Inducing consumer paralysis: how retailers bury customers in an avalanche of choice

How retailers bury customers in an avalanche of choice.

The retail ‘trick’ that costs you money

Robert Slonim, University of Sydney

Do you think you are paying more than you should for energy, banking, insurance, internet and phone services? You are not alone, and you are probably right.

Companies offer a growing number of deals that supposedly enable you to choose what is best for you. Every basic economics textbook tells us greater choice should deliver cheaper prices. But in reality this isn’t necessarily the case.

So what’s going on?

A big part of the answer is that businesses are taking advantage of the behavioural phenomenon of “consumer paralysis” to maximise profits.

They provide us with many plans and deals to make us feel like we are in control, but too many choices actually leads most of us to make a bad (or no) choice.

Energy pricing

Let’s consider how this works in the context of Australia’s electricity market.

In most areas of the country, residential customers have at least half a dozen retailers to choose from.

Market share by generation capacity by region, January 2018. ACCC, Retail Electricity Pricing Inquiry Final Report

Nonetheless, according to the Australian Consumer and Competition Commission (ACCC) , electricity prices and profit margins are among the highest in the world, and rising. The consumer watchdog calculates that in the decade to 2018 the average residential electricity bill increased by 55 per cent (or 35 per cent in real terms) – and only a very small part of that had to do with alleged culprits such as renewable energy.

Read more: Energy prices are high because consumers are paying for useless, profit-boosting infrastructure

Australia’s biggest electricity company, AGL, made a net profit of A$1.6 billion in 2018 – 194 per cent more than the year before.

Depending on where you live, AGL offers up to 11 energy plans to residential customers. There’s the “Savers” plan, “Savers Online”, “Everyday”, “Freedom”, “Standing Offer”, “Essentials”, “Essentials Plus”, and so on.

Each plan, in turn, has four to eight tariff type options: “Flexible Price”, “Time of Use Interval”, “5 Day Time of Use”, “Single Rate”, “Two rate: single rate with controlled load”, “Single Rate Demand Opt-in”, and so on.

That adds up to literally dozens of price plans from just one retailer. Other companies are hardly better. For a customer in inner Sydney, there are more than 350 retail plans to choose from.

All this “choice” gives the appearance of a competitive market, but its effect is the opposite. It give retailers wriggle room to charge more, not less.

Experiments in choice behaviour

Many experiments over the past three decades have demonstrated the ubiquity of too much choice leading to consumer paralysis.

One classic experiment was run by psychologists Sheena Iyengar and Mark Lepper in a San Francisco supermarket in 1999. Customers visiting the store were given a chance to sample jams. Half the time they were allowed to taste up to six jams; the other half they could taste up to 24 jams.

Traditional economics says a consumer is much more likely to find a jam they really like with a sample of 24 rather than six. So offering 24 jams should lead to more jam purchases.

Yet exactly the opposite was found. Of the consumers who chose to taste jams, only three per cent of those who could sample 24 jams ended up buying jam, whereas 30 per cent (or 10 times more) of those who could sample just six jams ended up buying.

More choices provided, more paralysis.

Sheena Iyengar explains the jam problem.

More recently, in 2012, Iyengar’s Columbia University colleague Eric Johnson and others reported on an experiment with much greater consequences.

They asked people to choose health insurance coverage from a set of four or eight options. The options varied on monthly premiums and deductibles. When given four options, 42 per cent of subjects chose the best value option. On average their choices cost about $200 more than the best option on offer.

When given eight options, only 21 per cent chose the best option – no better than simply making a random choice.

Read more: Confusopoly: Why companies are motivated to deliberately confuse

Reinforcing psychological biases

Given the massive number of products and plans available in the energy, banking, insurance, internet and mobile phone sectors, the time and effort needed to choose the best deal leaves us feeling overwhelmed and overloaded. In response, we rely on shortcuts (rules of thumb) to save both time (and our sanity).

