Article Abstract: Reprint 4518; Fall 2003, Volume 45, Number 1, pp. 24-28

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CONTRARIA

In Praise of Honest Pricing

Barry Nalebuff and Ian Ayres

A great variety of companies — cell phone operators, rental car companies, video rental chains and many others — price their products and services in ways that confuse and irritate their customers, according to the authors. They lure people in with teaser rates, two-for-one-deals, “free” gifts and so on, and then slap them with late fees, charges for “extra” usage and other unanticipated costs.

The conventional wisdom is that such tactics are a good idea; after all, they allow companies to boost profits while seeming to price competitively. But, say the authors, hidden pricing can be harmful not only for consumers who can’t figure out what something really costs, but also for the businesses that engage in it. That’s because it isn’t enough to fool customers. Companies also have to fool their competitors with pricing games, and that is much harder to do. Rivals are equally good at fooling customers and will spend heavily to attract them. If competition forces a business to spend an extra $1 today in order to attract a customer worth an extra $1 tomorrow, neither the business nor the customer ends up any better off.

Using examples from the appliance industry and restaurant business, the authors show how companies that engage in honest pricing can enjoy important benefits — happier customers, clearer product differentiation and, consequently, higher profits.

Barry Nalebuff is the Milton Steinbach Professor of Economics at the Yale School of Management in New Haven, Connecticut, and Ian Ayres is the William K. Townsend Professor of Law at Yale Law School. They can be reached at Barry.Nalebuff@yale.edu and Ian.Ayres@yale.edu.

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