CeDEx Seminar (joint with Senior Aceademic Seminar Series) - Ernst Fehr (University of Zurich)

Obfuscation in Competitive Markets

In many markets, firms increase product complexity through add-on features, which can make the evaluation and comparison of products difficult and thus increase buyers’ search cost. Does this product obfuscation limit buyers’ search behaviour and induce them to buy overpriced products? And if so, why does competition not eliminate obfuscated products? We show – based on competitive experimental markets – that if add-ons merely complicate the products without generating additional surplus, obfuscation via product complexity indeed becomes fragile because buyers display an aversion against complex products. However, in the presence of surplus-enhancing add-ons, obfuscation via product complexity becomes a stable market feature that severely constrains the depth and breadth of buyers’ search. Sellers anticipate and take advantage of this by hiding unattractive product features and selling add-ons persistently above marginal cost. Even the most favourably priced product in the market is offered above marginal cost, and buyers persistently fail to find the best product such that inferior products have a good chance of being bought, leading to enduring price dispersion. Surplus-enhancing obfuscation opportunities are the causal driver of persistent profits and price dispersion because if we remove these opportunities, overall prices quickly converge to marginal cost.