Consumer Policy Tools

Background Paper to Creating Confident Consumers

May 2003

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Market-Based Solutions

Within a competitive market, the market can itself correct informational problems by responding to the heuristic (determining) devices used by consumers when making decisions under uncertainty-for instance:

• Price as a signal of quality: At a certain price, consumers expect to find a certain quality, which allows them to make trade-offs. [7] For instance, consumers may avoid low-priced brands on the supposition that they are of inferior quality, or favour such brands on the basis that they do not require or want the additional quality that comes with additional price.
• Branding: One of the most important heuristic devices used by consumers is the assumption that past behaviour is an indicator of future performance. [8] Branding is a means of harnessing that assumption to increase market share.
• Warranties: Although generally unenforceable, [9] promises of quality from manufacturers may serve to structure an effective reputation mechanism to enable consumers to identify high quality manufacturers. [10] If manufacturers offer a warranty as a signal of good quality but the product is in fact poor quality, consumers would turn away as their beliefs were updated through word of mouth. [11]
• Experts and third parties: Independent parties can provide credible information to consumers, which can help them to make discriminating decisions (e.g. consumer magazines providing product reports and comparisons). However, information is a public good, and free-riding by consumers can result in an under-provision of information. [12] In addition, this information may be biased in favour of particular consumers, such as the more affluent. [13]
• Experience ratings: These ratings convey important information at low cost, and respond to the assumption that past behaviour is an indicator of future performance. For example, information such as the number of times a professional or business has been the subject of complaints or investigation. [14]
• Department store chains acting as screening agents for consumers: [15] This reinforces the consumer's assumption that products on the markets are generally safe. Depending on the branding of the department store, it can also give consumers an indicator of quality.
• Voluntary standards and certification: Standards are documented agreements containing technical specifications or other precise criteria to be used consistently as rules, guidelines, or definitions of characteristics, to ensure that materials, products, processes and services are fit for their purpose. [16] Standards are typically either performance (output) standards that require certain conditions to be met at the point of supply but do not specify how those conditions are to be met; or specification (input) standards that compel (or prohibit) the use of specific production methods or materials. [17] Consumers can use indicators of compliance with a standard as an indicator of safety or quality, as appropriate.
• Industry self-regulation: This gives traders a structured way of assuring consumers of quality of service. Self-regulation may itself use devices such as experience rating, branding, or standards as the mechanisms to provide assurances to consumers.

There are a number of situations where a market-based solution is unlikely to emerge in a competitive market, for instance: [18]

• repeat transactions are rare and consequently the performance incentives created by the possibility of repeat business from satisfied customers are blunted.
• entry and exit costs in the industry are low, leading to the possibility of a large number of fly-by-night operators with few sunk costs and only modest investments in reputational capital.
• many sellers or producers are extra-jurisdictional, making redress through private law more difficult for consumers.
• sellers characteristically have few assets against which a judgment may be enforced.
• the costs to consumers of a "bad" transaction are delayed or potentially catastrophic, making post-failure relief an inadequate or unsatisfactory solution.
• the small size of a typical transaction creates a significant disincentive to seeking post-failure relief through the courts.

Where a market-based solution is unlikely to emerge of its own accord, the government may use a variety of levers to facilitate the development of a solution. The government can use its influence, resources and expertise to overcome collective action problems, and resource and knowledge barriers to market-based solutions. The government can also use the prospect of regulation to prompt the development of a market-based solution.

Depending on the nature of the problem, market-based solutions may be focused on inputs (e.g. regulating behaviour of market players) or outputs (e.g. regulating the products and/or services provided by the market).

[7] Office of Fair Trading, Consumer Detriment under Conditions of Imperfect Information Research Paper 11, 1997, at 1998.

[8] Supra at note 2, at 160.

[9] Quality claims by manufacturers may not be contractually enforceable unless it can be shown that the manufacturer intended to assume contractual liability. Non-contractual claims may give rise to tort liability if untrue, but the remedies are limited to compensation for harm to person or property (consumers could not, for instance, sue for the difference between the thing as promised and the thing as is). Supra at note 2, at 165, n 18. Warranties may lead to liability under the Fair Trading Act 1986 if false or misleading. Civil remedies under that Act include refunds (s 43(2)(c)) and payment of the amount of loss or damage (s 43(2)(d)).

[10] Supra at note 2, at 142-143.

[11] Supra at note 6, at 119.

[12] See generally Hadfield et al, supra at note 2, at 144; Office of Fair Trading, supra at note 6, at 121; Trebilcock, supra at note 3, at 8.

[13] Twigg-Flesner, C, Weatherill, S, Willett, C, "Law, Information and Product Quality" Journal of Consumer Policy 25: 291-297, 2002, at 292.

[14] Supra at note 2, at 157.

[15] Supra at note 3, at 8.

[16] International Organization for Standardization definition. See also the definitions of "standard" and "specification", Standards Act 1988, s 2.

[17] Ogus, A, Regulatory Institutions and Structures, Working Paper 4 (2001) Centre on Regulation and Competition, University of Manchester, at 6.

[18] Supra at note 2, at 155-156.

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