Inconsistent Pricing: Distorting Consumption

I. Introduction

For as long as we remember, certain prices we see do not reflect the true value we have to pay. Have you had extra charges added to your mobile phone bill? Have you received a food bill which does not match the menu prices when dining at restaurants? These prices you pay deserve more attention as they distort a consumer’s personal budgeting. Basically,
advertisement of prices are misleading and usually include vague surcharges. The history and nature of these hidden costs has had an arguably significant impact on consumption patterns but is little-known to most consumers.

II. History and nature of surcharges

Surcharges come in several forms, usually concealed in small print or on another webpage. It also gives rise to inconsistency of advertisement pricing, as some businesses levy surcharges while others do not. It many cases, it has caused confusion and uncertainty amongst consumers who are not adequately informed on the nature of their extra payment. This paper will focus on the Restaurants and Hotels industry, the prime abusers of surcharges, which makes consumers suffer 2 key issues; Service Charges and Fine-print Pricing.

The Restaurants and Hotels industry is one of the more prominent sectors in our life, as we eat out on occasion. Do we ever ask ourselves, why are there surcharges added to the bill? Should it not be incorporated into the menu price initially? Consumer awareness is low and we are not fully informed about the additional payments that restaurants are taking from us.

With the upcoming GST in April 2015, will the surcharges be consolidated and disappear? No it will not, hence this paper will shed light on the current situation of surcharges and what can be done in the interest of consumer transparency.

Service Charges

The practise of implementing a Service Charge on top of a customer’s subtotal bill has been in existence in Malaysia since 1965, originating from the hotel business. Hotels traditionally added a Service Charge to the tabs of guests as well as bills for functions and banquets. Since there is no tipping culture in Malaysia, guests have generally assumed that they were paying it as a gratuity for the staff.

The Service Charge is to be pooled into a fund where 90% of the total is distributed to the workers whereas 10% is kept by the establishment to defray administrative costs. The effective function of this system is to complement the employees’ salary. It is exclusive to the hospitality industry and does not appear in professional or technical services.

As of today, the only official documentation with regards to Service Charges comes in the form of Collective Agreements. These agreements are signed between hotels and the National Union of Hotel, Bar and Restaurant Workers (NUHBRW), where the hotels collect the Service Charge on behalf of NUHBRW and distribute the funds to their employees accordingly.Approximately 100 hotels currently have an active agreement with NUHBRW and the number of members total around 10,000 people.

Service Charge was introduced to replace tipping so that every employee within the Collective Agreement enjoys a fair share of it, because tipping traditionally only goes to guest-contact employees such as waiters but not the chefs. The rationale behind the introduction of the Service Charge was a combination of a desire to replace cash tips given by patrons as well as to ensure that employees other than front-line employees also receive their share of the tips.

Over the years, this tradition was adopted by restaurants who learnt about the practice and started to collect Service Charges informally, without an agreement with NUHBRW. Somewhere along the line, hotels and restaurants realised that the Service Charge was usually not part of most guest’s value equation, which meant that they could reduce the front end prices of their menus by a small percentage and add in the Service Charge without notice.

The notion is supported in behavioural economics, where the traders are taking advantage of ‘choice architecture’ (Sunstein & Thaler, 2008) to abuse the bounded rationality of customers as in the Prospect Theory (Kahneman & Tversky, 1992). To put it simply, they are utilising the status quo bias with the ‘Default’ option of printing the Service Charge directly into the final bill, thus leaving the customer with an opt-out decision which has a high social cost.

Therefore in the absence of a framework and official legislation regulating the implementation of Service Charges, it has opened the window to businesses who freely implement the Service Charge on top of their menu bill at a rate ranging between 5 to 10%.

Fine-print Pricing

The malicious practice of hiding additional charges in the menu fine-print has been used by the Restaurants and Hotels industry since 1965 when Service Charges were first implemented. Later on when the Services Tax Act 1975 was enacted, the 5% (increased to 6% in 2011) Government Service Tax was also allowed to be fine-printed into the menu of restaurants and hotels. Hence, menus in Malaysia have come to adopt a system where the menu price does not reflect the true value which customers have to pay.

This concern is especially prominent in the Restaurants and Hotels sector, although it does exist in a few other industries such as tourism and telecommunications. Therefore, this causes evident inconsistency amongst various sectors. For example, wholesale retail outlets such as Tesco must advertise their shelf prices inclusive of Government Sales Tax but restaurants such as McDonalds may display deceptively lower prices exclusive of Government Service Tax (both of which will be converted to the Goods & Services Tax in April 2015).

This practice can arguably be classified as a form of bait pricing. Bait pricing generally refers to an advertising strategy which is used to attract customers by making them think that they will have to pay less for something that costs more.

