Released: July 22, 2006

Naïve consumers pay all the fees

Source: By Damon Darlin (Free Registration)

When Xavier Gabaix and David Laibson open a hotel room minibar, they see among the tiny liquor bottles and European chocolates a perpetual battle between companies charging hidden fees and the sophisticated consumer trying to avoid them.

The two economics professors — Mr. Laibson at Harvard and Mr. Gabaix at the Massachusetts Institute of Technology and Princeton — have looked at how companies hide fees and costs. They found that sophisticated consumers have somehow learned how to game the system by having enough naïve consumers around to subsidize them.

The smartest strategy, they say, is for the sophisticated consumer to choose the service with the most hidden charges and highest add-on prices, but then avoid paying those added costs. “The sophisticated consumer takes advantage of that,” Mr. Gabaix said. “The naïve pay all the fees.”

Companies hide add-on costs, of course, because it is lucrative. Hewlett-Packard sells inexpensive printers and makes its profit on high-margin replacement ink cartridges that can cost half as much as the printer. The fastest-growing segment of Wells Fargo & Cos banking business is income from fees, up 14 percent in the latest quarter.

Consumers see fees everywhere, in their cellphone and credit card bills, mail-order invoices, mutual fund statements, car rental and hotel charges. Actually, most consumers (particularly those who do not start their Saturday mornings reading financial advice) do not see them or they spot them too late. And that myopia perplexed the two professors.

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