeaten, overspent, or otherwise succumbed to temptation (despite having the best intentions to the contrary) can confirm, few of us have the willpower or the rationality we think we do.4
SECOND, firms know how to identify and exploit these customers’ weaknesses. Competitors tap into these “irrational moments” and exploit them to their benefit.
THIRD, although some consumers are savvier than others and know how to avoid the traps set for them, these consumers do not protect the weaker ones. This happens, as we’ll see, in part because savvier consumers benefit, to some extent, from the exploitation.
FOURTH, firms profit more from exploiting their customers’ weaknesses than from helping them. In these markets, there may be few, if any, “angelic” companies that come to our aid because there is no advantage to their doing so. It may be too costly to educate the naive customers, and even if they succeed, there is no assurance that these customers, once educated, will stick with them and use their products. Eventually competition encourages even once-angelic companies to exploit.5 Companies or managers who resist will lose business to those without moral qualms.6 Rather than a race to the top, companies compete in devising ever cleverer ways to exploit consumers’ shortcomings—the result being that increasing competition delivers ever worse products and services to us.7
The Good, the Bad, and the Ugly
Using these four factors, let us consider how the same companies might compete to help us in some markets, while competing to exploit us in other markets. This will help us to understand what the circumstances are that encourage exploitation. We’ll start with the banks, institutions that are highly knowledgeable about how to identify and exploit their customers’ weaknesses when it is to their advantage to do so. Banks operate in many different markets—lending, savings, mortgages, and credit cards. The competition in some, like credit cards, can be toxic to consumers, while in others, like savings, it is healthy. It is not the consumers who are the chameleons, switching between ignorant, incompetent “Homer Simpson” mode and hyperrational homo economicus mode. Rather, it is the companies who change, in response to the imperatives of the marketplace. In the case of banks, this will depend on whether they will profit more from helping us or from exploiting our human weaknesses.
With respect to savings accounts and retirement funds, financial institutions profit more by helping us—that is, by encouraging us to save. As competition has increased with the rise of online banks, banks have not only improved their interest rates and terms, they have designed tools that appeal to our deliberative sides and help us overcome our weak willpower.8 Automatic savings plans, for example, take the decision-making out of savings. When we get our weekly paycheck, we don’t have to fight between our temptation to blow part of it on a new pair of shoes or to put money aside for some long-term goal. Instead, the bank automatically deducts money from our paycheck and puts it into our retirement fund or our children’s college fund, or toward other long-term objectives. As one bank noted, consumers “often find they do not even notice the smaller amount they have to spend each month.”9
Now let us turn to credit cards. Here banks make more money the more often we use their credit card—from the transaction fees they charge merchants to the often very hefty interest and fees they charge us. Thus, compulsive shopping, from the banks’ perspective, is a gold mine. Credit cards feed into the impulsive I-want-it-now part of our brain.10 We get the immediate reward, whether it’s one of those $5 lattes or a $500 pair of shoes, while delaying the payment for it. Unlike taking cash out of our wallet, swiping a card is abstract. And because we can delay payment not just until our bill comes but for months and even years thereafter, the cost can continue to seem abstract, even as the interest and penalties build up and drain our pocketbooks.
Moreover, credit card companies often encourage us to live beyond our means. As the Harvard Business Review noted, “Many credit card issuers, for example, choose not to deny a transaction that would put the cardholder over his or her credit limit; it’s more profitable to let the customer overspend and then impose penalties.”11 When the credit card bill arrives, there is no Calvinist reproach to our extravagance, no need to repent by promptly paying down these debts. Instead, we are comforted—only a minimum payment is needed. We are lulled into becoming less conscious of what we are spending and more likely to overspend and incur huge penalties in the form of high interest rates on the balances we carry. The consequences became so damaging that Congress passed a law in 2009 requiring credit card issuers to tell us the consequences of making only the minimum payments each month.12
While the froth from the toxic competition has subsided, it nonetheless remains. Unlike the savings market, banks in the credit market continue to compete to exploit our weak willpower (rather than help us overcome it) and appeal to our impulsive nature (rather than the deliberative sides of our brain). Thus they are still offering us a never-ending stream of products that look superficially appealing (low teaser rate, 1 percent back in rebates, etc.), but where the costs of borrowing—including overdraft charges, late fees, and interest rates—are unconscionably high. Ultimately, their goal seems to be to put us into a debtors’ “sweatbox” in order to turn a profit.13
But as we’ve seen, the banks also profit when they encourage us to save. So, why don’t banks put their focus on helping us instead of sabotaging us? Let’s look again at those four conditions we discussed above.