To make matters worse, the allowance of Fine-print Pricing is exceptionally difficult to monitor, which results in low enforcement of menu fine-printing. Many restaurants and hotels were found to have broken the law and did not display any fine-print whatsoever, but they were still charging the 10% Service Charge and 6% Government Service Tax.

III. Impact of Inconsistent Pricing

Impact 1: Cost of Living in this sector is artificially high
With regards to Service Charges, the vast size of the Restaurants and Hotels sector at RM52.2 billion translates into a high portion of a consumer’s income going towards this industry. With the unregulated Service Charge usually levied at an additional 10%, its value could be in the range of RM4 billion to RM5 billion. This huge sum could artificially push up prices in other sectors through cost-push inflation.

On a micro level, the consumer’s disposable income would also be diminished as their spending patterns are subject to an additional 10% Service Charge when eating at restaurants, and this payment may not necessarily be voluntary. The hidden charges negates their expenditure budgeting because food and beverages in Restaurants and Hotels are more expensive than they are actually perceived. This has certainly made an impact on the Cost of Living, as food and beverages are a necessity and many people eat out occasionally as a treat or during the weekends.

Impact 2: Customer’s decision-making is exploited and abused by Fractional Pricing
From the consumers’ point of view, the nature of hidden costs distorts their choice architecture and impairs their decision-making to obtain the best value for themselves. Consumers do not realise that they have to pay more than the price stated on the menu, leading to overestimation and overspending.

Psychological pricing is a marketing practice based on the theory that certain prices have eaning to many buyers, with the hypothesis that Fractional Pricing (also known as Odd Pricing) suggests to consumers that goods are marked at the lowest price possible. Odd prices appear to represent bargains, therefore creating demand and encouraging buying.

Furthermore this strategy utilises the Left-Digit Effect, such as the example of pricing a product at RM 7.99 instead of RM 8.00 so that the customer views the price more favourably when the “7” is read instead of the “8”. It plays on the mental tendencies of consumers to establish a price that they perceive as better value. Consumers ignore the least significant digits rather than calculate the proper rounding.

Within this concept, businesses utilises Fractional Pricing to lure customers while hiding surcharges in the fine-print. Then they levy the Government Tax (6%) and Service Charge (10%) to add 16% on top of the fractional price. From the customer’s point of view, their perception of prices do not match the reality of prices that they pay.

The practise of printing the Service Charge into the total bill also abuses the behavioural nature of humans to pay without questioning the extra surcharge, it induces a high social cost to opt-out according to the status quo bias from the Prospect Theory. As aforementioned, consumers are vulnerable when the ‘Default’ option is abused and are subconsciously obliged into paying the Service Charge even if they endured bad service. The choice of paying the Service Charge should not be imposed as a compulsory unit on the bill, and instead should be entirely optional.

Impact 3: False information due to difficulty of Fine-print Pricing enforcement

The current Laws of Malaysia allows Fine-print Pricing, but this is loosely enforced and many businesses were found to possess menus which do not comply with the laws. In a typical scenario, their menus would have no fine-print stating the surcharges but when the consumer pays the bill, the restaurant would incorporate an additional Service Charge and some were even found to collect Government Service Tax illegally. The inconsistency in menu pricing practices exacerbates the problem of imperfect information which provides false information to customers. On the restaurant’s side, they are either tremendously ignorant or blatantly breaking the law. Deceptive pricing is a clear violation of Consumer Rights, which is ‘The right to be informed’. Customers must be given the facts needed to make an informed choice, and to be protected against dishonest or misleading advertising.

Impact 4: Lack of awareness raises confusion and misconception of Government Tax

The informality and confusion surrounding the Service Charge has caused misconceptions amongst the public, many of whom believe that the 10% levy is a tax from the government. With the confusion surrounding the 6% Goods and Services Tax (GST) replacing the 10% and 6% Sales and Services Tax (SST), many consumers believe that the Service Charge will be consolidated into the 6% GST. The public will receive an unwelcome surprise when the 10% and 6% charges remain on their bills post-April 2015. With the Service Charge currently unregulated, it could have repercussions to the consumer sentiment if left unchecked.

Impact 5: Unfair competition for businesses who do not levy Service Charges

Restaurants who levy a Service Charge are still allowed to advertise their menu at pre-Service Charge prices, which puts their menu on competitive parity with restaurants who do not. This gives certain restaurants an unfair advantage in the choice structure of consumers, especially those who are price sensitive. The problem lies in the market structure of this industry, which is perfect competition because restaurants offer very similar products and it is difficult to differentiate their food from competitors. Thus the choice is left to the customer’s value equation which may contain personal preference, mood and convenience, but most importantly; price sensitivity.

