Essays in Industrial Organisation Price Competition, Strategic Obfuscation, Advertising

175 Pages·2017·0.83 MB·English

Essays in Industrial Organisation
Price Competition, Strategic
Obfuscation, Advertising
& Consumer Behaviour
Thesissubmittedinaccordancewiththerequirementsof
TheUniversityofLiverpoolforthedegreeof
DoctorofPhilosophy
by
Robert Andrew Edwards
DepartmentofEconomics,Finance&Accounting
January2017
Thisthesisisdedicatedto
RebekahMcCarthy,
Frank&MaryYoung.
Acknowledgements
There are several individuals to whom I must extend my sincere gratitude. Firstly, to
ProfessorGaryCook,HeadofDepartmentofEconomics,FinanceandAccounting,for
inspiring me to pursue postgraduate studies. Gary has supported my development
throughout my academic education. His enthusiasm, encouragement and direction
willhavealastingimpactonmyapproachtobothresearchandteaching.
Secondly, I am indebted to my advisors: Dr. Yiquan Gu, Professor Brendan McCabe
and Dr. Yao Rao. Yiquan’s expertise in the application of Game Theory to topics in
IndustrialOrganisationstimulatedmyinterestinthisresearcharea. Brendan’swealth
ofknowledgeandexperiencehasbeeninvaluableindevelopingthisthesis.
Thirdly,ImustthankthemembersoftheMicroeconomicsResearchGroupattheUni-
versity of Liverpool Management School. Special thanks are due to Professor Do-
minique Demougin and to Dr. Robert Routledge. I must also thank my friends and
doctoralcolleagues: Claire,Sam,Michael,Yazan,Christiane,Harvey&Sanna.
Theresearcharticlescontainedinthisthesishavealsobenefitedfromcommentsatsev-
eralinternationalconferencesincluding: NorthWestDoctoralTrainingCentreAnnual
Conference (2015), Bielefeld Doctoral School Workshop on Economic Theory (2015),
Workshop on Game Theory & Social Choice at the University of Hungary (2015) and
the Annual Royal Economic Society Conference held at the University of Brighton
(2016). I also gratefully acknowledge the financial support of the Economic & Social
ResearchCouncil.
Finally, I must thank Rebekah and my family for their constant support throughout
my academic studies, without whom the production of this thesis would not have
beenpossible.
Contents
1 Introduction 1
2 Obfuscation,StrategicPricing&ConsumerBehaviour. 4
2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
2.2 Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2.2.1 Multi-DimensionalPricing&CompositeProducts . . . . . . . . . . . . . . . . 6
2.2.1.1 EndogenousConsumerSophistication . . . . . . . . . . . . . . . . . 10
2.2.2 PriceFramingEffects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
2.2.3 Salience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
2.2.3.1 AttentionGrabbingProducts . . . . . . . . . . . . . . . . . . . . . . . 23
2.2.4 SearchCosts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
2.2.4.1 Multi-ProductRetailing . . . . . . . . . . . . . . . . . . . . . . . . . . 28
2.2.5 FrequentlyChangingPrices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
2.3 Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
2.3.1 EmpiricalEvidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
2.3.2 Experiments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
2.3.2.1 DifferentiatedProducts . . . . . . . . . . . . . . . . . . . . . . . . . . 51
2.3.2.2 NaturalIncreasesinChoice . . . . . . . . . . . . . . . . . . . . . . . 57
2.3.2.3 Salience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
2.4 SimplicityBiases: Theory&Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
2.5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
3 CompetitionwithSimplicityBiasedConsumers 75
3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
3.1.1 SummaryofMainResults . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
3.1.2 RelatedLiterature. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
3.2 AModelofCompetitionwithSimplicityBiasedConsumers . . . . . . . . . . . . . . 82
3.3 EquilibriumPricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
3.3.1 SymmetricPricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85
i
3.3.2 AsymmetricPricing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
3.4 EquilibriumObfuscation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
3.4.1 SymmetricEquilibria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
3.4.2 AsymmetricEquilibria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92
3.4.3 MixedStrategyEquilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
3.5 WelfareAnalysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
3.6 Discussion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
3.6.1 TheRoleofTiming . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
3.6.2 DivergentConsumerPreferences . . . . . . . . . . . . . . . . . . . . . . . . . . 100
3.6.3 CostlyObfuscation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
3.6.4 FurtherExtensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
3.7 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102
3.8 AppendixA:MainProofs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
3.9 AppendixB:AlternativeCharacterisationofFirmProfit. . . . . . . . . . . . . . . . . 110
3.10 AppendixC:SupplementaryMaterial . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
4 PromotionswithBiasedConsumers 113
4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113
4.1.1 RelatedLiterature. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117
4.2 TheModel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120
4.2.1 EquilibriumPayoffs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123
4.2.2 EquilibriumObfuscation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126