FIRST, because we are not in fact homo economicus, we ourselves allow this to happen. Toxic competition intensifies when naive consumers do not demand or use better products.
SECOND, because the banks know this, they exploit us. One former CEO, for example, explained how his credit card company targeted low-income customers “by offering ‘free’ credit cards that carried heavy hidden fees.”14 The former CEO explained how these ads targeted consumers’ optimism: “When people make the buying decision, they don’t look at the penalty fees because they never believe they’ll be late. They never believe they’ll be over limit, right?”
THIRD, because the consumers who know how to game the system don’t protect the victims of it, competition delivers the benefits unequally: The money flows from the pockets of the exploitable to the exploiters, and also to those sophisticates savvy enough to be able to avoid the pitfalls of debt and high interest rates. So the savvy consumers do not call for reform. Rather, they are focused on preserving the current competition, as they want to hold on to whatever perks they can extract from the credit card company, like the 1 percent rebates, the refundable membership fees, the extended warranties, the mileage awards, and the zero fees on foreign transactions—perks the exploitive credit card issuers can afford to offer because of the fees they charge the more naive consumers.
And finally because, per the FOURTH condition, although it’s true that banks can profit from both helping and hurting their customers, exploitation turns out to be much more profitable. Banks typically earn considerably higher returns from credit cards than from their other commercial banking activities. Earnings patterns for 2016 were consistent with historical experience: In that year, the average return on all assets, before taxes and extraordinary items, was 1.32 percent for all commercial banks, compared with 4.04 percent for the large credit card banks.15
But let us suppose that an angelic bank does take the time and effort to help naive credit card users get out of debt and start saving. Where does this now solvent consumer turn? Well, probably to one of those exploitive credit card companies, the ones that offer such tempting perks as rebates, airplane miles, etc. So what is the point in helping these customers, if they won’t bank with me in the future?
In short, banks have little financial incentive to help consumers choose better products (e.g., credit cards with higher annual fees, but significantly lower late fees and interest rates). Market forces will instead skew toward products and services that exploit or reinforce consumers’ weaknesses.
Even those of us who don’t succumb to these temptations may get swept out to sea if an emergency of some kind—a catastrophic medical bill, a fire, flood, or hurricane—lands us in the debtors’ sweatbox. And even the most fastidious of Calvinists, looking disapprovingly at the other swimmers struggling in the distance, may find themselves being billed for monthly services, such as credit monitoring, without their knowledge. Many older Americans complained to one federal agency of being billed for these subscriptions that they did not want or need, and discovered only “when a family member or other trusted third party reviewed their accounts.”16 According to a government report, people who are not vigilant may end up making payments for unwanted services that continue for months (if not years).17 Ultimately, as one UK study found, many of us, when it comes to banks, are “paying above-average prices for below-average service quality.”18
Having seen how competition can turn toxic under these four conditions, let us travel to where the rip current is the strongest, where there are the perfect conditions of human weaknesses and of competitors who know how to sense and exploit these weaknesses for profit. Let us go, in short, to Las Vegas. The brief summary we gave you earlier of what happens when you try to get a good deal on a hotel room doesn’t really do justice to the seductive insidiousness of the process.
Exploitation, Las Vegas Style
The casinos, most of which are located in hotels, need to attract visitors in order to make money, and those visitors need a place to stay. So, one might expect that this would result in a very healthy competition with multiple casinos wooing you to stay in their hotels. You’ll end up with a great deal on a hotel and presumably they’ll make money off of your gambling. But somehow it doesn’t work out that way.
In booking a hotel room along the Strip, as in many places across America, you’ll find that online reservation sites typically quote a very low “total price” or “estimated price.” The price includes “only the room rate and applicable taxes.” On other websites, the quoted price has an asterisk next to it. To find out what the asterisk means, you would have to go to another page on the website, where, if you read the fine print, you will find the resort fee, though you may or may not find out what this mysterious but mandatory fee covers. A few online sites don’t even identify any additional fees. You are simply told that “other undefined fees may apply.”19
Welcome to the world of “partition” pricing and “drip” pricing—two strategies that do a great job of exploiting our weaknesses. Partition pricing works by separating the room price into two or more components. To see partition pricing, try booking a room at the Luxor Hotel and Casino in Las Vegas. You’ll see the room rate in large type ($79 when we last checked), highlighted in a blue panel; in smaller print, which isn’t highlighted, you might notice “Plus $35 daily resort fee plus applicable taxes.”
