Reflections on Consumer Sophistication and Its Impact on Ethical Business Practice

170 T H E JOURNAL OF CONSUMER AFFAIRS

PHILIP A. TITUS AND JEFFREY L. BRADFORD

Reflections on Consumer Sophistication and Its Impact on Ethical Business Practice

This paper investigates consumer sophistication and its role in the development of proactive public policy. Consumer sophistication is examined in light of several historical shifts in market structure and consumer lifestyles. These shifts create market conditions that foster the emergence of a “Corporate Dilemma” in which unsophisticated consumers reward unethical business practices and punish ethical business behavior. To reduce unethical business practices in the market, this paper proposes that the optimum level of interim government intervention should be based on the level of consumer sophistication in the market.

Given the ongoing debate over regulatory policy by conservative and liberal economists, it seems prudent for scholars to regularly examine the underlying beliefs and assumptions used in the formula- tion of this policy. For over a decade, there has been an emphasis on the deregulation of the U.S. economy (Gart 1993; Richards 1991; Smith 1990). This period, characterized by a laissez-faire economic philosophy, produced an era of reduced antitrust and consumer protection enforcement and the absence of new regulatory initiatives. This laissez-faire philosophy rested on three beliefs: (1) consumers were “sovereign,” (2) consumers exercised this sovereignty via purchase behavior in the marketplace, and (3) market failures could be eliminated or significantly reduced by increased competition (Francis 1993; Gart 1993).

When reviewing the beliefs of the laissez-faire economic philosophy, it is important to understand what is meant by a market failure. Francis (1 993) identified two categories of market failure-economic and social. An economic market failure is a situation in which a consumer’s freedom of choice among goods and services is restricted due to insufficient competition in the marketplace. A social market fail-

Philip A. Titus is Assistant Professor, Marketing, Bowling Green State University, Bowling Green, OH: Jeffrey L. Bradford is Assistant Professor, Marketing, Drake University, Lks Moines, IA.

The Journal of Consumer Affairs, Vol. 30, No. 1, 1996 0022-0078/0002-170 1.50/0

1996 by The American Council on Consumer Interests

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ure is described as a situation where goods and services offered in the market put the consumer at greater risk than can be foreseen or are marketed using morally questionable behavior. Regulation designed to protect consumers from health and other personal risks is described as social regulation, as distinguished from economic regulation designed to foster competition.

While free market conservatives endorsing the laissez-faire economic philosophy have conceded to some degree the need for economic regulation to facilitate fair competition (Amacher and Ulbrich 1995), they argue that in a competitive marketplace social regulation is of little benefit (Friedman 1981). Social market failures are believed to be kept in check via “consumer sovereignty,” that is, consumers redirecting their purchase behavior away from firms initiating such market failures. As a result, competing firms are compelled to correct the failure or exit the marketplace. Implicit is the assumption that consumers are sophisticated enough to make appropriate marketplace decisions, thereby reducing the need for social regulatory intervention by government.

This raises the question: how sophisticated are today’s consumers? Are they more demanding and discriminating when making purchase- and consumption-related decisions than consumers of ten, 20, or even 100 years ago? Or have consumers actually become less sophisticated with respect to their purchasing practices? Has the structure of today’s marketplace become so complex and confound- ing that today’s consumers are actually less equipped than their predecessors to function as effective decision makers? Popular opinion suggests that today’s consumers are better educated and more sophisticated than in 1980 (Rice 1990). Further, they have been described as more demanding, discriminating, and concerned with product value (Rice 1990). Such beliefs provide support for the deregulatory policies of free market conservatives and the notion that consumers have become more sophisticated.

In contrast, liberal economists and consumer advocate groups con- tend that these deregulatory policies have left consumers vulnerable to deceptive and unscrupulous business practices, thus calling for the social reregulation of industry (Burns 1993; Gart 1993; Samuelson 1990; Smith 1990). They agree that competition has provided consumers with more choices, however, they argue that consumer sovereignty does not always translate into effective regulation of the marketplace (Francis 1993; Samuelson 1990). These social interven-

172 THE JOURNAL OF CONSUMER AFFAIRS

tionists conclude that consumers cannot always distinguish between safe and unsafe products or products that are placed in the marketplace using moral versus morally questionable behavior. They argue that the laissez-faire philosophy does not adequately reduce the occurrence of social market failures. Social interventionists hold that consumers are simply not sophisticated enough to solely regulate the market and that some degree of government intervention is necessary (Amacher and Ulbrich 1995; Francis 1993). The common occurrence of market abuses such as the mislabeling of seafood (Burns 1992), the automobile repair fraud perpetuated by Sears (The Wall Street Jour- nal 1992), and the unethical substitution of sugar water for apple juice in Beechnut’s baby food line (Miller 1989) calls into question the belief that today’s consumers are becoming increasingly more sophisticated.

