Bruce Carlin


Firms seek revenues by confusing customers

Assistant Professor Bruce Carlin believes that product managers commonly use complex marketing and pricing strategies to baffle consumers and boost profits. According to Carlin, consumers face particular challenges shopping for financial products such as mutual funds, mortgages and credit cards. "The number of financial products on the market is staggering," he says. Newcomers in the market have more to learn before making a decision, and experienced consumers have a harder time keeping up.

Buyers face similar challenges shopping for cars, computers and many other products, according to Carlin. While sophisticated consumers may learn what to buy and how much to pay, unsophisticated consumers can be overloaded with information and choices.

Carlin refers to this marketing ploy as obfuscation. He says it goes back forever -- but is becoming increasingly sophisticated thanks in part to the Internet. "Consumers have access to more information than ever before -- most of which is managed by marketers," he says, "Consumers can make suboptimal choices in the face of too much information."

And Carlin points out that the more knowledgeable consumers become, the more firms, "shuffle the deck." Obfuscation is when firms add frictions to consumer learning, he says. "By keeping things somewhat confusing, firms gain rents. When there are more rents to be gained, obfuscation increases."

Carlin recently developed a mathematical model of mutual fund transactions to illustrate this phenomenon. The project is described in a paper co-authored by Gustavo Manso called, "Obfuscation, Learning and the Evolution of Investor Sophistication."

"We assumed that the consumer base is comprised of experts and non-experts," Carlin explains. The hypothetical market was populated with a variety of products and prices. "As things change in the market, experts catch on quickly and always get the best deal. As time passes, non-experts can learn by reading or by interacting with experts. However, the firm can counter this with new products or prices. This is a very dynamic setting in which obfuscation evolves over time."

In the paper, Carlin takes the perspective of a social planner who wants to maximize welfare for both buyers and sellers. What is the optimal amount of education for consumers and how often should sellers shuffle products and pricing? The trick is to minimize the total costs associated with education and obfuscation -- and contain the number of consumers driven to flee the market in frustration.

One finding is that a small investment in education, like creating a new Web site, is not likely to help consumers and may even hurt. "This induces firms to shuffle the deck more frequently, which causes a welfare loss," says Carlin. So if a government wants to educate investors, it had better do so on a grand scale. But this can be expensive.

Carlin suggests a couple alternatives. One is to provide investors with the option of having an expert make their investment decisions. "This makes you an expert by proxy," he says. Carlin points out that this could reduce obfuscation since it would decrease potential rents in the market.

Another option for a government is to encourage competition in its financial markets. Carlin's study shows that increased competition should reduce the number of redundant products in a market, decrease obfuscation and increase overall welfare. "In a market with perfect competition, obfuscation could disappear completely," he says.

"What's novel here," he explains, "is that typically we just look at the consumer side and say it has to be a good thing if consumers are more educated. But you can't ignore the fact that firms manipulate markets by controlling information about their products. You have to take into account their potential responses."

Carlin's study provides a new perspective on a prevailing view about investing. "We always encourage consumers to buy mutual funds," he continues, "and that does have a welfare benefit, but we ignore the fact that firms will make a market more complicated as it expands. So there is a trade-off to consider."

Carlin says that his study offers the first dynamic view of obfuscation and that the topic will increase in importance as markets become more complex. "The number of share classes and redundant mutual funds has just exploded," he says. Many educated and sophisticated people have no idea what they're doing in the financial markets. People just don't have the time to be an expert in everything."

Carlin hopes that studies like this will help make financial markets more competitive. "There shouldn't be big markups on mutual funds or home loans," he says. "They should be competitive -- but they're not. The fees charged by credit card companies and the rules concerning when your interest rate goes up are very opaque and hard to understand. So I think this is an important thing to be looking at."