Therefore, restaurants have great commercial incentive to advertise cheap menus with the lowest prices possible, with food prices stripped of all surcharges. For example, Shop A (Service Charge) and Shop B (no Service Charge) list a dish of food for RM 10.00 on each of their menu. However, Shop A only notifies the customer about the 10% Service Charges in the fine print and ultimately produces a chargeable bill of RM 11.00 to their customers whereas Shop B charges RM 10.00. This pricing system may be classified as unfair business practices amongst traders and also presents misleading information to consumers.

Impact 6: Employees are not receiving their fair portion of Service Charges

Employees are entitled to 90% of the Service Charge funds which is to be distributed equally. However, the restaurants and most hotels do not have Collective Agreements with the NUHBRW, leading to many cases where businesses collect the Service Charge without distributing it proportionately, thus defeating its purpose. Many employees in the industry have no knowledge of their entitlement and their right to raise a civil claim against their employer.

As aforementioned, even popular restaurant chains such as Sushi King and Pizza Hut collect Service Charges but do not distribute a single cent to their employees. It is a clear violation of Employees Rights to be denied the Service Charge which was collected in the name of employee distribution. Moreover, it provides false information to unsuspecting customers who believe that they are paying the Service Charge for the employees, but the truth is that they are being grossly overcharged. Restaurants are hustling both their employees and customers for extra revenue.

Impact 7: Businesses are profiteering

Several popular restaurant chains (Pizza Hut, Sushi King) were found to be keeping 100% of the Service Charges and not distributing any portion to their employees. They only pay their workers a basic salary (in most cases the Minimum Wage) and nothing else. In this scenario, the 10% Service Charge can effectively be classified as the restaurant’s revenue and profit.

IV. Policy solution: Display Single/All-inclusive Price
Policy 1: Single Pricing policy, must display the final price which consumers pay (Australia)

Australia implemented the Goods and Services Tax (GST) in 2000, and received legal advice that section 53C of the Trade Practices Act (TPA) 1974 required displayed goods to include any GST payable. Initially, it was implicitly assumed that section 53C would also prohibit other forms of component pricing (taxes, fees, Service Charges, surcharges), unless a single figure was specified7 . On the contrary, it was found that subsequent decisions of the Federal Court of Australia in Australian Competition and Consumer Commission v Dell Computer Pty Ltd (2002) FCAFC 434 and Australian Competition and Consumer Commission v Signature Security Group Pty Ltd (2003) FCA 3, suggested that section 53C of the Trade Practices Act 1974 does not require a single figure price to be specified.

With this ambiguous loophole in the law, it led Australia to introduce the Single Pricing policy with the Trade Practices Amendment (Clarity in Pricing) Act 2008, to amend the Trade Practices Act 1974 for related purposes. The government considered that consumers should be able to readily identify the price they will pay for a product or service. The amendment subsequently prohibited corporations from using a component price when making a representation as to the price of a good or service without also prominently specifying the single figure price a consumer must pay to obtain the product or service. The Trade Practices Act 1974 was later renamed the Competition and Consumer Act (CCA) 2010

Of utmost importance to implementation and enforcement, the Australian Competition &
Consumer Commission (ACCC) is the independent statutory authority that enforces the
Competition and Consumer Act 2010, which comprises the Australian Consumer Law in
Schedule 2.

Section 48 of the Australian Consumer Law provides –
(1) A person must not … make a representation with respect to an amount … unless the person also specifies, in a prominent way and as a single figure, the single price for the goods and services. 0
The components that must be included in the single price are listed as –
(7) The single price is the minimum quantifiable consideration for the supply of the goods and services … including each of the following amounts …
(a) a charge … payable to the person making the representation
(b) the amount [of] … any tax, duty, fee, levy or charge imposed on the person making the representation

These laws requires businesses to show an all-inclusive price in their advertising, otherwise the ACCC will pursue those who fail to display the single price by requesting corrective advertising and instituting court proceedings for substantial penalties8 . The ACCC explains that ‘Businesses must provide a single figure that reflects the total price to be paid. This does not mean that businesses cannot show the various components that make up that price, but if they do, they must also show in a prominent way, the total price to be paid.’ The new law means businesses are now competing on a level playing field in advertising to consumers.

With regards to enactment, the ACCC publishes guidelines on their website with clear information for consumers. Under the ‘Price Displays’ section, the Single Pricing principle requires prices which are advertised or promoted, to clearly display a single price which is the minimum total cost that is able to be calculated and should INCLUDE all compulsory aspects. The only exception are optional charges like delivery, add-ons and extras which may be excluded from the ‘single price’. The ‘Displaying Prices’ section reiterates the importance of this matter under the provision for Component Pricing, where producers must present prices to their customers that states the total price of the good or service as a single figure, and this should include any government tax, duty, fee, levy or other additional charges (e.g. service charges or airport tax).