PURPOSE

This public policy debate between free market conservatives and liberal economists actually centers around the issue of consumer sophistication. While both have raised issues related to the concept of consumer sophistication, neither has explicitly addressed the con- struct. This paper examines the role of consumer sophistication and its relationship to public policy and ethical business practice. To achieve this, the paper is divided into four areas of inquiry and discussion. First, the concept of consumer sophistication is discussed and defined. Second, the assumption of increased consumer sophistication is examined in light of several historical shifts in market structure and consumer lifestyles. Next, a conceptual framework, referred to as the “Corporate Dilemma Model,’’ is offered to explain the impact of unsophisticated, unprotected consumer markets on ethical business practice. Finally, consumer sophistication as a criterion for establishing appropriate levels of governmental intervention is explored.

AN EXPANDED VIEW OF CONSUMER SOPHISTICATION

Research has addressed several issues related to consumer sophistication (Barnes and McTavish 1983; Hirschman 1980) and shown it to be an important factor influencing efficient consumer decision making (Sproles, Geistfeld, and Badenhop 1978, 1980). This stream

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of research has conceptualized consumer sophistication as an inherent set of characteristics and abilities possessed by consumers. Sproles, Geistfeld, and Badenhop defined consumer sophistication as “an individual’s aggregate level of acquired knowledge, experience in purchasing products, and skills which are relevant to being an efficient decision-maker’’ (1978, 91). Further, Sproles, Geistfeld, and Badenhop conceptualized efficient consumer decision making as “the degree to which a consumer obtains the greatest possible utility or satisfaction from a consumption decision’’ (1980, 37). Hirschman (1980) defined a related concept, “consumer creativity,’’ as the problem-solving capability of consumers to solve consumption- related problems (i.e., make efficient consumer decisions). Finally, Barnes and McTavish (1983) described sophisticated consumers as those possessing certain characteristics (e.g., more experienced, better educated). Combining these definitions suggests that sophisticated consumers possess the necessary traits and abilities to make efficient consumer decisions.

Although instructive, these conceptualizations overlook a very important component of consumer sophistication, consumer’s actual participation in wise buying practices. That is, past conceptualizations failed to explicitly recognize the need for consumers to behave in a sophisticated manner. For instance, it is entirely possible for consumers to possess strong problem-solving skills, and yet, fail to engage in wise purchasing practices (e.g., extensively gathering product information, negotiating prices, registering complaints), simply because they choose not to engage in these activities or have insufficient time to do so. Thus, to conceptualize consumer sophistication as a set of individual characteristics ignores an important behavior dimension of consumer sophistication. Research has taken a narrow view of consumer sophistication, and as such, has failed to recognize the distinction between sophisticated consumer characteristics and sophisticated consumer behavior. The conceptualization advanced here takes a more expansive view of consumer sophistication, defin- ing it as the extent to which consumers possess and utilize the characteristics and abilities necessary to make efficient consumer decisions and participate in wise purchase practices.

It is beneficial t o take a more expansive view of consumer sophistication when discussing it in the context of a public policy framework, because of its relevance to the concept of consumer sovereignty. The efficient operation of the free market requires consumers to be


sophisticated enough to regulate ethical business practice via their purchase decisions and behavior. It is incumbent upon consumers to shoulder this responsibility and behave as sophisticated shoppers. Therefore, it is not enough to possess the prerequisite knowledge and ability to make efficient consumer decisions, one must also act according to that knowledge.

Note that while the expanded notion of consumer sophistication encompasses both consumer characteristics and behavior , it does not include the structural characteristics of the marketplace (e.g., volume and technical complexity of product offerings). Rather, such marketplace characteristics are believed to moderate the relationship between both elements of consumer sophistication (i.e., ability and behavior), and thereby, directly influence the level of consumer sophistication present in the marketplace.

What makes a consumer sophisticated enough to make efficient consumer decisions and participate in wise buying practices? Re- search has consistently identified several factors that affect efficient consumer decision making. Sproles, Geistfeld, and Badenhop (1978) found consumers’ knowledge and experience using and purchasing products to influence efficient decision making. Further, they argued efficient decision making requires consumers to be fully informed about product prices. Similarly, Hirschman (1980) suggested that creative or sophisticated consumers tend to possess more knowledge and experience with products and consumption situations. Finally, Barnes and McTavish (1 983) identified sophisticated consumers as being more experienced, better educated, and in a position to compare products on a greater number of bases. Research, then, indicates that at a minimum, efficient consumer decision making requires a sufficient level of knowledge and experience to allow consumers to evaluate products with respect to price and performance. Consumer Sophistication can be viewed as a continuum with consumers possessing varying levels of knowledge, experience, and ability to make decisions regarding product quality and value.