With drip pricing the hotel offers a room price that keeps increasing as the customer goes through the buying process.20 Here’s an example for Circus Circus on one booking site, where it appears that you are only going to have to pay $26 a night.21 Wow, that’s quite a deal! Once you click through to book the room, however, the price increases 150 percent to $66.65, once the mandatory resort fees and taxes are added.
How is it possible that these practices have become standard in the hotel industry? In competitive markets, we, the consumers, should reign as sovereign. And, as a survey of three thousand consumers conducted by the UK’s competition agency revealed, we hate drip pricing—with 75 percent of those surveyed objecting to it, and 70 percent stating that they believed all compulsory charges should be revealed up front.22 Consumer advocates also decry drip pricing. As the person who writes the Travel Troubleshooter blog says, “Quite simply, it’s lying.”23
So is competition eliminating this exploitation? To the contrary: We see drip pricing spreading across many seemingly competitive markets, including online booking sites like Airbnb and eDreams,24 airline tickets,25 car rentals,26 and prepaid telephone calling cards.27
If the marketplace is getting more competitive, yet more firms are resorting to the unpopular practice of drip pricing, something would seem to be wrong with this picture. To diagnose it, let’s start with our first factor: consumers’ weaknesses.
Our superhuman homo economicus would not fall prey to drip pricing.28 It would continue searching all the online sites, while calculating the different hotel rooms’ costs—until, in economics jargon, the marginal cost exceeded the marginal benefit—and ultimately it would end up with the cheapest rate.
But many consumers fail to anticipate the existence of additional fees or the high prices of add-ons. To see why, let us consider how drip pricing taps into several human weaknesses. Try this thought experiment on yourself or friends.
First, think of a number, such as the last two digits of your social security number. Next, convert that number into dollars. Now, would you pay that amount—let’s say it’s $14—for a 1998 Côtes du Rhône? Finally, what is the maximum amount that you are willing to pay for that bottle of wine? Should thinking about the last two digits of your social security number affect how much you are willing to bid?
Before you answer, consider a second experiment, in which forty-two experienced judges and prosecutors were given a legal file about a rape case and asked to consider what kind of sentence they would hand down if they were the judge on the case. They were further asked to imagine that during a recess in the court, a journalist called them to ask what kind of sentence they intended to impose. Half of the judges and prosecutors were told that the journalist would ask: “Do you think the sentence for the defendant in this case will be higher or lower than one year?” The other half were told that the journalist would ask: “Do you think the sentence for the defendant in this case will be higher or lower than three years?” They were all told not to answer the journalist. After the supposed recess, these legal professionals were to render their verdicts. Do you think that the question asked by the journalist affected the duration of the sentences they imposed?
When we give these examples to our students, the overwhelming response to both questions is No. Nonetheless, in both examples, what economists call “the anchor value”—in these cases the social security number and the suggested sentencing times—did indeed influence the participants.
In the first set of experiments, participants with the highest-ending social security numbers (80 to 99) bid, on average, the highest for the bottle of wine; those with the lowest-ending SSNs (1 to 20) bid, on average, the lowest. Those with the higher SSNs bid, on average, 216 percent to 346 percent more than those with the lower SSNs.29
Similarly, whether the journalist asked about a one-year sentence or a three-year sentence did influence the judgment of those experienced judges and prosecutors. Participants who heard the higher sentencing anchor gave considerably higher sentences (mean of 33.38 months) than those given the low anchor (25.43 months).30 As the authors of this study concluded, from this and other similar experiments they conducted, “God may not play dice with the universe—as Albert Einstein reassured us. But judges may unintentionally play dice with criminal sentences.” And these “anchoring effects” may result in rolls of the dice in many other areas of judgment, too, including prices set by hotel reservation sites and real estate agents.31
We may reject the idea that an arbitrary number could have an impact on our own decisions. But drip pricing is a way of anchoring us to a low headline price (say $26 for the Circus Circus hotel room). Once we’ve got that price of $26 in our head, we fail to adjust our “perception of the ‘value of the offer’ sufficiently as more costs are revealed.”32
Drip pricing also taps into a second weakness. Although as we shop for a hotel room we haven’t actually purchased that reservation for $26, some part of us feels like we have and we now feel attached to it. With drip pricing, a former chief economist of the UK competition authority noted, “Consumers feel they’ve already made the decision to purchase [which] creates loss aversion—consumers have committed time and effort to the search before being hit with extra charges.”33
A third weakness is something we often perceive as a strength, namely commitment and consistency. Here, after having invested a lot of time and effort into this purchase, we want to see the purchase through to its end.34 Economists call this the sunk cost fallacy.
