Selling Consumer Information

ABSTRACT - Two market failures impede the development of consumer information services. First, even uninformed consumers benefit from the search by a relatively small number of consumers. Second, consumers may share information among themselves. Both these factors make it difficult for an information service to become financially self-sufficient, if their only revenue source is sales of information to consumers. However, if the right to use an information service's results in advertising were sold to rated sellers, then revenues could be more nearly equal to the total social value of the information provided. While this strategy may entail some risk to the credibility of the information service, this risk seems small. The potential gains to the financial viability of the information system suggest that the strategy is worth exploring.

Citation:

Howard Beales and Steven Salop (1980) ,"Selling Consumer Information", in NA - Advances in Consumer Research Volume 07, eds. Jerry C. Olson, Ann Abor, MI : Association for Consumer Research, Pages: 238-240.

Advances in Consumer Research Volume 7, 1980     Pages 238-240

SELLING CONSUMER INFORMATION

Howard Beales

Steven Salop

[Bureau of Economics, Federal Trade Commission. The views expressed in this paper are those of the authors alone, and should not be construed as necessarily representing the views of the Commission or any individual Commissioner.]

ABSTRACT -

Two market failures impede the development of consumer information services. First, even uninformed consumers benefit from the search by a relatively small number of consumers. Second, consumers may share information among themselves. Both these factors make it difficult for an information service to become financially self-sufficient, if their only revenue source is sales of information to consumers. However, if the right to use an information service's results in advertising were sold to rated sellers, then revenues could be more nearly equal to the total social value of the information provided. While this strategy may entail some risk to the credibility of the information service, this risk seems small. The potential gains to the financial viability of the information system suggest that the strategy is worth exploring.

INTRODUCTION

It is generally agreed that consumer information is undersupplied by private markets and that consumers would benefit from more shopping information. Yet at the same time innovative consumer information services have only begun to fill this gap in the marketplace. In this brief paper, we discuss some of the reasons for this failure. Those suggest, in turn, an alternative strategy for information services that might be explored.

There are two separate, but related, strands in the explanation of the shortage of consumer information. One concerns the perceived benefits and costs of information gathering and the other deals with what economists call "market failures" in the market for information.

We will discuss the perceived costs and benefits of information only briefly, since they are well-known and analyzed elsewhere (Beales et al. 1979). Information is costly to gather, process and evaluate. These costs include the actual monetary costs of information as well as the time and energy required to analyze data collected. As a result, it is generally not cost-effective for consumers to become perfectly informed before making purchase decisions. Second, consumers often require some information in order to perceive the benefits of further learning. This suggests that information services might build a market by alerting consumers explicitly to the monetary gains from their information.

MARKET FAILURES

The manner and institutional structure by which information is transmitted through the marketplace also help create an information shortage. Perhaps most important is the fact that information gathered and acted on by well-informed consumers induces market responses by sellers that in turn benefit all consumers, not just those who become informed. This "externality" occurs because sellers compete for the patronage of the informed consumers by tailoring their products or lowering their prices to this market segment. Once these responses are made, even uninformed consumers obtain the better buy.

The response of the cereal industry to concerns about nutrition provides an excellent example of this process. Congressional hearings heightened public awareness of the nutritional content, or lack thereof, of cereals. A standard of nutritional adequacy was available in the form of Recommended Dietary Allowances for major nutrients. Some consumers wanted more vitamins in their cereals, and were willing to pay for them. Producers responded rapidly, by fortifying existing brands and promoting new brands which achieved high levels of various nutrients. This response occurred even though most consumers do not read labels, and advertising rarely refers to the content of specific nutrients. The result is that cereals are more nutritious, as measured by the percentage of the RDA of various nutrients they provide.

Similarly, the cigarette market has responded to the provision of standardized information about tar and nicotine content. Tar and nicotine of existing brands was reduced, and new brands entered with marketing strategies specifically geared to those who wanted lower tar and nicotine levels. Again, the result is that the average cigarette has considerably less tar and nicotine than before the availability of standardized information even though most consumers probably do not know the tar and nicotine content of the brand they smoke (Ippolito, Murphy, and Sant 1979).

