the undercover economist

Minibar Economics
Why you should stay at hotels that overcharge for drinks and Wi-Fi access.
By Tim Harford from Slate.com
Posted Saturday, Feb. 17, 2007, at 6:29 AM ET

There are, of course, two types of charges: the ones you see coming and the ones you don't. I write this from an inexpensive hotel room, but you would not guess that looking at the price list in front of me. Two dollars a minute for phone calls (price on the Planet Earth: 10 cents), $20 for a day's wireless access (Earth price: $20 a month), $4 for a chocolate bar. It's like being in some bizarre alternate universe. If I'd known in advance that the hotel was going to try to pick my pocket, I might have considered staying somewhere that cost a little more up front and charged terrestrial prices for all the add-ons.

Perhaps, however, these hidden extras aren't quite so bad. In fact, I think the world might be more expensive—and more unfair—without them. If that seems counterintuitive, it's because we tend to assume that the alternative to hidden charges is no charges at all.

That seems unlikely. The hotel room is fairly cheap because the hotel wants to get me through the door, hoping that I'll spend more lavishly on the phone and the minibar than I will on the room itself. The more incontinent my spending habits, the more it is worth having me as a guest, and the lower the advertised price will fall. The logical extreme is the complimentary VIP suite in Las Vegas for the high-rolling gambler.

So, the large print giveth, and the small print taketh away. The interesting question is whether the effects balance each other out. You might expect that hidden charges would blunt the forces of competition. They certainly can, to the extent that they make price comparisons more difficult—and that effect is likely to be pernicious. Observing that one hotel room is $100 and another is $120, I can pay my money and take my choice. It is more difficult to make a straightforward comparison if I know that I could be charged whimsically high rates—or, perhaps, nothing at all—for wireless access or breakfast.

I am unlikely to stay in a hotel chain simply because I have done so before, but for other products, such as a razor and the compatible razor blades, I am buying into a stream of purchases. Here, hidden charges can sharpen competition instead of blunting it. Famously, the razor is cheap, and the blades are expensive. The idea is both to conceal the true price and to charge more to hirsute customers—who presumably value the razor highly. But the side effect is that it becomes relatively cheap to switch brands. An expensive razor and cheap blades might seem more honest, but if it were so expensive to change razors, would the blades stay cheap for long?

Another notorious example is the overpriced printer cartridge. This is simply a way of charging heavier users a higher price. If manufacturers were forced to price their cartridges at cost, printers themselves would become much more expensive—and the price would be especially painful for light users.

Hidden charges do seem to aggravate a lot of customers—witness perennial campaigns against sneaky bank charges. So, it is something of a mystery as to why we don't see more companies come out with advertising campaigns boasting about their what-you-see-is-what-you-get pricing.

Economists Xavier Gabaix and David Laibson recently published an ingenious explanation for why such campaigns are rare. If one bank has tempting interest rates but hidden fees while the rival offers lower rates but no hidden fees, an advertising campaign could easily backfire.

"Our prices include no hidden fees" is a nice enough slogan, but the implicit message to sophisticated customers is, "If you are good at avoiding hidden fees, you might care to bank with our rivals."

The advertising campaign would drive sophisticated customers toward the exploitative competitor where, being sophisticated, they would not allow themselves to be exploited. Meanwhile, the no-hidden-fees bank would attract naive customers but fail to take advantage of their naiveté. The result would be that the expensive adverts pushed both types of customer to where they would spend less, and both companies would be worse off.

Sophisticated readers may care to seek out companies that charge hidden fees. Steer clear of the minibar, and you may get an excellent deal.

Tim Harford is a columnist for the Financial Times. His latest book is The Undercover Economist, which will be published in paperback on Jan. 30, 2007.

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