4.2.3 DerestrictingtheSimplicityBias. . . . . . . . . . . . . . . . . . . . . . . . . . 127
4.2.4 FirmProfit&PriceDistributions . . . . . . . . . . . . . . . . . . . . . . . . . . 127
4.2.5 DecreasingMarginalEffectofObfuscation . . . . . . . . . . . . . . . . . . . . 128
4.3 ComparativeStatics&PolicyMeasures . . . . . . . . . . . . . . . . . . . . . . . . . . 129
4.3.1 ComparativeStatics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129
4.3.2 PoliciestoImproveConsumerSophistication . . . . . . . . . . . . . . . . . . . 130
4.3.3 AnIllustrativeExample . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132
4.4 EndogenousSimplicityBiases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134
4.4.1 StrategicAdvertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134
4.4.2 FalseAdvertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136
4.5 Discussion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137
4.5.1 PolicyImplications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140
4.5.2 HypothesesforExperimental&EmpiricalResearch . . . . . . . . . . . . . . . 140
4.5.3 Limitations&Extensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141
ii
4.6 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142
4.7 AppendixA:MainProofs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143
4.8 AppendixB:SupplementaryMaterials. . . . . . . . . . . . . . . . . . . . . . . . . . . 151
5 Conclusion&FurtherResearch 157
5.1 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
5.2 FurtherResearchProjects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161
5.2.1 LowIncomeConsumersandAdd-OnInsuranceProducts . . . . . . . . . . . 161
5.2.2 CommercialObfuscation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162
Bibliography 163
iii
List of Figures
2.1 Hossain&Morgan(2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
2.2 TreatmentTypes: Taiwan,Brownetal(2010). . . . . . . . . . . . . . . . . . . . . . . . 47
2.3 TreatmentTypes: Ireland,Brownetal(2010). . . . . . . . . . . . . . . . . . . . . . . . 47
2.4 KalayciandPotters(2011). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
3.1 SymmetricPricing: {L,L} . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
3.2 SymmetricPricing: {H,H} . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
3.3 AsymmetricPricing: {L,H} . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
3.4 AsymmetricPricing: {L,H} . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
3.5 EquilibriumObfuscationI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
3.6 EquilibriumObfuscationII. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
4.1 EquilibriumPricing: δ < δc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123
4.2 ProbabilityAssignedtoLowComplexity . . . . . . . . . . . . . . . . . . . . . . . . . 132
4.3 PriceDistribution(δ = 0.25) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133
4.4 PriceDistribution(δ = 0.4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133
iv
Chapter 1
Introduction
Thisthesisexplorestheincentivesforfirmstointroduceunnecessarycomplexityintotheirpricing
schemesorproductinformationwiththeintentionofconfusingconsumers,apracticethatindus-
trial economists refer to as strategic obfuscation. This type of behaviour includes firms decom-
posing their price into excessively many components, using non-standard terminology or mea-
surements to express their price, using mathematically complex prices and updating their prices
frequently. Obfuscation also includes the ability of firms to increase the difficulty, time or effort
requiredforconsumerstolocateaproductoritsprice,withinastoreoronawebsite.
Obfuscation is a growing concern for competition authorities. In the UK, the Competition &
Markets Authority reports that complex pricing harms retail market competition by suppressing
consumer engagement and limiting switching between sellers.1 Therefore, understanding the
precise incentives for a firm to obfuscate, enables competition authorities to formulate policies
thatsafeguardconsumersandenhancethecompetitiveprocess.
This thesis is organised as three related articles with distinct contributions. In Chapter 2, I
presentacomprehensivereviewofboththetheoryandevidencerelatingtoobfuscationandprice
competition. Theprimarycontributionistoprovideanoverviewofthissubstantialbodyofliter-
ature. Thesecondarycontributionistohighlightseveralinconsistenciesacrossthisresearcharea.
Thismotivatesfurtherstudyandthesubsequentchapterscontainedinthisthesis.
In Chapter 2, I also review how consumers tend to respond to obfuscation strategies of firms
in retail markets, which remains an under-researched topic. I document strong evidence for a
simplicity bias by consumers, according to which buyers actively discriminate against firms that
obfuscatetheirprices. Thisideahasnotbeenfullyexploredinthecontextofstrategicobfuscation
anddrawsinsightsfromtherelateddisciplinesofLaw,MarketingandPsychology.
In Chapter 3, I present a model in which each firm selects a pricing scheme that consists of
a price for their product and a complexity level with which to present their price. In the game,
1www.gov.uk/government/news/cma-proposes-better-deal-for-bank-customers.www.gov.uk/government/news/cma-
sets-out-case-for-energy-market-reform.Accessed03/16.
1
Chapter1.0
firmscommittothecomplexityoftheirpricingschemebeforeselectingtheirprice. Thiscaptures
the idea that prices can be adjusted quickly but the complexity of the pricing scheme requires a
longer time to adjust. Therefore, obfuscation in this model might specifically include: The ease
withwhichconsumerscannavigateafirm’swebsitetoidentifytheprice,orthecomplexityofthe
termsandconditionsattachedtotheproduct’sprice.