While this "public good" or "externality" effect benefits consumers, however, it also prevents the economically efficient provision of information by the private marketplace. When a consumer calculates his or her private benefit of information against the cost, this "external" benefit is generally not included. This has two implications. First, this view provides a strong rationale for public subsidy of information services. Second, it suggests that information services must attempt to discover methods of capturing revenue concomitant with the total benefits they provide, if they are to become economically viable without public subsidy.

This inability to capture revenue in proportion to total social benefits is reinforced by the other market failure usually discussed. That is, once purchased, consumers often pass information along to other consumers. This information sharing may cut deeply into the potential revenues of periodicals like Washington Checkbook or Consumer Reports.

One way of dealing with this free rider effect is to disseminate information which obsolesces rapidly, or is tailored only to the consumer who purchases it. While these strategies may work to some extent, they tend to increase the cost of gathering and disseminating the information, and lead to a focus on information which is less valuable to consumers precisely because it obsolesces rapidly.

A MARKET COMPATIBLE APPROACH

An alternative strategy is worth exploring. This strategy is to sell the information collected, or the right to use it in advertising, to the seller of the product or service rated. While this approach has seldom, if ever, been employed by consumer information services, it has been used extensively and effectively by a variety of organizations such as Underwriters Laboratory (UL). While Consumer Reports has a circulation of only one percent of its potential market, it is virtually impossible to market an electrical appliance without UL certification (FTC 1978). There are both advantages and disadvantages of taking this approach.

From the point of view of information providers, selling the right to use the results in advertising can help to cope with the public good aspects of information. While the benefits of the market response are external to a consumer considering the decision to search, they are internal to the firm which is attempting to lead the market response. While consumers may rely somewhat on the information gathering efforts of other consumers to police high quality and low prices, in general, firms cannot rely on the efforts of their competitors to direct customers to them. Nor can they completely rely on consumer search; some consumers who would gain by purchasing from some firm will not necessarily find it left to their own devices. Firms often have a stronger incentive to convey information than consumers have to seek it out, because the firm can capture a larger fraction of the benefits. Of course, this also means that the price the firm would be willing to pay for the results of the local information service's tests will more closely reflect the true social value of that information. If the choice is between selling information to consumers and selling the right to distribute information to firms, it seems likely that total revenues will be higher from sales to firms.

These are not necessarily mutually exclusive alternatives, however. Even if the best firms advertised that fact, there will still be some demand for the full set of information provided by the local information service. There are always market tradeoffs between quality, price and convenience, which will make different consumers prefer different choices. For example, if the highest rated auto repair service is all the way across town, it may be worthwhile to accept slightly lower quality from a neighborhood mechanic. Because advertising information cannot be tailored to the exact needs of each individual consumer, there should remain a direct consumer market for the information as well. The market will no doubt be smaller than if direct purchase is the only source of information, but it will continue to exist. Use of the information by advertisers may even provide free advertising to the information service.

From consumer's point of view, the main advantage of selling the right to use local information system's recommendations or ratings in advertising stem from the fact that this approach exploits natural market forces to serve the ends of the information service and consumers. When an information service evaluates alternative firms or products, some firms will rate better than others. The better firms have a strong incentive to credibly convey their superiority in advertising. While firms may be unwilling to produce enough information to guide consumers in an appropriate fashion, they have demonstrated great willingness to convey information provided by others when that is to their advantage. The proliferation of gas mileage claims in the wake of EPA's provision of an objective measure of mileage, or the profusion of low tar and nicotine claims based on the FTC's measurements of tar and nicotine content demonstrates the willingness of sellers to use information which can help sell their products.

While firms may wish to convey their superiority, they often find it very difficult to establish that superiority in a way which is credible to consumers. Every seller has an incentive to claim that he is the best, even if he is not. Consumers know this, and tend to discount unsupported claims of superiority. Where a credible source of information provides data to back up superiority claims, however, then firms can make those claims in a credible fashion.

Because some firms would be willing to widely distribute information about their products, the impact of consumer information gathered by a third party can be greatly expanded. Firms have dealt with consumers unwillingness to purchase product information by thrusting information upon them through advertising. Local information services, or national ones, could take a free ride on this enormous effort, thereby greatly expanding the market impact of their information. More consumers will receive the message about the better firms at least, and other firms will have a much greater incentive to compete for high ratings from the consultant, and for the customers which are likely to come with a good rating.