Finally, drip pricing taps into brain fatigue. Each Las Vegas hotel on the Strip offers many different types of rooms, with varying square footage, number of beds and bathrooms, and views. Each type of room has a different room rate, with different promotions for rewards club members. If you want to bring your parrot, check in early, or check out late, additional fees apply. And different hotels impose different resort fees—plus tax. Now, to decide which kind of room you want and where you want to stay, run calculations for two types of rooms at five different casinos on the Strip. That requires a lot of mental processing. That is what the consumer protection agency, the Federal Trade Commission (FTC), concluded in its 2017 report, Economic Issues: Economic Analysis of Hotel Resort Fees. Drip pricing increases the “cognitive costs of making purchase decisions.”35 Consumers not only expend the time and cost of searching for the best deal, they must also expend mental energy to calculate and evaluate each option to determine how it fares against the other options.
This takes us to our second factor for toxic competition. Firms can identify and exploit the customers’ weaknesses. Drip pricing is a shiny lure. The UK’s competition agency, for example, experimented with five common price schemes to see which would most appeal to consumers:
- drip pricing;
- sales, where the “sale” price is based on an inflated regular price (e.g., was $2, now $1);
- complex pricing (e.g., three-for-two offers), where the unit price requires some computation;
- baiting, where sellers promote special deals with only a limited number of goods available at the discounted price; and
- time-limited offers, where the special price is available for a short period.36
As the experiment found, firms can use any and all of these pricing schemes to manipulate our purchasing behavior to our disadvantage. But guess which pricing practices were the most harmful to consumers, in terms of making errors and overpaying? Drip pricing and time-limited offers. And not surprisingly, online hotel reservation sites make widespread use of both tactics.
Now let us return to the example of the Luxor Hotel and Casino, where the hotel posts a base price and a surcharge, and puts both on the same page.
That shouldn’t trick us. But even here, according to the FTC report, many consumers “tend to underestimate the total price.”37 For a night at the Luxor, the total comes out to $129.25, once we add up $79 a night plus a $35 daily resort fee plus $15.25 in “applicable” taxes—which we have to go to another page to find. We react quite differently to “$129.25” than to “$79 (plus a $35 daily resort fee plus applicable taxes).” According to the FTC, putting the surcharge in smaller font increases our tendency to underestimate the total price or to ignore the surcharge. Requiring us to click through to another page to find the “applicable taxes” no doubt further increases that tendency. Drip and partition pricing cause us, as the FTC found, “to behave as if the price is lower than it is.”38
This brings us to the third condition for toxic competition. Savvy consumers, if they actually do spend the time and mental effort required to quantify the total price for the different rooms, might find the cheapest one. But their mathematical gymnastics will not protect the rest of us (unless they call you up and tell you which hotel offers the lowest or best value). In fact, their efforts won’t even help them the next time they research hotel room prices. Prices for hotel rooms, in Vegas and elsewhere, change regularly. The price that savvy customers pay today might differ from tomorrow’s price. So, unless they are prepared to put in the exact same amount of work they put in today to find the best price tomorrow, they won’t.
Moreover, as we’ll see, some casinos are engaged in sophisticated price discrimination, so the VIP price you receive might be higher or lower than the VIP price your grandmother or neighbor received.39 So, like credit card companies, the hotels can offer sophisticated buyers better deals, which are subsidized by the resort fees that the rest of us pay. Competition in these circumstances can indeed make things worse.40
Won’t people eventually recognize the scam and start adding up the fees? Potentially. According to the FTC, behavioral experiments showed that people who went through the drip pricing scenario multiple times made fewer buying mistakes. But they still made more mistakes than those people in the “transparent price setting”—where the total price was revealed much more quickly and easily.41
Before we even step on the casino floor, the casinos have begun exploiting our weaknesses—especially if we are among the many naive consumers who book rooms infrequently and are unaware of the way add-ons increase the overall purchase price.
