Shrouded Attributes as Sludge

King C. Gillette, the founder of the razor company bearing his name, is said to have invented the marketing strategy of giving away the razor and making the money on the blades. The idea is that if the razor is essentially free and you get customers into the habit of buying blades from Gillette, then the company will be able to charge a higher price for the blades. The model seems to have worked: Gillette still sells a substantial percentage of the razor blades in the United States, and its blades are found all around the world. We don’t find anything especially troubling about the razor example (the cost of switching is pretty low), but the same model is used in several markets with higher stakes, such as inkjet printers. The strategy here: sell the printer cheap and make the money on the ink.

From the standpoint of consumers’ welfare, the problem is that it can be hard for people to know the real cost of using a printer. Suppose you find a model online with features such as wireless printing for less than $100. But try to find out how much the ink costs and how often you have to replace the cartridges, and you will have more trouble. Furthermore, printers are often designed so that they will not accept ink cartridges from other suppliers (to make sure that your valuable printer is not damaged, of course).

The ink cartridges are an example of what behavioral economists Xavier Gabaix and David Laibson call “shrouded attributes.” 5 The headline price of the good understates the true cost to the user because the shrouded attributes, and their costs, are hard to discover. Hotels are notorious for shrouding the prices of various services such as parking and wi-fi, and they sometimes hit guests with something called a “resort fee,” which is not an optional extra. As anyone who has been unfortunate enough to have to get a suit cleaned at a hotel has learned, the cost is usually at least two or three times that of a local dry cleaner. Of course, an economy-minded hotel guest can find a local service provider and get the suit cleaned there, but whether traveling on business or for pleasure, it can be hard to find the time to run errands.

In our view, shrouded attributes should be seen as a source of sludge. To identify them, consumers, patients, investors, and others have to navigate their way through a viscous mixture. Shrouded attributes make shopping far more difficult. Of course, if comprehensive Smart Disclosure were incorporated into good travel choice engines, the problem would be greatly mitigated, at least for travel (until hotels think up new things to charge extra for, such as using the shower). But until that day comes, this is a market with a lot of sludge. The credit-card market, discussed in Chapter 11 of the source, also includes a lot of shrouded attributes, and that is true more generally for many retail banking services. A checking account is free as long as you keep a certain balance, but what if you dip below that balance? Then what happens?

It is reasonable to ask why competition among hotel chains or banks doesn’t eliminate this sludge, but it should be easy to see why it has not happened. Suppose Cheap Bank advertises “Free Checking!” and makes all its money on sneaky fees. Let’s suppose that the cost to the bank of maintaining a checking account is $100 per year, and a competitor comes in and offers “Checking account for just $100 and No Hidden Fees.” Who is going to win this battle? No one opens a checking account intending to bounce checks, just as no one intends to scratch the entire back quarter of their car pulling into a parking garage. Somehow stuff happens.

Subscription traps, rebates, and shrouded attributes can all make pricing less transparent. That is obviously true for the latter two examples, but its relevance to the subscription trap may be less clear. One of the reasons why magazines, cable companies, and gyms make it hard for people to quit is that they want to price discriminate—that is, charge varying prices for the same product (one month of service). The way they can accomplish this is to make some prices available only to those who make a fuss, for example by threatening to quit!

Suppose that a customer service agent (on the phone or via an online chat) asks customers why they want to unsubscribe. If the answer is, “It costs too much,” they are armed with a “special deal we can offer to loyal customers.” In fact, just the opposite is true. This is a special deal that is available only to disloyal customers who threaten to leave. Some credit cards that charge an annual fee will waive it to anyone who threatens to cancel the card. This is price discrimination via sludge. As customers, we prefer to deal with businesses that post their prices and don’t offer lower prices just to those who complain. That is also the way we would choose to run a business.