ASSUMPTION OF INCREASED CONSUMER SOPHISTICATION

Armed with a better understanding of the concept of consumer sophistication and its underlying components, attention is turned toward the historical assessment of consumer sophistication. Although other elements may exist, the discussion is confined to


those components of consumer sophistication that have been repeat- edly identified in research. In particular, the assumption of increased consumer sophistication is questioned by exploring consumer product (1) knowledge and experience, (2) quality assessment, and (3) value assessment. The approach employed, the historical method, was strongly advocated by Savitt (1980) and more recently Smith and Lux (1 993) when investigating changes in consumer phenomena over time. In particular, they point out that the historical method is very useful for explaining “broad-gauged patterns of social, cultural . . . and intellectual activity” (Smith and Lux 1993, 595). Thus, the research question of interest here, the historical assessment of the evolutionary change in consumer sophistication, lends itself well to such an approach.

Product Knowledge

The assumption that consumers have increased in sophistication implies that they have become more knowledgeable about the product offerings in the market. We explore several marketplace developments that directly affect consumer product knowledge levels.

Amount of product information

The belief that today’s consumers are much more knowledgeable about product offerings than their predecessors has been fostered by increased consumer access to product-related information. Informa- tion is much more abundant and accessible than in the past. For example, consumers have access to a variety of consumer-oriented publications (e.g., Consumer Reports, Consumers Digest) and news style television programs (e.g., 60 Minutes, 20/20, 48 Hours) which shower the consumer with information. Thus, it stands to reason that today’s consumers have the potential to acquire more knowledge than in the past. Unfortunately, research has shown that consumers make little use of important sources of product-related information even when it is readily accessible (e.g., Dickson and Sawyer 1990; Dickson and Wilkie 1985). Dickson and Wilkie (1985) found only 20 percent of surveyed purchasers of major appliances (e.g., refrig- erators, freezers) consulted Consumer Reports prior to purchase. Similarly, Dickson and Sawyer (1990) reported that 40 percent of all


grocery shoppers interviewed did not even check the price of the brand they had just placed in their cart.

Expansion of product lines

Another marketplace development that has diminished the benefits of this increase in product information is the rapid expansion of product lines. This expansion has led to the proliferation of new and varied product offerings. In 1992 manufacturers introduced a record 15,866 new products (Miller 1993). Similarly, the average number of supermarket products had grown to nearly 21,000 in 1987 (Zaich- kowsky 1991). Currently an estimated 400 different brands of beer and close to 300 different types of cars are available to consumers. These marketplace developments have ultimately increased the number of attribute and brand comparisons required of consumers when deciding among competing products, even when accounting for the fact they may only be interested in a small percentage of these products. An increased number of competing products dramatically increases the possible brand and attribute comparisons required of consumers. For example, a consumer making comparisons among products with three important attributes (e.g., price, quality, service) is required to make 30 comparisons in a market that contains five products, however a market composed of ten products requires 135

comparisons (formula C 3n). Zaichkowsky (1991) referred to this

marketplace development as one of “over choice.” Thus, while consumers may have increased their “total product knowledge,’’ on a per product basis their knowledge level has at best remained constant or even declined.

n-1

1

Experience-based product knowledge

Proponents of the assumption of increased consumer sophistication find support in the demographic profile of the U.S. population. The largest percentage of Americans are between the ages of 35 and 45, the “baby boomers.” These individuals have had a substantial amount of experience purchasing and consuming products and are likely to have acquired more product knowledge than younger consumers. While this may be true, one must question the utility of experience-based knowledge. Experienced-based knowledge is most


useful in a fairly stable marketplace. Unfortunately, the base of product knowledge has become increasingly unstable. A major cause of this instability has been the compression of the new product development cycle. The average new product development cycle has decreased from ten years in the 1970s, to less than two years today (Slade 1993; Stalk and Hout 1990). As a result, the marketplace has experienced an influx of new products utilizing new and varied tech- nologies. Many products such as automobiles, home movie/video equipment, and computers have advanced at such a rapid rate that the technology employed in the consumer’s existing products may have long since been displaced by more advanced technological designs by the time the consumer re-enters the market. These technological advances ultimately limit the benefits of the consumer’s shopping and consumption experience related to the product.

Time pressure

Several historical developments have lead to a marketplace of consumers that feel increasingly more harried and pressed for time. Robinson (1991) reported that almost half of American workers would give up a day’s pay to get a day off. Surprisingly, Americans actually have more free time today than ever before (Robinson 1989). However, not all segments of the population are experiencing an increase in free time. Robinson acknowledges that “there is no denying the fact that many Americans are caught in a real time crunch” (1989, 35). Middle-aged Americans are one segment whose leisure time is actually declining (Cutler 1990). Free time for fathers of preschoolers has also shrunk by ten hours per week, while mothers of preschoolers have experienced a drop of about four hours per week (Robinson 1989).

