Use this URL to cite or link to this record in EThOS: https://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.724493
Title: Essays in industrial organisation : price competition, strategic obfuscation, advertising & consumer behaviour
Author: Edwards, Robert Andrew
Awarding Body: University of Liverpool
Current Institution: University of Liverpool
Date of Award: 2017
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Abstract:
This thesis explores the incentives for firms to introduce unnecessary complexity into their pricing schemes or product information with the intention of confusing consumers, a practice that industrial economists refer to as strategic obfuscation. This type of behaviour includes firms decomposing their price into excessively many components, using non-standard terminology or measurements 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 required for consumers to locate a product or its price, within a store or on a website. 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 that safeguard consumers and enhance the competitive process. This thesis is organised as three related articles with distinct contributions. In Chapter 2, I present a comprehensive review of both the theory and evidence relating to obfuscation and price competition. The primary contribution is to provide an overview of this substantial body of literature. The secondary contribution is to highlight several inconsistencies across this research area. This motivates further study and the subsequent chapters contained in this thesis. 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 obfuscate their prices. This idea has not been fully explored in the context of strategic obfuscation and draws insights from the related disciplines of Law, Marketing and Psychology. 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 firms commit to the complexity of their pricing scheme before selecting their price. This captures 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 with which consumers can navigate a firm's website to identify the price, or the complexity of the terms and conditions attached to the product's price. One contribution of Chapter 3 is to formally introduce the idea that consumers are biased towards simple pricing schemes and to investigate this idea further than has been considered by previous studies. The central tension borne out in the model is that a firm can soften price competition in the market by obfuscating its prices, which prevents more consumers from identifying the seller with the lowest price. This incentivises firms to obfuscate their prices. However, confused consumers prefer to purchase from the firm with the least complex pricing scheme. Therefore, the seller that obfuscates most will obtain a smaller fraction of the consumers who are confused. This places downward pressure on the incentive for each firm to obfuscate. In equilibrium, this incentive structure induces a mixed strategy in both prices and obfuscation for firms. Therefore, sellers randomise both their price and the complexity of their price according to well-defined probability distribution functions. This is consistent with the behaviour of firms in 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 obfuscation and follow a mixed strategy in pricing their product. The impact of simplicity biased consumers on consumer welfare is particularly novel and interesting. 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 subsequently intensifies and firm profit decreases. It is demonstrated that the presence of simplicity biased consumers, who are biased towards the simplest and most expensive firm, can reduce average prices in the market and increase consumer welfare. In this direction, Chapter 3 investigates the implications of policies to inform consumers that firms may attach a price premium to simple pricing schemes. I show that such policies can often leave consumers worse off. In Chapter 4, I consider a restatement of the model developed in Chapter 3. The primary difference is that firms select their price and obfuscation level simultaneously. This captures market settings in which obfuscation and prices are both instantaneously adjustable. Therefore, obfuscation in this framework includes: The quantity of dimensions used in a pricing scheme and the complexity of the units used to express the total price. In the fully simultaneous framework in Chapter 4, the firm with the highest price chooses the 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 from the cheaper rival. Therefore, consumers who are biased towards the simplest pricing scheme 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 consumer welfare. 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 and firms' advertising campaigns. This sharpens our understanding of the circumstances in which it is profitable for firms to stimulate and suppress consumers' 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 consumers who are able to compare prices. Advertising determines whether consumers perceive a firm's price to be simple or complex. Therefore, a firm in the extended model is able to combine an intrinsically complicated price scheme that is difficult for consumers to compare, with advertising that makes the price scheme appear simple. I show that this distinction elicits a novel form of false advertising that has become a common practice in retail markets but is absent from academic research. In Chapter 5, I conclude this thesis by discussing the overarching contributions of the models in the context of the wider literature. I also outline several specific avenues for further research that builds directly on the work reported in this thesis.
Supervisor: Gu, Y. ; McCabe, B. ; Rao, Y. Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID: uk.bl.ethos.724493  DOI:
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