But these shortcuts can also cause biases that result in further paralysis, including:

Present bias – we put much greater weight on the present than the future. Since the cost of making decisions happens in the present (like the time and effort to compare options and switch services) while the benefits happen later (like saving money), we minimise the time we spend making decisions

Status quo bias – we tend to stick with a chosen option or default, even when a much better option may be available

Loss aversion – we place much greater weight on losses and often overestimate the chance of a bad outcome.

There is considerable evidence pointing to how these biases lead to consumer paralysis in the retail banking and energy sectors.

In 2017, Britain’s energy regulator, Ofgem, ran a randomised control trial involving more than 130,000 electricity customers. Participants received personalised letters either from Ofgem or their current provider offering substantially better electricity deals.

The result: compared with the control group in which only one per cent switched tariffs within the next month, 3.4 per cent of those who received an offer from their electricity provider switched to a better deal. Even when presented with notable savings, more than 96 per cent stuck with the status quo.

Results of Ofgem’s Cheaper Market Offers Letter (CMOL) trial. Ofgem

Other Ofgem research shows that among those who have not switched energy plans, 51 per cent consider it a hassle they don’t have time for, and 48 per cent worry that things would go wrong.

Yvette Hartfree and her colleagues at the University of Bristol’s Personal Finance Research Centre have noted similar fears among bank customers: “The biggest concern for those considering switching is that something will go wrong at some point in the process of switching.”

Read more: Simpler account switching would help keep our banks honest

Taking action

We should not be surprised that energy companies and others use an avalanche of choice to confuse us. It is a brilliant business strategy: it seems more competitive from a traditional assessment, yet actually reduces competition.

So what can you do?

On your own, you will need to make a conscious effort to overcome paralysis. You need to devote the time to carefully compare offers.

Fortunately, you can find tools that can help, such as the Australian government’s energy comparison website. However, be wary of commercial “switching services” and websites that provide comparisons. These operations are often being paid by retailers. Their motives are not necessarily to direct you to the best deal.

What can we do collectively?

One option is government action to ensure switching services are trustworthy. At a minimum, there should be guidelines that switching services not take payments from retailers, and only charge you when you actually save money.

Another option is to form “consumer unions”, which can bargain collectively to get members better deals. The potential of community groups to leverage bulk-buying arrangements has demonstrated in other contexts. In Victoria’s Gippsland region, for example, local organisations have banded together to offer discounts on renewable energy technology.

There’s no reason something similar could not be done to overcome the choice problems induced by big energy retailers and the like.The Conversation

Robert Slonim, Professor of Economics, University of Sydney

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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    To make a comment, please register or login

    23rd Jul 2019
    Isn't this article a tad late? Hasn't the government addressed this marketing ploy by legislating that all offers are based on a set figure so that a discount can be shown to be comparing like with like?
    23rd Jul 2019
    And then we get companies like "One Big Switch" who capitalise on all this confusion with a promise that they have already done all the hard work and made the decision for you.

    What they have actually done is negotiate large commissions to direct you to a product which is most profitable for themselves and the suppliers.

    Over the past 4 years, their offers have been consistently more than a thousand dollars more expensive than my current plan with my current provider.