These declines in leisure time are directly related to the dramatic increase in the dual-income family. Today, over 56 percent of all women work outside the home compared to 25 percent in 1950 (Engel, Blackwell, and Miniard 1993). This has significantly altered consumer shopping patterns forcing families to restrict shopping activities to evenings and weekends. The number of singles, who share this time burden, is also increasing. Statistics indicate that about 23 million Americans live alone, a 91 percent increase for women and a 156 percent increase for men since 1970 (Zinn, Keets, and Treece 1991). These demographic shifts have produced a new


breed of harried, time-pressed consumers. One must question, then, whether the household as a shopping unit has become more sophisticated, acquiring more product-related knowledge, or whether the increased time pressure has led consumers to reduce their information gathering activities.

If research findings are any indication, one would expect today’s consumers to curtail their informational gathering activities. In- creased time pressure has been shown to dramatically reduce consumer search activity (Newman 1977). The problems of over choice, coupled with increased time pressure and a rapidly expanding information base, suggest that consumer knowledge levels on a per product basis may actually be deteriorating. Although consumer access to information has improved, increased time pressures appear to be limiting its use. Zaichkowsky hinted at this fact when she suggested that “there is too much choice and not enough discretionary time to engage in extended cognitive effort for purchases” (1991, 54).

Product Quality Assessment

An assumption of increased consumer sophistication implies not only an increase in product knowledge, but also in the consumer’s ability to make accurate judgments of product quality. Popular opinion suggests that consumers in the 1990s are tougher and demand higher quality products from the marketplace (Dychtwald and Gable 1990; Rice 1990). However, decreases in household production along with marketplace developments that aggravate consumer sensory limitations may actually diminish the consumer’s ability to make accurate judgments of product quality.

Decreases in household production

The belief that consumers have not advanced their ability to judge product quality is supported by the presence of an important historical trend in the marketplace. Consumers have slowly shifted away from household production of goods and services to purchase of market substitutes (Nickols and Fox 1983). For example, consumers perform fewer product repairs (e.g., cars, clothing) and prepare less of their own food. The 1990-1991 Consumer Expenditure Survey indicates that consumers are spending twice as much money on food

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away from home as they did in 1980 (U.S. Department of Labor 1985, 1993).

As consumers have become more reliant upon producers and service providers, they have lost much of the basic knowledge about product design and construction. For instance, the decline in the household production of clothing has left consumers without the prerequisite knowledge to judge the quality of garment construction (Norton 1988). Thus, it is not surprising that consumers unknowingly purchased millions of dollars worth of inferior quality counterfeit Levi’s jeans (Gaines 1990) or that Sears’ automotive repair division was caught performing unwarranted repairs on nearly 90 percent of the automobiles brought in for servicing (Yin 1992). Additionally, the trend toward dual-income families and the continual loss of discretionary time seem to indicate that consumers will continue to shift from household production, furthering their dependence upon the knowledge and expertise of the business sector. In sum, it is unlikely the consumer’s ability to accurately judge product quality is on the rise. In fact, as consumers relinquish more control over the production of goods and services, their ability to evaluate quality likely diminishes.

Consumer sensory limitations

Understanding marketplace sophistication also requires an understanding of some of the inherent cognitive limitations of consumers. Consumers’ product quality judgments are dependent upon the sen- sitivity of their five senses. Research has shown these sensory abilities to be limited and subject to error. Studies have found that consumers have difficulty discriminating among many types of competing products such as beer (Allison and Uhl 1964) and pudding (Tom et al. 1987). These discriminatory limitations are also evident in the study reported in Consumer Reports (Burns 1992) regarding the labeling practices of the seafood industry. The investigation analyzed the con- tents of 97 different packages of finfish and shellfish. The findings indicated that only 29 percent of the fish analyzed matched the labels on the packages. This implies that the typical consumer is not sophisticated enough to realize when a species of lesser quality has been substituted for one of higher quality. The consumer’s sensory abilities are limited and not always sensitive enough to properly discriminate among competing levels of product quality.


These discriminatory limitations are further exacerbated during judgments of service quality. In contrast to goods, services are intangible, making them difficult to evaluate via the five senses. Research suggests that, because of its intangible nature, consumers often have difficulty evaluating service quality even after the service has been provided (Zeithaml 1981). Consumers’ limited ability to evaluate service quality was further demonstrated by Bitner (1990). Bitner found consumers’ post-service evaluations to be easily altered by cues in the service environment (i.e., office and service provider appearance). Taken together, these findings suggest that consumers do not always demonstrate a high degree of sophistication in judgments of service quality.

It is important to recognize consumer’s sensory limitations in light of two marketplace developments. First, because of intensified worldwide competition, products have become increasingly more “homogeneous,” making it difficult for consumers to discriminate among competing products. Second, the service sector of the U.S. economy continues to grow and is now more than twice as large as the manufacturing sector (Lovelock 1984). According to 1990-1991 Consumer Expenditure Survey data, the average U.S. family spends roughly 35 percent of its household budget on services (U.S. Depart- ment of Labor 1993). Given an economy that is experiencing an explosion of new service offerings and research that suggests consumers have difficulty evaluating service quality, one must question whether today’s consumers are better judges of service quality.

