Price is not necessarily an indicator of product quality.
Do prices provide us with adequate information about the quality of the goods or services we purchase? The question remains unanswered for a category of goods that economists call credence goods, which can be translated as "trust goods," to indicate that the value of these goods is based on the trust that the buyer places in the seller.
Philippe Mahenc, University of Montpellier
The quality of a fiduciary asset includes a component that addresses a public concern related to the environment, ethics, or health. An eco-friendly or fair trade label enhances the value of the fiduciary asset by proclaiming that its production and/or distribution complies with more or less specific standards.
It is not easy to verify that a company complies with these standards: only an expert can certify—often with a margin of error—that the company is trustworthy. As a result, buyers can never be sure that they have been properly informed about the quality of a fiduciary good, even after consuming it. Entrepreneurs may therefore be tempted to abuse their trust.
To dispel uncertainty among buyers, producers, and distributors of a fiduciary good must find a credible way to signal its quality, such as price.
A company may sell a product at a single price—high or low—to signal that it is of good quality, as we showed in a research article published in 2007. However, the price of a fiduciary good may not always send a credible signal, as illustrated by the following three examples in the wine, automotive, and healthcare industries.
In 1907, winegrowers fell victim to fraudsters
Before the law of June 29, 1907 protected natural wine from adulterated wine, the wine market in France was disrupted by the supply of piquette. According to this law, wine must come exclusively from the alcoholic fermentation of fresh grape juice. In the absence of an official definition, wine was a fiduciary good.
To make piquette, grape marc was pressed and diluted with water, or the color and taste of poor-quality grape juice was improved with chemical additives. Traders and winegrowers who engaged in this unfair competition accounted for around 5% of the market.
Wikimedia
When wine prices collapsed in France after 1900, winegrowers in the south attributed the cause to adulterated wine. Small winegrowers in Languedoc and Pyrénées-Orientales found themselves ruined by poor sales of the 1906 harvest. The wine crisis sparked a spontaneous revolt in 1907, which was brutally suppressed by the government.
In this case, the market displayed the same price regardless of quality, making it impossible to distinguish natural wine from cheap wine. Under these conditions, it was not unreasonable to think that bad wine was dragging good wine down with it.
Subsequently, the law of June 29 and associated decrees made it possible to organize fraud prevention and control. They gave the authority and means to ensure compliance with standards to an entity representing the interests of winegrowers, the General Confederation of Winegrowers.
Volkswagen's opportunism
More recently, opportunistic behavior has emerged in the European diesel vehicle market. With the help of misleading advertising, car manufacturers claimed that their diesel engines, labeled "Clean Diesel," were environmentally friendly.
In 2015, the US Environmental Protection Agency accused the Volkswagen Group of violating the Clean Air Act, based on a report by the International Council on Clean Transportation. This organization highlighted discrepancies in nitrogen oxide (NOx) emissions between American and European vehicle models.
See also:
Volkswagen's unfair competition
It was thus proven that Volkswagen had equipped its diesel cars with software programmed to cheat emissions tests. After passing laboratory tests, the vehicles emitted up to 40 times moreNOx on the road than the level permitted by US standards. Volkswagen pleaded guilty in 2017.
Other independent tests carried out by the German automobile club ADAC showed that, under real driving conditions, Volkswagen's competitor diesel engines exceeded the legalNOx emissions limit in Europe by more than 10 times.
Among vehicles with the same technical characteristics, if one stands out from the crowd because it is less polluting, its price must reflect this unique feature. Depending on sales prospects, this unique feature takes the form of a discount or a price increase that a dishonest manufacturer would not be able to offer. The signal thus lends credibility to the advertising for the model.
Laboratories guilty of dishonest communication
The third example of opportunistic behavior comes from three pharmaceutical companies, Genentech, Novartis, and Roche (GNR). The trio markets two drugs for blindness, Lucentis and Avastin, which do not target the same symptoms. Lucentis treats age-related macular degeneration (AMD), while Avastin treats cancer caused by diabetic macular edema.
Unlike Lucentis, Avastin is not approved for ophthalmic use. However, it is still prescribed to slow the effects of AMD by many doctors who believe that the treatment is as effective as Lucentis. The UK's National Health Security reached the same conclusion in 2018.
Furthermore, Avastin has a decisive economic advantage over Lucentis: it is sold at 30 to 40 times less worldwide. With such a price difference, GNR is sending rather troubling signals.
In 2013, the French Avastin versus Lucentis Study Group also demonstrated the equivalence of Avastin and Lucentis in terms of efficacy, with no differences in safety identified.
In response, GNR conducted a communication campaign based on a selective and biased presentation of scientific results with the aim of misleading ophthalmologists about the risks associated with the use of Avastin. Finally, in September 2020, the Competition Authority sanctioned Genentech, Novartis, and Roche for abusing their collective dominant position in the French AMD treatment market. Among the grievances, it is above all the dishonesty of the communication methods that is criticized by the trio.
In these three examples, prices did not reveal information about the actual quality of fiduciary goods. They encouraged opportunistic behavior rather than discouraging it. Prices did send signals, but these signals were not credible because they did not distinguish good quality.
Send credible signals
As we showed in a research article published in 2017, it is therefore necessary for the signals transmitted by prices to be credible in order to guarantee the reliability of certification.
It is easy to explain why prices did not send credible signals in the case of French winegrowers. They were too small to decide on prices, which were imposed on them by competitive pressure.
On the other hand, car manufacturers and pharmaceutical companies have sufficient market power to set their prices strategically. They set the price of a product at a higher level because they expect their competitors, if any, to do the same. When products are fiduciary, manufacturers can also use prices to signal quality. As we have seen, they sometimes prefer to mislead buyers.
The existence of such strategies gives pause for thought at a time when pharmaceutical companies are touting the effectiveness of various COVID-19 vaccines in order to segment the market and prepare for price competition. This raises the question: do the prices offered to purchasing countries truly reflect the effectiveness of the vaccines?
Philippe Mahenc, Professor of Economics (Environmental Economics/Industrial Organization/Agricultural Economics), University of Montpellier
This article is republished from The Conversation under a Creative Commons license. Readthe original article.