The curious economics of being ripped off on holiday

27th September, 2019

I once wrote that there are two types of charges: the ones you see coming and the ones you don’t. Perhaps I was too reductive. There’s a third category: the fees that you know are looming, but the fog is so thick that you can’t see them clearly.

Travellers are well used to these: the strange cover charge in the tourist-trap restaurant; the outrageous price of the hotel minibar and WiFi; those painful fees for flying with luggage. (Does it cost more to carry your bag on to the plane, or to put it in the hold? I lose track.)

I found myself pondering this a few weeks ago in the baking heat of Europcar’s Munich office. We’d hired a car online, arranging to drop it off in Milan and agreeing to pay the extra charge for doing so. Now the grumpy lady behind the desk insisted that there was a further charge of €14.99. Why? Because we planned to drive the car outside Germany. Apparently, the price we’d paid online was perfectly valid, but only if we arranged to teleport the car to Malpensa airport.

Surrounded by heat-exhausted children, my wife was outraged. It was the principle of the thing: Europcar had found a way to charge an extra fee despite not supplying anything beyond the original service. I was more relaxed, but only because mentally I’d already started drafting this column. (Europcar now tell me that because of a “system error” the charge was not clearly flagged at the time of booking, and they hope to prevent repeats.)

In fairness to Europcar, the only reason we had booked with them was because their rival Avis had stiffed us for a substantially larger sum of money the previous year. We are always careful to refuse all the overpriced extras, but this time, when we dropped the car off, Avis charged us almost €90 for “windscreen insurance” and then ignored our complaints about the matter. (I guess the true value of the insurance to be more like 90 cents than €90.)

Perhaps, somewhere in the byzantine process, we had failed to seek out and untick a “please overcharge me later for windscreen insurance” box? Even after the fact, it is often hard to tell.

How much should we worry about these hidden extras? Perhaps we should laugh them off as a cost of modern life. After all, businesses must still compete with each other and cover their overheads, so if these hidden charges could somehow be made to vanish, the everyday price might have to rise. We all know that such charges lie in wait when we deal with certain sorts of business — tourism and banking spring to mind. So why worry?

Unfortunately, it’s not that simple. Even when we know that certain charges will be added, we behave differently when those charges are highlighted. Over a decade ago, three economists, Raj Chetty, Kory Kroft and Adam Looney, conducted an experiment with a US retailer in which the familiar sales tax on everyday items was either made explicit or left implicit.

The sales tax, of nearly 7.5 per cent, is traditionally added only at the checkout. When products were relabelled to show clearly both the usual pre-tax price and what the post-tax price would be, shoppers bought substantially less. Professor Chetty and his colleagues had demonstrated that we respond differently when a cost, even a familiar one, is drawn to our attention.

There’s another reason to object to hidden charges: they make it harder to compare prices. The harder it is to compare prices, the less vigorous the forces of competition will be, to the detriment of the typical customer. I can rely on the fact that any car hire company will try to overcharge me, but I can have no confidence in just how hard the financial sucker punch will be, or when and where it will land. Should I refuse to do business again with Europcar, or should I reckon that they let me get away lightly?

A company could, of course, make a great play of not engaging in such tricks. Why not offer a price with “no hidden extras”? Alas, there are two problems with this. The first is that anyone can claim to offer a price with “no hidden extras”. When I typed the phrase into a search engine, one of the top results was Avis. Given my painful experience with the company, that is not encouraging.

There is a subtler problem too, explored a few years ago by the economists Xavier Gabaix and David Laibson. Even if an advert proclaiming “no hidden charges” is credible, it is not necessarily profitable. The problem is that not all customers would find the promise appealing. Some would instead infer “if you are good at avoiding hidden charges, try one of our competitors, who will offer you a cheap deal in the vain hope of ripping you off”. The transparent company would attract the suckers without exploiting them; the sneaky company would be a magnet for the sophisticates, who might well then avoid the tricks. The advertisement would backfire.

Perhaps it is no surprise, then, that companies boast about offering clear, transparent prices less often than we might expect, and that the boasts are often empty. That is my view as an economist. My reaction as a consumer will require some careful thought. Windscreens are transparent; prices, less so.

Written for and first published in the Financial Times on 30 August 2019.

My book “Fifty Things That Made the Modern Economy” (UK) / “Fifty Inventions That Shaped The Modern Economy” (US) is out now in paperback – feel free to order online or through your local bookshop.

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