The subprime mortgage debacle, in one recent example, is really several market failures in one: a failure of consumers to learn about the self-destructing contract terms they were signing up for; a failure of risk assessors to acknowledge the high correlation between loan defaults in California and loan defaults in Carolina; and a failure of shareholders to reward CEOs more highly for prudence than they do for daring.
James Surowiecki explained the latter problem clearly in his New Yorker column:
Stanley O’Neal, who was recently forced to resign as the C.E.O. of Merrill Lynch, made eighty-four million dollars in 2005 and 2006, a figure based in part on the huge profits that Merrill booked as a result of its forays into the subprime market. Last week, thanks to those same forays, Merrill announced giant losses and writedowns that obliterated most of those profits. O’Neal, however, won’t be giving any money back.But the subprime mistake isn't on my mind today. The market failure I'm concerned with is why mattress shopping is such a miserable and beleaguering activity.
I enter the Sleepy's mattress store at the corner of Flatbush and Fulton St. near downtown Brooklyn. I am reluctant to spend hundreds of dollars on a mattress only marginally better than the one I already own. I am apprehensive about navigating the many mattress options and making the right choice. And thirty minutes later I leave, even more uncertain.
In a perfect market, I would know the relative quality of increasingly expensive mattresses, and I'd know exactly what Sleepy's needs to make on each mattress to stay in business. Sleepy's would know exactly how much I can pay. Neither of us has this information, but we are not equally in the dark. Like a car dealership, Sleepy's knows that it knows much more than its customers about its products. And like a car dealership, Sleepy's has years of research and training on how to read a customer's ability to pay.
A writer with the memorable name Jon Mooallem wrote last week's Times Magazine cover story about the enormous commerce in sleep aids and specialty mattresses, including this anecdote from an industry convention in Las Vegas:
At a seminar on creating “SleepSperiences” at the retail level, the speaker kicked things off by asking the room full of mattress salespeople what they thought shoppers most often compare them to. Everyone groaned, “Used-car salesman” at once, except the woman seated in front of me. She said, “Like going to the dentist.”The task before Sleepy's then is to exploit its favorable imbalance of information, but to appear not to. Hence the Sleepy's price guarantee (they'll beat any competitor's price by 20%, or the mattress is free--a laughable promise, considering that they collude with manufacturers so that the mattresses Sleepy's carries have slightly different product names that appear nowhere else). Hence the inflated sticker prices, ripe for dramatic discount. Hence the song and dance performed for me in my visit, entirely in monotone:
Salesman, to boss: I need you to okay something: I offered to double this customer's savings.Here's where I think Sleepy's miscalculates: I would be willing to pay more for a mattress if there were no negotiation possible than I am willing to pay after negotiating, because I can never be satisfied that I have gotten fair terms.
Boss: You doubled the savings without asking me!? Now you've done it! That mattress just can't be sold so low!
Salesman, to me: Sorry, I shouldn't have doubled the savings.
Boss: Wait, wait. You already promised him double the savings. I don't like it. In fact, I hate it. But if corporate can approve it downtown, we'll see what we can do.
[Dials number.] Hello, Roy? I have a salesman here, he doubled the savings--that's right, he took the single savings, which is already 10% off, and he doubled it, to a price you're never gonna see matched by anyone else.
I know. I know. Dammit Roy, I know. Step back from the ledge, Roy, it ain't worth it. We let this one get away, Roy, but we'll eat Ramen for a few years and we'll be back on our feet. Yes, I know your wife is having twins. Yeah, I have the same insurance. No, it's called seppuku in official Japanese. Harakiri is just a slang term, little known fact. Yes, I will deliver your death poem to headquarters. Etc.
True, Sleepy's would surely make less money per mattress if they did away with sales negotiation, losing profits from richer customers (since they would be willing to pay more) and losing sales to poorer customers (since they wouldn't be willing to pay the higher average price). But a significant number of customers put off by the haggling wouldn't be lost, and might become repeat customers or word of mouth advertisers, important considering that a new mattress is likely to come up in conversation. The same goes for comparison shopping: when customers feel misled, even successful sales represent lost business because the customers don't recommend the store to others.
Surowiecki's essay concludes:
One lesson of the current market chaos, then, is that it’s hard to get incentives right. Investors, after all, want fund managers and corporate executives to take reasonable risks—that’s the only way to make money—and many of them do just that. But, in trying to reward reasonable risks, we’ve encouraged unreasonable ones as well. And when you make it rational for people to bet the house, you may end up without a roof over your head.Let me use Surowiecki's language: Sleepy's commission and franchise structure create a perceived incentive to maximize the profit on sales that happen, at the less obvious cost of sales that don't happen because of the lack of information, the hard selling and the obfuscation. Companies like Sleepy's may be content with that balance, but I wonder if the incentives to salesman from commissions really offset the disincentives to customers by making the sales process fundamentally adversarial and dishonest.
The internet is the great answer in many cases like this: comparison shopping is easy online, and price discrimination and haggling are impossible. Even with the model names precluding real comparison, I longed to order a mattress from 1800mattress.com, even without lying down on the damned thing. But unlike other industries, mattress sellers don't need to learn much from the online competition. It'll be a long time before mattresses, wedding rings and jeans are bought online with the kind of volume they sell when people can touch them.
In the end, I stumbled my way into haggling mastery. After putting down a (supposedly) refundable $100 deposit and waiting a week, I stopped in to cancel and get the deposit back. Suddenly the mattress, already discounted 20%, dropped another 30%. I had had to cajole my way through corporate-scheduled resistance to get to that 20%; getting the extra 30% by haggling would have taken a good hour of talking Roy through bushido arcana.
Surely there's a better way.