While consumers are less likely to learn the identities of bad firms through advertising, it is not clear how essential this is. Surely the primary value of a rating service like Consumer Reports is that it identifies good buys, not that it disparages bad ones. This approach is a more efficient one; the consumer who knows which firms to avoid must still determine whom to patronize. While consumers might pay to be told which firms to avoid, it seems likely that they would rather be told which firms are worth patronizing. Thus, the information of greatest value to consumers will be conveyed to them by advertisers.

Even bad firms may be identified through advertising, especially in the cases where identifying them is most useful. If the worst firm in the market is also the largest, for example, it may well be worthwhile for a competitor to advertise both its own rating, and the poor rating of the market leader, in comparative ads.

Selling the right to use the ratings may also reduce the costs of compiling the necessary information. Good firms will have an incentive to cooperate. In fact, if a pure certification strategy were pursued, then participating firms would bear all or nearly all of the costs of compiling information. A repair shop, for example, could provide the local information service with access to its records or its mechanic. The certifier would then certify the quality of the shop on the basis of this information. This may be much cheaper than attempting to ferret out the true quality of uncooperative merchants. Such a program could not be universal, because universal cooperation is quite unlikely. But, it could identify the best firms, because they should have the greatest incentive to cooperate. Since this is the most useful information to consumers anyway, the benefits of the certification strategy may be nearly as great as those of a universal system. The enormous market impact of a successful certifier is perhaps best indicated by the fact that they have now attracted regulatory attention (FTC 1978).

The risk of selling the right to use ratings to advertisers is the potential loss of the information service's credibility, or, for a new service, the difficulty of establishing credibility. For a service which initially has credibility, there is no necessary reason for that credibility to suffer from the sale of the right to use ratings to advertisers. Selling the right to advertise ratings is not selling the ratings themselves, which would undoubtedly impair credibility. Many organizations have survived and prospered by selling certificates of quality to firms; Underwriter's Laboratories is probably the most outstanding example. If the "best buy" in some product category, as determined by Consumer's Union, advertised that fact, it is difficult to see why consumers would think less of Consumer's Union because of it. Where isolated parts of a rating or report might be misused to mislead consumers, the rating service could require appropriate disclaimers as a condition of using the information in advertising, although excessive disclaimers may be the equivalent of prohibiting the use of information in advertising. Comparative ads could also be required.

Even if the credibility problems of sales to producers prove to be insurmountable, it should be possible to sell the right to display the information to retailers of rated products. Retailers often exist precisely because of the informational services they provide for consumers; clearly many are willing to spend their own resources to make information available. If an appliance dealer, for example, could make available the latest ratings of competing brands of appliances, many of the same benefits could be achieved with less risk to the ratings' credibility. Again, restrictions could be placed on the use or format of the information. If retailers handle only one brand of the product, or provide only one variety of a service, then of course, sales to retailers are essentially no different than sales to producers.

The credibility problem is most severe for a new service. One obvious way to establish credibility would be to affiliate with an organization which already possesses that rare commodity. This approach may not always be possible, however. Another alternative is to bundle the information service with something else--such as a consumer redress mechanism. The American Automobile Association program for certifying the quality of car repairs is perhaps an example of this approach. Participating repair shops agree to a contract which uses AAA to provide a redress mechanism in the event that consumers have complaints. The redress mechanism, like a warranty, provides protection for the consumer in the event that the information turns out to be bad information. However, there is a problem of establishing the credibility of the redress mechanism itself. Establishing credibility may well be the most difficult problem confronted by a local information service, especially one which attempts to exploit the gains from selling the right to use the information in advertising.

No approach to the provision of market information is without its problems, given the inherent public goods aspects of information and the potential for free riders. Selling the right to use information in advertising is attractive because it is consonant with normal market incentives, and is most likely to produce revenues which reflect the social gains from the provision of information. These advantages suggest that it is worth a try.

REFERENCES

Beales, Howard, et al. (1979), Consumer Information Remedies, Federal Trade Commission.

Federal Trade Commission (1978), Staff Report on Standards and Certification.

Ippolito, Richard; Murphy, R. Dennis; Sant, Donald (1979) Consumer Responses to Cigarette Health Information, Bureau of Economics, Federal Trade Commission.

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