Product Value Assessment

A sophisticated consumer should possess a sufficient amount of product knowledge, be a competent judge of product quality, and also be able to accurately assess the “value” of products in the marketplace. This implies that consumers know prices and are not easily fooled by clever pricing practices employed by marketers. Here, value conscious consumers demand the “best price,” given a particular level of product quality. Again, popular opinion seems to be that consumers in the 1990s are “value conscious” and demand the highest quality at the lowest prices (Rice 1990). The sheer volume of products available argues against consumers that are knowledgeable about product prices. This belief finds empirical support from studies that measured consumer price knowledge (e.g., Allen,

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Harrell, and Hutt 1976; “How Much Do Consumers Know About Retail Prices?” 1964; “Then and Now: Shopping Behavior 10 Years Apart’’ 1975). The findings from these studies suggest that about 50 percent of consumers know the exact price of items purchased. In a recent study, Dickson and Sawyer (1990) reported that more than one-half of the shoppers interviewed could not accurately recall the price of the item just placed in the shopping cart. Further, they reported that half of the shoppers purchasing sale items were not even aware the price of the item had been reduced. In sum, it appears that consumers’ knowledge of product prices has not significantly increased as expected of a market increasing in sophistication, but rather may have actually declined.

Even the best shoppers may find it difficult to judge value in a market beset with products that are continually on sale or that contain noncomparable alternatives. Marketing efforts have become so complex and refined that it is extremely difficult to accurately compare product value. For example, many computer manufacturers produce models with different hardware configurations specifically for different retailers, making it difficult for consumers to make value judgments among competing models. Similarly, many services are so idiosyncratic that it is impossible to accurately assess their value (e.g., legal, consulting, education). In sum, it appears unlikely that today’s consumers possess more knowledge of product prices and are any better judges of product value than consumers of the past.

Summary

It is questionable whether today’s consumers are more sophisticated in their purchase decisions than their predecessors. In fact, one may argue from a historical perspective that changes in market structure and lifestyles have actually led to a decline in consumer sophistication. Tremendous expansion of product offerings, rapid advances in product technology, significant increases in time pressure, restruc- turing of the U.S. family, declines in household production, and the influx of service offerings to the marketplace all work to suppress any significant increase in consumer sophistication.


IMPLICATIONS FOR ETHICAL BUSINESS PRACTICE AND PUBLIC POLICY

The preceding discussion raises some doubts about an assumed increase in the sophistication level of today’s consumers and their ability to regulate the market. More importantly, it raises serious questions about the possible effects of past deregulatory policies on ethical business practice and future public policy.

Ethical Business Practice

A central tenet of this paper is that the purchase behavior of unsophisticated consumers in the market, if left unprotected, will ultimately become a catalyst for unscrupulous and unethical business practices. Increased unethical behavior is inevitable because lack of sophistication in a laissez-faire economy can create a marketplace that rewards unethical business practice and penalizes ethical business behavior. To understand the mechanics of a marketplace void of sophisticated consumer behavior, it is instructive to examine a well- known framework commonly referred to as the “prisoner’s dilemma .” The prisoner’s dilemma

The “prisoner’s dilemma” belongs to a branch of mathematics, known as game theory. It provides explanatory frameworks for understanding competitive behavior under conditions of limited information (Axelrod 1984; Fader and Hanser 1988). As originally conceived, the dilemma involves two criminals being held in separate cells awaiting trial. The district attorney has sufficient evidence to convict both of minor crimes, but the criminals are believed to be guilty of a more serious offense. Unfortunately, the evidence is not sufficient to gain a conviction on the more serious offense without a confession from one or both of the prisoners. Therefore, the district attorney, who possesses a significant amount of knowledge, experience, and expertise with respect to criminal justice and behavior (i.e., sophistication), creates the necessary conditions to obtain the desired confession. The district attorney informs each prisoner that if both confess to the more serious offense, a reduced sentence of five years will be recommended, however, if only one of the prisoners confesses, then the recommendation will be that the confessor receives a


token sentence of 90 days and the nonconfessor a full ten years. If neither prisoner confesses, each will be convicted of the minor crime and sentenced to two years in prison. What should each prisoner do?

Consider the two options provided by the district attorney to each prisoner and the consequences. The best overall outcome is for both prisoners to remain silent. However, each prisoner could enhance their individual outcome by confessing, provided both do not confess. To achieve this outcome requires that each prisoner trust the other to behave for the common good rather than pursue hidher own self-interest. If both prisoners confess, the worst overall outcome results and each goes to jail for five years. This is called the prisoner’s dilemma: mutual cooperation produces a desirable result, while the pursuit of self-interest gives rise to an undesirable result. In this scenario, the dominant strategy tends to be confession over silence because the actions of the district attorney create the proper incentive to gain the desired behavioral result (confession).