    23rd Jul 2019
    Exactly - and the only people who get a better rate are those who have been too lazy to do their own research and have done nothing about looking for a better rate. Suddenly OBS comes along, they get a cheaper rate, and thing it is wonderful! When ever I have checked out OBS for anything - electricity, health insurance - their rates are ALWAYS, ALWAYS dearer than what I am currently paying. And considerably dearer. OBS is only for the lazy.
    23rd Jul 2019
    Hawkeye, I read the terms and conditions and privacy statement of OBS which were enough to stop me in my tracks. If you want your personal information sold around the commercial world this would be a great way of doing it. What I don't understand with so many online providers is why they need so much personal information to provide a price.
    23rd Jul 2019
    the AAAC involved!!! .. what a joke they are!
    23rd Jul 2019
    the AAAC involved!!! .. what a joke they are!
    23rd Jul 2019
    Live in WA and you have NO choice when it comes to electricity suppliers !!!!!
    23rd Jul 2019
    fed up with all this comparison rubbish, the govts to pull its finger out and take control of the energy suppliers, by force if necessary, this madness has gone on long enough.
    23rd Jul 2019
    The government created this and should fix it along with new buildings and private certifiers, doctors who charge so much ( thanks for selling Medibank) and road tolls where in the same period cost of living went up 5% and tolls up to 50%
    Am sick of overpaid pollies whinging about Newstart and pensions DIGITUS EXTRACTUS
    23rd Jul 2019
    There are simpler examples, like the way big name brands occupy a lot of shelf space in super markets by providing a lot of trivial variation in the fragrance of their product. But if you want (fragrance free) its hard to get.
    24th Jul 2019
    Hawkeye, good consideration with regards to One Big Switch.

    To indulge my perspective:

    One direction that I champion is leveling the playing field. In particular, I feel that giving consumers information on the best deal and hoping they will act is not enough. We need a circuit breaker solution to address the deep-seated behavioural issues. A third party ‘switch service’ – who acts as an agent for consumers – I believe is the best chance we’ve got to overcome consumer paralysis, drive effective competition and shift profits from retailers to consumer pockets.

    What I have in mind is that third party services could act as an agent for consumers, searching the entire market and taking action where a consumer can save money. To maximize the benefits of the service for consumers, a well-designed energy switch service needs to meet six key criteria:

    - Continuously search the entire market for the best plan;Covering the entire market will be important. Many existing comparison sites only include a subset of market offers (generally from retailers who pay commissions to the comparison site).

    - Have access to individual consumer energy usage data; To offer the best deal to each consumer – based on their actual usage – an energy switch service needs regular easy access to consumer data that does not burden the consumer to find the plan that matches usage.

    - Have the power to switch a consumer to a better deal (with authority from the consumer); It is also important that consumers can grant authority to a third party to automatically switch on their behalf. This is critical, as consumers often find taking action just too much hassle, even when they’re guaranteed fairly substantive savings [Deller et al. (2017)].

    - Act in the best interests of consumers (and therefore not accept payments or commissions from retailers);Most comparison sites accept commissions and it is not always clear to consumers that a comparator has an affiliation with an electricity retailer. Trust will be a vital feature for any switch service – consumers need to trust the service with their personal data, and trust that an automatic switch will genuinely be in their best interest.

    - Be structured so that consumers can pay for the service when they save, and not before;The benefits of switching often come with a significant lag, and the consumer typically won’t see the counterfactual (that is, they aren’t reminded of how much they would have paid if they didn’t switch). Aligning payment for the service with quarterly bills, and explicitly drawing attention to the counterfactual will make savings salient, and avoid present bias.

    - Bargain collectively for consumers. An ideal energy switch service would operate on a large scale. This would allow the service to collectively bargain and counter-balance retailers’ market power.

    I also think the ACCC can play an important role:

    With the Consumer Data Right coming online, we can expect more players to enter the switching service market. But how will consumers know which service best meets the above six criteria? Government can play a critical role by ensuring third parties provide the best possible benefits to consumers. Accreditation or ratings systems are an easy way to help consumers quickly assess the quality of market offers. As the consumer regulator, the ACCC is well-placed to assess whether switch services are living up to their promises. Similar to the ACCC’s broadband performance dashboard, a rating or certification system (based on the six criteria, performance, ease of use and independence) could be the best way for government to support consumer interests.

    Switching and collective bargaining services with accreditation or ratings systems also have merit in other markets. This proposal has the potential to reshape the energy market landscapes. It is worth governments investing in this opportunity to drive competition and shift outcomes in favour of consumers.

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