Price isn't 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 open for a category of goods that economists call “credence goods,” a term used to indicate that the value of these goods is based on the trust the buyer places in the seller.
Philippe Mahenc, University of Montpellier
The quality of a trust asset includes an aspect that addresses public concerns regarding the environment, ethics, or health. An eco-friendly or fair-trade label enhances the value of the trust asset by indicating that its production and/or distribution comply with specific standards.
It is not easy to verify whether a company meets these standards: only an expert can certify—often with a margin of error—that the company is trustworthy. As a result, the buyer can never be certain that they have been properly informed about the quality of a fiduciary product, even after purchasing it. Business owners may then be tempted to abuse that trust.
To alleviate uncertainty among buyers, producers and distributors of a good must find a credible way to signal its quality, such as through pricing.
Thus, a company may sell a product at an unusual price—whether high or low—to signal that it is of high quality, as we demonstrated in a research paper published in 2007. However, there are times when the price of a tangible good fails to send a credible signal, as illustrated by the following three examples from 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 French wine market was plagued by the supply of cheap, low-quality wine. Under this law, wine must be produced exclusively through the alcoholic fermentation of fresh grape juice. In the absence of an official definition, wine was considered a commodity.
To make cheap wine, grape pomace was pressed and diluted with water, or the color and taste of poor-quality grape juice was enhanced with chemical additives. The merchants and winemakers who engaged in this unfair competition accounted for about 5% of the market.
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When wine prices plummeted in France after 1900, winemakers in the South blamed the problem on adulterated wine. Small winegrowers in the Languedoc and the Pyrénées-Orientales found themselves ruined by the 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 charged the same price regardless of quality, making it impossible to distinguish natural wine from cheap plonk. Under these circumstances, it wasn’t unreasonable to think that bad wine was dragging good wine down with it.
Subsequently, the law of June 29 and the associated decrees established a framework for the prevention and control of fraud. They granted the authority and resources necessary to ensure compliance with standards to an organization 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. Through a barrage of misleading advertisements, automakers claimed that their diesel engines, labeled “Clean Diesel,” were environmentally friendly.
In 2015, the U.S. Environmental Protection Agency accused the Volkswagen Group of violating the air quality provisions of the Clean Air Act, citing a report from the International Council on Clean Transportation. The report highlighted discrepancies in nitrogen oxide (NOx) emissions between U.S. and European vehicle models.
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Volkswagen's Unfair Competition
It was thus proven that Volkswagen had equipped its diesel vehicles with software designed to cheat emissions tests. After passing laboratory tests, the vehicles emitted up to 40 times moreNOx on the road than the level permitted by U.S. standards. Volkswagen pleaded guilty in 2017.
Further independent tests conducted by the German automobile club ADAC have shown that, under real-world driving conditions, competing diesel engines from Volkswagen exceeded the legal limit forNOx emissions in Europe by more than 10 times.
Among vehicles with identical technical specifications, if one stands out from the rest because it is less polluting, its price should reflect this distinction. Depending on sales projections, this distinction takes the form of a discount or a price increase that a dishonest manufacturer could not offer. This distinction thus lends credibility to the advertising for the model.
Laboratories guilty of misleading advertising
The third example of opportunistic behavior involves 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 does not have marketing authorization for ophthalmic use. It is nevertheless prescribed to slow the progression of AMD by many doctors who are convinced that the treatment is just as effective as Lucentis. The UK’s National Health Service reached the same conclusion in 2018.
Furthermore, Avastin has a decisive economic advantage over Lucentis: it is sold at 30 to 40 times lower prices worldwide. With such a price disparity, GNR is sending some rather troubling signals.
In 2013, the French Avastin versus Lucentis Study Group also demonstrated that Avastin and Lucentis are equivalent in terms of efficacy, with no differences in safety observed.
In response, GNR launched a communications campaign based on a selective and biased presentation of scientific findings 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 market for AMD treatment. Among the allegations, the trio was primarily criticized for the dishonesty of their communication methods.
In these three examples, prices did not provide any information about the actual quality of the goods in question. Instead of discouraging opportunistic behavior, they encouraged it. While prices did send signals, those signals were not credible because they did not allow for the identification of high quality.
Send credible signals
As we demonstrated in a research paper published in 2017, it is therefore essential that price signals be credible in order to ensure 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 set prices, which were instead dictated by competitive pressure.
In contrast, automakers and pharmaceutical companies have sufficient market power to set their prices strategically. They therefore set a product’s price at a level that is all the higher because they expect competitors, if any exist, to act in the same way. When products are trust-based, 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 efficacy 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 governments truly reflect the vaccines’ efficacy?
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.