Consumer inattention and firm behavior

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2023-04-14

Authors

Kraft, Andreas, Ph. D.

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Abstract

Lack of information distorts markets, and communicating product value to potential consumers is a crucial ingredient of marketing strategy. However, a large body of behavioral research has suggested that even when information is easily accessible, consumers often fail to attend to it. Evidence of consumer inattention has been studied in various settings, both inside and outside the laboratory. How an intermediary should react when communication fails as a result of consumers’ failure to use the provided information is unclear. Can or should firms profit from asymmetric information caused by consumer inattention? If so, by how much? Does competition alleviate the effect? We consider these questions in the context of resale markets, both theoretically and empirically. The theoretical model demonstrates that a centralized intermediary can extract surplus from serving consumers who are less attentive and, as a result, overestimate the product value. We test the theory using a detailed dataset of millions of automobile transactions from a seven-year period. First, we find clear evidence of a specific type of inattention: Buyers exhibit left-digit bias and systematically underestimate the depreciation of vehicles that have odometer readings immediately below round cutoffs. Second, the estimated level of inattention is twice as high in dealership transactions than in consumer transactions, so that dealers make a significantly higher margin on such vehicles. Third, we estimate the supply-side response to consumer inattention and find 2.53% additional transactions, compared to the no-inattention counterfactual. As a result, the average margin is 1.8% higher, leading to an aggregate increase in operating profits of 4.37%, or about $422 million, within the seven-year sample period. The surplus obtained by the product owners who sell in the market increases by about 2.77%. Back-of-the-envelope calculations imply that U.S. used vehicle dealers’ annual profits attributable to consumer inattention are about $700 million.

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