Policy 2: All-inclusive Pricing, products must not be sold higher than advertised price (Canada)

The Competition Act was first introduced by the Canadian government and came into effect in 1986. The Act governs most business conduct and is purposed to encourage and maintain competition in Canada. The Competition Bureau of Canada is an independent law enforcement agency which administers the Competition Act and ensures that Canadian businesses and consumers prosper in a competitive marketplace.

The Competition Act contains 5 provisions which deal specifically with price representations. They include relevant laws on false or misleading ordinary selling price representations (Section 74.01) and sale above advertised price (Section 74.05).

Section 74.05 of the Competition Act provides –
(1) A person engages in reviewable conduct who advertises a product for sale or rent in a market and … supplies the product at a price that is higher than the price advertised.

Section 74.05 of the Competition Act has clear civil provisions which prohibit the sale or rent of a product at a price higher than its advertised price. If a court determines that a person has engaged in conduct in violation of Section 74.05, it may order the person not to engage in such conduct, to publish a corrective notice and/or to pay a penalty of up to CAD $750,000 in case of a first time occurrence for an individual and CAD $10,000,000 in the case of a corporation. The fines rise to CAD $1,000,000 and CAD $15,000,000 for second time violations by individuals and corporations respectively.

Additional information is provided on the Competition Bureau website regarding ‘False and Misleading Representations’. Section 2 on ‘Representations relating to products’ states that any representation relating to a product that is being offered for sale should contain all information necessary to enable a reasonable purchaser to make a sound purchasing decision. This section also deals with 2.4 Non-disclosure of material information and 2.5 Hidden or additional charges.

The Competition Bureau also addresses deceptive marketing practices under the Competition Act in promoting the supply or use of a product or any business interest. It is clearly stated that deceptive marketing practices can have serious economic consequences, especially when directed towards large audiences or when they take place over a long period of time.

Explicit advertising guidelines are provided to help businesses comply with the Competition Act:

• Do avoid fine print disclaimers. They often fail to change the general impression conveyed by an advertisement.
• Don’t sell a product above your advertised price.

The misleading advertising provisions prohibit any deceptive representations for the purpose of promoting a product, and instead encourage the provision of sufficient information to allow consumers to make an informed choice. Accountability would be enhanced with the disclosure of taxes, fees and charges in the advertised price.

Challenges for Malaysia: Current laws allow Fine-print Pricing to mask hidden costs

In Malaysia, restaurants and hotels display misleading menu prices which exclude Service Charges and Government Tax, and the total bill will turn out higher than the prices advertised to consumers. This practice is misleading to consumers and is designed to gain a competitive advantage over their competitors by promoting deceptively lower prices. The former Australian Competition & Consumer Commission (ACCC) chairman Graeme Samuel once said “An unscrupulous business gets an unfair advantage by advertising only a part of the total price a consumer would end up paying and hiding the rest in fine print.”

Just like the case of Australia during GST implementation in 2000, the Laws of Malaysia may seem like it provides for single pricing, but it contains an ambiguity which allows businesses in the Restaurants and Hotels Industry to place hidden costs in their menus through a fine print.

Section 15 of the Trade Descriptions Act 2011 provides –
Price deemed to include tax –
(1) Where in any advertisement the price of any goods or services is quoted, such price
shall, unless the contrary appears, be deemed to include all eligible government taxes
and duties and any other charges.

The words ‘unless the contrary appears’ allows for inconsistent menu pricing where surcharges can be hidden in the fine print. Section 15 of this Act needs to be amended to protect consumer rights and to endorse fair competition.

Without the exception of the law ‘unless the contrary appears’, the Trade Descriptions Act 2011 does provide for Single Pricing where the advertisement of prices shall be deemed to include all taxes, duties and charges.

Recommendation

Enforce Single Pricing policy where restaurants must display standard nett prices. Businesses must sell products at face value with no additional surcharges. In both cases, they must show prices which are all-inclusive of the 5% to 10% Service Charge and any prevailing Government Tax. Due to our similarity with Australia, we have a prime example of best practices to model our policy around it. Additionally, it would be timely to implement along with the Goods & Services Tax (GST) which should make it compulsory for producers to include the tax into their menu pricing. With this policy in place, it will establish a fair playing field for restaurants who do not levy the Service Charge. It will also eliminate the ‘hidden cost’ element and consumers can make better decisions to minimise their Cost of Living. Transparency is the key benefit we can obtain from this policy, along with several positive effects on competition and consumer markets.

Regulator/Implementer: Ministry of Domestic Trade, Cooperatives and Consumerism

*Jarren Tam is the Research & Programme Executive at the Centre for Public Policy Studies (CPPS), Malaysia. He can be reached at [email protected] / [email protected]

VI. References
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