The corporate dilemma

Analogously, the behavior of consumers in the marketplace also creates incentives that direct the behavior of competing firms. A market operating without the benefit of sophisticated consumer behavior or government protection can create a “Corporate Dilem- ma” for ethical businesses that contains many of the features of the prisoner’s dilemma. While a firm operating in such a market may wish to behave according to moral principles and guidelines, lack of knowledge, experience, and appropriate consumer purchase behavior can produce strong incentives for the firm to abandon these principles and behave unethically.

Figure 1 provides an illustration of two hypothetical firms (i.e., fisheries) in the grips of a Corporate Dilemma. The fisheries are competing for profits and market share in the silver salmon market, the highest quality and most expensive salmon. Unfortunately, silver salmon is in short supply and neither fishery is able to secure enough salmon to satisfy their profit objectives. Both fisheries are aware of a common industry practice of substituting a lesser quality fish, pink salmon, for a higher quality fish, silver salmon. Each fishery is also aware of past consumer purchase behavior indicating consumers lack sophistication and are unlikely to discover such a substitution. There- fore, a fishery that chooses to offer silver salmon rather than engage


FIGURE 1 Corporate Dilemma in the Fish Market

aIndicates market share. bIndicates profits in thousands.

in unethical product substitutions is not likely to be financially rewarded in the market.

How will the owners of the fisheries behave when faced with such a dilemma? The options provided by the Corporate Dilemma suggest that each firm could enhance its individual outcome by behaving unethically. However, the best outcome for a firm desiring to behave ethically is if neither firm substitutes. To achieve this outcome


requires each firm to behave for the common good of society rather than pursuing individual self-interest. While each fishery may wish to correctly label salmon, it should be noted that the profits of an ethical fishery will erode further if unsophisticated customers shift their patronage to the unethical fishery. This then is the Corporate Dilemma: Should a firm behave according to moral principles and guidelines, trusting the competition also to behave ethically; or should the firm abandon ethical standards to safeguard its own sur- vival against the undesirable effects of unethical business practices? In this scenario, the purchasing behavior of unsophisticated consumers presents the competing firms with an incentive that can even- tually lead to a dominant strategy of unethical behavior (mislabeling salmon).

To better understand the Corporate Dilemma, compare and contrast it with the prisoner’s dilemma. In both, a set of noncollaborat- ing, competing players are faced with two choices with interdepen- dent outcomes. Also, each framework produces a dominate strategy (i.e., confession, substitution). Finally, the payoffs are determined by a dilemma architect (district attorney or silver salmon customers). While there are similarities, there is a single significant point of contrast: the dilemma architect’s level of sophistication. The architect creates and administers the reward structure for the dilemma. In the prisoner’s dilemma, the district attorney, with an understanding of the two prisoners and their self-interests, provides incentives that increase the probability of socially desirable behavior (i.e., confession). In contrast, the consumers in the Corporate Dilemma, without an understanding of the fisheries and their self-inteqest, provide incentives that increase the probability of socially undesirable behavior (substitution and mislabeling).

Most business environments contain more variables and competi- tors than can be captured in a simple game theory framework, such as the Corporate Dilemma. Nevertheless, the primary objective of game theory is not to provide a descriptive model, but to illustrate what strategies rational players are likely to follow and what expecta- tions they can possibly entertain about other players’ strategies. To this end, the Corporate Dilemma framework illustrates the important role sophisticated consumers’ behavior plays in directing the ethical behavior of firms in the market.


Corporate Dilemma in the Marketplace

While the Corporate Dilemma model is intuitively appealing, it finds further support from the plurality of marketplace abuses that can potentially spawn this type of ethical predicament for business firms. For instance, top management at both Beechnut and Sears were caught defrauding customers (Miller 1989; Yin 1992). In each case, the vast majority of consumers were unable to detect the unscrupulous business practices and unknowingly rewarded unethical businesses. However, it should be noted that such abuses are a necessary but not sufficient condition to favor the appearance of a corporate dilemma.

One can only speculate as to why these well-known and well- respected businesses would undertake the risks associated with such unethical practices. In all likelihood, these companies observed a lack of sophistication in their customers and believed such practices would go undetected. In fact, these beliefs proved to be correct. It took years to detect the practices and it was not consumers who detected the unethical behavior. It was the confessions of company employees that alerted government regulators.