In the effort to deceive consumers, drip pricing is spreading. Hotels across the United States are now imposing—and concealing—mandatory resort fees “for amenities such as newspapers, use of onsite exercise or pool facilities, or Internet access.”42 As one New York University report found, these mandatory fees and surcharges emerged as an industry practice around 1997 and have increased every year since except for periods following 2001 and 2008 when demand for hotel rooms declined.43
That takes us to the final factor for toxic competition: when firms have a greater incentive to exploit us than to help us. The casinos and their hotels certainly exemplify this motivation. Given that so much of their profit derives from these deceptive practices, why would they choose to do otherwise?
And yet, there are occasional instances in which companies do try to do the right thing by their customers. And one might expect that when they do, they can stop the toxic competition. After all, if, for example, consumers hate drip pricing as much as they say they do, then one powerful casino, in doing the right thing, should certainly be able to triumph over its rivals. Right?
The Case of Caesars
In 2011, about fifty showgirls from Caesars Entertainment took to the Las Vegas streets.
The showgirls—with their signs, “Just Say No to Resort Fees!” and “Our Money, Our Choice!”—were exposing the injustice of hidden resort fees.44 Other Vegas celebrities, including Marie Osmond and Penn & Teller, joined the protest. Caesars wrapped its casinos with ads proclaiming that unlike its rivals, Caesars did not exploit customers with resort fees. Caesars estimated it saved Las Vegas visitors $37 million a year by not engaging in this drip pricing.45 Caesars also launched a Facebook page inviting consumers to “join the fight against Las Vegas resort fees.”46
Here we have a powerful company, which owns several popular casinos on the Las Vegas Strip, taking a powerful stand against an unpopular, and abusive, pricing scheme. Caesars’ “no resort fees” Facebook page drew tens of thousands of followers.47 Under these circumstances we might expect the toxic competition to end.
But in fact the unpopular, exploitive practice did not stop. Resort fees on the Strip, and throughout the United States, continued to increase, and more competitors kept adding them. A trend analysis report written by a professor at NYU concluded that such “fees and surcharges are highly profitable; many have incremental profitability of 80 to 90 percent or more of the amounts collected, so they represent significant contributors to industry profits.”48
Source of data: 2017 NYU School of Professional Studies: Trend Analysis Report49
So a powerful casino chain takes a stand against an unpopular, exploitive practice. And not only does it fail, but by 2013, Caesars gives up on its quest to warn consumers of these resort fees and joins the race to exploit.
Why did Caesars cave? The answer is very simple. Showing us the true price led to a fall in sales. On the other hand, drip pricing paid off. Initially Caesars charged resort fees primarily for its Las Vegas properties. In 2015, Caesars began charging resort fees for all its properties, which drove most of the increase in its rooms revenue.50 Caesars’ net revenue in 2016 increased $41 million, or 1.9 percent, compared with 2015.51 As the FTC report concluded:
The experience of Caesars Entertainment may suggest that it is difficult for a hotel not to charge a separately-disclosed resort fee when competing hotels charge such fees. The prices of hotels that charge separate, mandatory resort fees will appear lower than the prices of hotels that do not charge the fees, even if the total prices are the same. Consumers are attracted to resort fee hotels because they advertise the lowest upfront price. If search and cognitive costs did not exist, consumers would ultimately find the hotel of the quality they wanted at the lowest price. However, if separately-disclosed resort fees increase search and cognitive costs, it would be harder for consumers to discover a hotel with no resort fee that offers a better deal. This situation suggests a “Prisoner’s Dilemma” style game where the efficient outcome cannot be achieved because any hotel offering a better deal without a resort fee will lose business to competitors charging separate resort fees and lower advertised room rates.52
Ultimately, deceptive drip pricing proved to be a shinier lure than Caesars’ truthful all-inclusive price. We, the customers, did not back Caesars’ efforts. We may think we don’t like drip pricing, but nevertheless we fall prey to it and don’t do the work to find out which is the cheapest rate.