One contribution of Chapter 3 is to formally introduce the idea that consumers are biased to-
wards simple pricing schemes and to investigate this idea further than has been considered by
previousstudies. Thecentraltensionborneoutinthemodelisthatafirmcansoftenpricecompe-
titioninthemarketbyobfuscatingitsprices,whichpreventsmoreconsumersfromidentifyingthe
seller with the lowest price. This incentivises firms to obfuscate their prices. However, confused
consumersprefertopurchasefromthefirmwiththeleastcomplexpricingscheme. Therefore,the
sellerthatobfuscatesmostwillobtainasmallerfractionoftheconsumerswhoareconfused. This
placesdownwardpressureontheincentiveforeachfirmtoobfuscate.
Inequilibrium,thisincentivestructureinducesamixedstrategyinbothpricesandobfuscation
forfirms. Therefore,sellersrandomiseboththeirpriceandthecomplexityoftheirpriceaccording
towell-definedprobabilitydistributionfunctions. Thisisconsistentwiththebehaviouroffirmsin
modern retail markets. In addition, the firm with the least complex pricing structure will charge
the highest price, to capitalise on consumers’ preferences for simple pricing. If the simplicity
biases of confused consumers are removed from the model, firms universally select maximum
obfuscationandfollowamixedstrategyinpricingtheirproduct.
The impact of simplicity biased consumers on consumer welfare is particularly novel and in-
teresting. Simplicity biased consumers buy from the firm with the lowest obfuscation and this
firm charges the highest prices, which increases firm profit. However, the presence of simplicity
biased consumers exerts downward pressure on the incentives for firms to obfuscate. This leads
to lower obfuscation and enables more consumers to understand prices. Price competition sub-
sequently intensifies and firm profit decreases. It is demonstrated that the presence of simplicity
biasedconsumers,whoarebiasedtowardsthesimplestandmostexpensivefirm,canreduceav-
eragepricesinthemarketandincreaseconsumerwelfare. Inthisdirection,Chapter3investigates
theimplicationsofpoliciestoinformconsumersthatfirmsmayattachapricepremiumtosimple
pricingschemes. Ishowthatsuchpoliciescanoftenleaveconsumersworseoff.
InChapter4, IconsiderarestatementofthemodeldevelopedinChapter3. Theprimarydif-
ferenceisthatfirmsselecttheirpriceandobfuscationlevelsimultaneously. Thiscapturesmarket
settings in which obfuscation and prices are both instantaneously adjustable. Therefore, obfus-
cation in this framework includes: The quantity of dimensions used in a pricing scheme and the
complexityoftheunitsusedtoexpressthetotalprice.
2
Chapter1.0
InthefullysimultaneousframeworkinChapter4,thefirmwiththehighestpricechoosesthe
most complex price scheme. The intuition follows that the least competitive firm benefits most
from confusing consumers because consumers who are able to evaluate prices will always buy
fromthecheaperrival. Therefore,consumerswhoarebiasedtowardsthesimplestpricingscheme
will obtain a lower price than if they had selected a seller at random. The welfare impact of the
simplicity bias is also now unidirectional. Biased consumers purchase from the cheapest seller
and their presence continues to suppress firms’ obfuscation incentives, which always increases
consumerwelfare.
In a series of extensions, I develop the model to explore the implications of several consumer
protection and competition policies. This includes policies that influence consumers’ aversion
to complex prices, and policies that enable more consumers to compare the prices available for
any given level of market complexity. The strength of consumers’ preference for simple pricing,
termed the degree of simplicity bias, is also endogenised as a function of both regulatory policy
andfirms’advertisingcampaigns. Thissharpensourunderstandingofthecircumstancesinwhich
itisprofitableforfirmstostimulateandsuppressconsumers’biases.
In Chapter 4, I also distinguish between obfuscation and advertising. This distinction is not
present in mainstream models of obfuscation. The strategy for each firm now consists of three
dimensions: Pricing, obfuscation and advertising. Obfuscation determines the fraction of con-
sumers who are able to compare prices. Advertising determines whether consumers perceive a
firm’spricetobesimpleorcomplex. Therefore,afirmintheextendedmodelisabletocombinean
intrinsicallycomplicatedpriceschemethatisdifficultforconsumerstocompare,withadvertising
that makes the price scheme appear simple. I show that this distinction elicits a novel form of
falseadvertisingthathasbecomeacommonpracticeinretailmarketsbutisabsentfromacademic
research.
InChapter5,Iconcludethisthesisbydiscussingtheoverarchingcontributionsofthemodels
in the context of the wider literature. I also outline several specific avenues for further research
thatbuildsdirectlyontheworkreportedinthisthesis.
3