The savings and loan corporate dilemma

The $600 billion savings and loan disaster provides an example of an unsophisticated and unprotected market and the inevitable rise in unscrupulous and unethical business practices. In this real world Corporate Dilemma, the deregulation of the savings and loan industry allowed unscrupulous operators to make high risk investments in commercial real estate (Pizzo, Fricker, and Muolo 1989; White 1991). To secure necessary funding to finance these investments, operators offered inflated interest rates on consumer deposits. The majority of consumers in the marketplace were not sophisticated enough to recognize that the increased returns they were offered also carried an increased risk of default. Thus, a large percentage of depositors left their current savings institutions in the hope of obtaining better returns on their deposits. This behavior rewarded unethical savings and loan firms and penalized ethical firms. This created a Corporate Dilemma for the competing savings institutions. Should they com- promise their ethical standards and participate in high risk investments similar to the competition, or should they refuse to engage in


these unethical practices and slowly watch their deposits disappear? Unfortunately, the deregulation of the savings and loan industry created a set of opportunities, capabilities, and incentives that proved to be too tempting for hundreds of thrifts (White 1991).

The consuming public was simply not sophisticated enough to adequately regulate institutional practices. Instead, consumers in the market inadvertently rewarded corporate irresponsibility and penalized businesses acting in a socially responsible manner. As a result, many ethical firms were driven out of the market, while many unethical firms prospered. Competition alone proved to be an insufficient force to ensure consumer welfare. The consumer’s lack of sophistication disrupted the mechanics of the laissez-faire advocate’s idealized free market system. Not until savings and loans institutions started defaulting and government investigations began did the dominant strategy shift back toward more ethically sound banking practices.

Public Policy Implications

A major goal of public policy is to foster a market economy that allows consumers to sovereignly determine what goods and services are available in the market (Hospers 1984). Both competition and consumer sophistication must be present to allow consumers to fully exercise sovereignty. Consequently, one of the main objectives of regulatory policy must be to enhance consumer sophistication. Research has identified several key criteria for determining when government should intervene in the marketplace (Carman and Harris 1986). Surprisingly, researchers have overlooked consumer sophistication as a criterion. Future public policy makers wishing to avoid market failures resulting from either an overregulated or under- regulated market must explicitly recognize consumer sophistication as a key determinant for establishing appropriate levels of governmental intervention.

Figure 2 summarizes the relationship that exists between consumer sophistication and the use of interim governmental intervention in competitive markets. The arc represents a theoretical balance between consumer sophistication and government intervention to ensure ethical business practices. The appropriate level of government intervention to reduce the number of market failures should be determined by the actual level of consumer sophistication in a given


FIGURE 2 A Marketplace Public Policy Model: A Proposed Balance Between Consumer Sophistication and Government Intervention to Ensure Ethical Business Practices

aThe arc represents a theoretical balance between the level of consumer sophistication and interim government intervention required to ensure ethical business practices. The shading in the Corporate Dilemma Region represents the likelihood of unethical business practices. The darker the shading the higher the likelihood of unethical behavior by business in the marketplace and likewise the higher the likelihood of a corporate dilemma arising. The Government Waste Region represents excessive government intervention to ensure ethical business practices. S, through S4 represent varying levels of consumer sophistication. G, through G, represent varying levels of government intervention in the market.

market, not assumptions made by advocates of economic philosophies. For example, with consumer sophistication at level S2, a medium level of interim government intervention G2 is necessary to abate the potential for unethical business practices. However, as the level of sophistication increases (S2 to SJ, the interim government intervention measures can be reduced from G2 to GI.


Markets composed of highly sophisticated consumers (S,) require little or no government intervention (G,) to ensure ethical conduct in the marketplace. The area above the arc labeled Government Waste Region represents a market with excessive government intervention. In a market characterized by a high level of consumer sophistication, the marketplace traditionally assumed to exist by laissez-faire advocates, consumers effectively self-regulate the marketplace leaving little justification for use of government intervention. Indeed, such intervention, as indicated by the intersection of S, and G,, would be redundant and wasteful (Hamm 1986). While a laissez-faire market may only exist in theory, it should be the goal of business and government public policy makers.

Alternatively, markets characterized by low levels of consumer sophistication (Sj and S4) are the most likely candidates for some type of interim government intervention. The Corporate Dilemma Region represents the market as viewed by liberal economists. The absence of governmental intervention in these markets (SJ, GI; SJ, G,; S4, GI; S4, G,) leaves consumers vulnerable to unethical business practices. In fact, it is precisely these market conditions that foster the appearance of the “Corporate Dilemma,” by rewarding unethical behavior and penalizing ethical business conduct..

Finally, the model adopts the capitalist market proposition that consumer sovereignty is superior to government sovereignty. The socialist and communist economic systems, which have adopted per- manent government intervention strategies that eliminate consumer sovereignty, have not been successful in reducing unethical business practices and social market failures (Amacher and Ulbrich 1995). Capitalist economic systems recognize the need for temporary government intervention in the marketplace. However, this intervention should be reviewed to determine its effectiveness in reducing social market failures and in restoring consumer sovereignty (i. e., increasing the level of consumer sophistication in the market).