You could say, shame on us. Maybe we deserve to be exploited. But it has to be acknowledged that with hotels, airlines, and rental car agencies all now engaging in drip pricing, it takes more and more work to try to figure out the actual cost of booking a vacation. If we are really determined to find the best deals, planning our Vegas trip becomes a full day spreadsheet exercise.
Since few of us have this spare time, this puts the honest seller—and us—at a disadvantage.53 The competitors who make it easier for consumers to see the overall price ultimately lose business, as tourists flock to the manipulative hotels. Eventually, as more hotels engage in drip pricing, the few remaining decent competitors buckle under the competitive pressure, until they, too, exploit us.
And there we have it—a seemingly competitive market in which the rivals compete on how best to exploit us, rather than benefit us.
The Power of Behavioral Analytics
By the 2020s, as companies develop tools to monitor and profile us, exploitation via drip pricing will likely appear downright quaint. Big data and analytics are the next stage in consumer manipulation. And the future is here.
To catch a glimpse of this next wave of toxic competition, let us return to Las Vegas. It’s no longer true that what happens in Vegas stays in Vegas. Instead, what we do there will go into a data dump that enables us to be exploited with ever greater efficiency—as we’ll see when we examine one recent experiment involving about 1.5 million consumers who frequented MGM’s Las Vegas casinos.54 A team of experts in data-driven marketing analytics developed a computer program that allowed MGM to determine the profitability of various kinds of promotional offers—and it worked very well indeed.
Like all the larger casinos, MGM uses loyalty cards and other sources to amass this data. Advertisements for MGM’s loyalty card, for example, promise “amazing rewards and benefits” for every dollar one spends at its resorts.
So, when you exchange your cash for a casino’s play-card, the card is linked to your unique loyalty-card ID. As you use the casino’s play-card, you can earn more perks, like priority hotel check-in lines. The casino’s database now can easily capture “where, when, how long, and how much” you played, as well as your activities (“rooms stayed at, shows watched”).55 The data helps the casino to “price optimize”—that is, to offer you the cheapest mix of perks that will work to entice you to spend the most amount of money at their casino—not just once, but over your lifetime.
To arrive at this conclusion the casino first considers whether you are a low-value, high-value, or loyal customer.
You would be a “low-value” customer if you’re either: too good (highly skilled “experts” who win back from the house more than they wager), a freeloader (consumers “who utilize comps but do not play at the resort”), or too strategic (consumers “who wager nothing more than their Free-play dollars, thereby gaining the upside from the promotion, with little downside for themselves and no gain for the ‘house’”).56
If you’re too good, too cheap, or too strategic, MGM doesn’t want you and won’t compete with the other casinos to attract you. So don’t expect any attractive promotions—from MGM or any of the other Vegas casinos.
On the other hand, if you’re a “loyal” customer, you might expect your loyalty to be rewarded. And relative to the low-value customers, it will be. But because MGM knows you are likely to stick with MGM with or without a promotion, MGM does not want to condition you to expect promotions. You’ll get them sometimes, other times you won’t.
So the real competition is in identifying and wooing the “high-value” customers, namely those whom the casino can hook and keep profiting from over the gamblers’ lifetimes. The “high-value” consumers are those with the highest marginal propensity to respond to a promotion, basically those who would spend the greatest amount in response to the smallest inducement needed to woo and hook them.
Suppose you’re a high-value customer. MGM, like the other casinos, has multiple promotions to woo you. These include:
- room offers (like the room type, room discount, number of comp nights, whether the comp is midweek or weekend);
- entertainment, sports, and facility offers;
- retail and spa offers;
- air and limo offers;
- free-play and promo-chip offers;
- resort credits; and
- food and beverage offers.
But the challenge is not simply snagging the high-value customer once. Rather, it is assessing the dynamic effects of promotions on each such customer “to get an accurate picture of the ROI [return on investment] profile from the promotions, and to allocate them appropriately based on their expected long-run benefits to the firm.” Basically, what is the cheapest inducement they can offer to get you to come to MGM on your next trip—and trips thereafter—and spend money not just on the slots and tables but at the restaurants, shows, and shops? Would a limousine at the airport do the trick? Or would a free drink suffice? Or does MGM need to offer you a limo as well as a free dinner and show?
To answer these questions with a higher level of precision and sophistication than MGM had been able to do in the past, the casino turned to a computer model designed by its marketing analytics experts. The computer first compiled all the available data on each consumer’s observed behavior “at all past visits (and not just the most recent visits).” That would include not only their time at MGM Grand, but the other MGM-owned casinos: ARIA, Bellagio, Circus Circus, Excalibur, Luxor, Mandalay Bay, Mirage, New York–New York, and Park MGM. The model also used “information across the entire range of activities by the consumer to measure how promotions affect behavior.”57 For those consumers on whom very little data existed, the computer model pooled information from the behavior of similar consumers.
In processing all this data, MGM’s computer program then identified for each consumer how that person would likely respond to myriad combinations of promotions, and the likely profits from that consumer over the long run under the different inducements. This information shaped the marketing strategies it then used.
Ultimately, the behavioral discrimination was highly effective and profitable. When MGM ran its new data-driven personalized promotions, the profits, the study found, were about $1 million to $5 million higher per campaign than under MGM’s existing marketing strategy. In other words, every dollar MGM spent on promotions that used the data-driven computer model generated about 20¢ more in incremental profits than the earlier promotional campaign.
In short, the data helped MGM identify with greater accuracy whom to target, and how, in order to maximize the profit it got from each person. As the study documenting these changes noted, “The source of the improvement arises from shifting marketing dollars away from average consumers who would have played even in the absence of the promotion toward marginal consumers for whom the promotion has an incremental impact; and from the improved matching of promotion types to consumer types.”
Now it’s clear that the other casinos on the Strip are going to want in on this data-driven success, and soon everyone will be competing to collect even more (and better) data on us in order to exploit us with maximum efficiency. The casinos will all crunch their own data and they’ll also increasingly work with data assembled by data brokers. If Google, Facebook, Amazon, and other super-platforms acquire a casino, they’ll add this rich data to their extensive profiles of us, which will only get richer with the data available through our digital assistants like Alexa and Google Home.
Going forward, the toxic competition will become highly stratified. If you resemble the homo economicus or are a skilled gambler, few, if any, of the casinos will compete to attract you. No perks for you.
If you are loyal to a casino (that is, if you are one of those “average consumers who would have played even in the absence of the promotion”), you won’t get much in the way of perks either, because the casino already knows that you don’t require a limo at the airport to convince you to spend money at its hotel and its restaurants and slots.
The rest of you, however, can expect some perks—whatever the casino’s computer models have determined are necessary to hook you. You might get a free show or limo, if the data indicate that the cost of offering these perks will be worth it. But don’t expect this competition to benefit you in the end. The casinos will be competing, but only in finding your weaknesses. So when that limousine driver greets you at the airport, keep in mind that he’s really just another cog in the machine that is designed to extract your money with maximum efficiency.
Reflections
The tactics used today are like rip currents—calm and inviting on the surface while seducing us into taking the plunge and inevitably dragging us out to sea. Assuming we stay the current course, the future will likely require a new analogy: gazelle sprinting across the savanna. In the online world, the gazelle all have trackers. The lions can determine when the gazelle are thirsty or tired. They know where each gazelle is, and where, based on its routines, it is likely to go. With all the data, the gazelles’ instincts and nerves appear as patterns on a screen. Pinch a bundle of fibers here, see the sensation produced in the brain neuron there, get the desired behavioral response now. Even if there is an honest pride of lions, which seeks to give the gazelles a sporting chance, their pride will thin out, as other prides increase in size because they are hunting their prey with ever-greater efficiency.
What’s most alarming about this overdose is that unlike what happened with the two overdoses described in the previous chapters, businesses in this overdose all profit handsomely from the competition, so they have little incentive to halt the competition. Indeed, the very nature of competition has now been changed—from sellers trying to figure out how best to attract us by improving service and quality and reducing price to trying to figure out how best to exploit us.
Since the rivals don’t want this toxic competition to end, they want to be sure no one intervenes to protect us. So they’ll decry regulation as paternalistic and appeal to our rugged individualism. As we’ll see later, they will prescribe competition as the cure.
If we continue to accept this explanation, then we will indeed become prey—stalked with ever increasing skill and sophistication. Firms will track our behavior, collect data about us, and use this information to better exploit our weaknesses. Occasionally, we might escape our trackers, with their personalized advertisements, promotions, and pricing. But, over the long term, as we limp across the savanna, most of us are going to get savaged.
Or we can demand change. But before we do, let us see our final competition overdose.