Measuring Consurn er Sophistication

The recognition of consumer sophistication as a key policy determinant intimates that future public policy makers and academicians need to develop a reliable means of assessing consumer sophistication levels. Attempts to investigate consumer sophistication and related constructs have primarily focused attention on the measurement of


indicators, or surrogate measures, of consumer sophistication. For instance, Sproles, Geistfeld, and Badenhop (1978) combined eight different surrogate measures to develop an overall index of consumer sophistication (i.e., age, education level, brand name awareness, years of purchase experience, family size, marital status, purchase confidence, number of consumer education courses completed). Fur- ther, Barnes and McTavish (1983) cited studies employing measures of age, education level, experience with the product category, and number of jobs held. With the exception of the work by Sproles, Geistfeld, and Badenhop (1980) on efficient consumer decision making, few attempts have been made to devise more direct measures of consumer sophistication. sproles, Geistfeld, and Badenhop (1980) constructed a decision-making task that allowed the researchers to compare subjects’ actual choices among competing products to an ideal choice. The ideal choice was established based upon objective measures of the product’s performance taken from Consumer Reports.

The expanded theoretical conceptualization of consumer sophistication proposed suggests that future measurement instruments should include measures of overt behavior as well as more objective measures of consumers’ product knowledge. For example, it may be possible to develop a list of wise purchasing practices that can be easily measured via observation or consumer self-report. Additional- ly, it may prove fruitful to examine more objective measures of product knowledge that have been successfully employed in other contexts (e.g., Brucks 1985; Park, Feick, and Mothersbaugh 1992). Such measures may prove useful in developing similar product knowledge measures for investigating consumer sophistication. Finally, research needs to identify additional variables to be included in an overall measure of consumer sophistication.

Consumer Sophistication and Establishment of Public Policy

The development of better measures of consumer sophistication would allow businesses to recognize sophistication deficits and aid government regulators in determining the appropriate level of interim intervention necessary to adequately reduce social market failures. The instrument could be used to review the effectiveness of governmental intervention programs. The advent of a reliable mechanism to assess the level of consumer behavior could reduce govern-


ment waste by directing regulatory programs toward industries where consumers are particularly vulnerable to social market failures and away from industries that can self-regulate. This mechanism would allow public policy to be based on market information, rather than assumptions and beliefs of popular economic philosophies that may or may not reflect market realities. Also, a longitudinal measure of consumer sophistication would allow researchers to audit government programs. A public audit, undertaken by an independent exam- iner, would provide a public account of governmental action. There- fore, future funding decisions could be based on the program’s accomplishment of increased consumer sophistication rather than vague objectives (Beale, Bowers, and Lange 1986; Hamm 1986).

Many past government intervention strategies trumpeting a moral crusade have been ineffective, inefficient, and unjust (Niskanen 1994). A prime example is the bicycle industry. The cost of manufacturing bicycles rose as a result of a bicycle safety program imple- mented and enforced by the Consumer Product Safety Commission. The safety program proposed to substantially reduce the percentages of serious and fatal bicycle-related injuries. However, a review of its effectiveness revealed that the percentages of serious injuries and fatalities to bicyclists had actually risen since the program was imple- mented over two decades ago (Petty 1994). For the bicycle industry, this government intervention program has led to increased production costs with no apparent additional social benefit to consumers. The model (Figure 2) suggests that highly sophisticated consumers can regulate the marketplace without government intervention (upper left-hand corner). However, a high level of government intervention (GJ without sophisticated consumers in the market (S4) is not an effective means of completely removing social market failures. Government intervention requires a minimum degree of consumer sophistication (SJ before it can be effective.

Without consumer sophistication as an evaluation criterion, the potential waste of public funds, even when government intervention may be warranted, will continue for two reasons. First, the impor- tance of consumer sophistication in the market was not considered in development of regulations. Therefore, regulations were not designed to increase consumer sophistication in the market. Second, regulations were not viewed as temporary, requiring regular review to continue. Finally, the recognition of consumer sophistication as a key policy determinant suggests that consumer education may be


equally effective as governmental regulation of business. Therefore, further research needs to be directed toward this topic.

CONCLUSION

The deregulatory policies of the past suggest that competition alone is not sufficient to ensure the protection of societal welfare. To assume that consumers are highly sophisticated in all market arenas and focus public policy decisions around the enhancement of marketplace competition can and has sometimes led to disastrous results (e.g., savings and loan industry). The “invisible hand” operating in a laissez-faire market is not simply “competition,” as some have suggested (Dickson 1992; Rosenberg 1979), but rather a sufficient level of both competition and consumer sophistication. Further, absence of consumer sophistication in a highly competitive market can create a business environment that is counterproductive to the needs and welfare of society. These conditions may give rise to “Corporate Dilemmas’’ that reward unethical and unscrupulous behavior, while simultaneously penalizing firms that operate in an ethical fashion. Even the most principled and ethical corporations may find it difficult, under these conditions, to adhere to their standards of ethical business conduct.

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Documents

Reflections on Consumer Sophistication and Its Impact on Ethical Business Practice