Planet Fitness, Tinder Plus & Negative Consumer Surplus

This Wall Street Journal piece about wasteful spending on subscriptions made me think of a neologism

Regan Arntz-Gray

and I are hoping catches on: 'fraudulent in spirit'. Some things companies do, or even entire business models, might be totally legal, but feel “fraudulent in spirit”. At base, this involves profiting off customers paying for something they don’t really want. This isn’t sufficient though. We purchase lots of things that we don’t want, in some sense of the word “want”. We can’t pin all of that blame on businesses. But some tactics and models do deserve special sanction, since they’re unfair but more importantly, an economic drag on the capitalist engine of prosperity.

Let’s start with an uncomfortable question: Why do people like me have a hard on for markets? One answer is surpluses - the consumer typically derives more value from the purchase than the price they pay. In other words, they pay less than their willingness to pay (almost by definition).  And producers or firms get to make a profit, since providing that service costs them less than consumers pay them. In the short run, firms might make losses and that’s fine - they’ll go out of business eventually. It’s also possible that the consumer sometimes has to begrudgingly pay as much as he’s willing to pay. But when you see transactions in which consumers routinely pay more than the value they reasonably place on it, our hard-ons should turn into alarm bells.

Sometimes consumers pay more than they should reasonably be expected to pay, normatively speaking; perhaps the government imposes ridiculous taxes on something or someone just holds a gun to their head and asks them to pay up. Unfair as it may be, the consumer still pays exactly as much as he’s willing to pay, now that his willingness to pay has skyrocketed by the presence of a loaded gun. This isn’t super interesting. But, can we imagine scenarios in which consumers do end up paying more than they are willing to pay? I’d argue this requires consumers being misguided about one or more of the following: (i) the product or service they’re buying (ii) the price they’re paying (iii) what they actually want.  

One way they can be misguided about (i) or (ii) is if the seller actively deceives them. Enter fraud. I’ll make a brave guess that Bernie Madoff’s investors’ willingness to pay for the service of Bernie lying to them and spending all their money instead of investing it was exactly 0. Yet they ended up paying millions for precisely that, because Bernie defrauded them, primarily by lying about the goods they were being sold. Like anything else, deceit is a spectrum; from annoying but ostensibly innocuous fine print all the way to Bernie Madoff. The line that separates the legal from the illegal cuts through this spectrum at some point, based on considerations of intent and magnitude of harm, amongst other factors.

Being actively misled is just one way consumers can be misguided. They can also be impatient, irrational or outright irresponsible. All else equal, subscription and membership services have features that make it more likely that one or more of conditions (i), (ii) and (iii) is satisfied. Most of this has to do with deferral of services and payments into the future. All transactions have an implicit legal contract but subscriptions stipulate not just the price and terms of the current transaction but several future ones, and provisions for exiting that contract.

This increases the likelihood that the consumer has either misunderstood or been actively misled about what’s on offer. It also increases the likelihood that the product or service evolves over time in unanticipated ways. More subtly, the temporal distance between purchase decisions and accrual of value makes it more likely that consumers misjudge what they want, since humans are famously bad at predicting their future preferences and behaviors.

Let’s start with the most anodyne example: Subscriptions that you intend to cancel but forget to cancel? You intended to use Sundance Now for about 2.5 hours to watch some obscure foreign film. $12 seems like a fair price to watch a French erotic thriller. You will, after all, cancel the subscription first thing tomorrow. Except you don’t. 10 months have gone by and you’ve paid $120 for a mediocre movie. 

Having paid much more than the value derived (or willingness to pay), your consumer surplus is in the red, all of which has been captured by the vendor. In this example though, you did know what you were paying for - the ability to watch a movie for $12 if you remember to cancel the subscription. As a rational agent, you can eventually recognize that it takes you 3 months on average to cancel a subscription. The next time you want to watch an erotic thriller on Sundance Now, you can update the price to $36. In other words, you have all the information you need to make a rational decision and that information isn’t being made hard for you to access in any way. Now of course, you aren’t actually a rational agent and we can have a separate debate about how much the state should step in to correct for that.

In the above case, lack of evidence of deception or unfairness doesn’t imply economic efficiency. At its core, when businesses profit off of people forgetting to cancel subscriptions they would’ve wanted to cancel if you asked them periodically, you’re making money off of human irrationality or cognitive biases. For practical reasons, we might not clamp down on it, but it’s economically much worse than profiting off of conscious choices people make. This is because we can expect some portion of the conscious choices people make to make them more productive or to free up more time, which they can then use to either benefit themselves or others. The economic loss that such transactions create can themselves be reason enough for regulations that require businesses to remind consumers about their subscriptions periodically.

Now consider subscription services that actively make it hard for you to cancel. The unsubscribe button is in the metaphorical asshole of the website, almost impossible to find without furiously clicking deep and thorough. You also have to make sure you don’t accidentally click “No, I would like to keep my subscription” after having tried so hard to find it. Sometimes you have to get on a live chat with an agent who will confirm that you really want to cancel. If you’re unlucky, you have to actually call a person to confirm your cancellation. This whole process could easily take 20-30 minutes of your time. 

This seems ethically incomparable to our earlier example. You couldn’t have reasonably known that cancellation would be this difficult. One could argue that as a rational consumer, you should expect 10% of subscription services to behave this way and price that into your willingness to pay. That, however, is not only unreasonable but also unfair to businesses who behave fairly. Every bad subscription experience makes you slightly less likely to try another subscription service, given the possibility that they could make cancellation virtually impossible. Yes, other businesses could signal their honesty by advertising their easy cancellation policy up front. But now you’ve just imposed a cost on an honest business so that fraudulent ones can keep doing what they want. 

These “fraudulent in spirit” spirit practices can have enormous economic implications, even if fraud is not central to a company’s business model. Unlike outright fraudulent schemes that can’t go on forever, these practices that slightly but regularly chip away at consumers can carry on unencumbered by regulation or redressal, cumulating the toll they exact on the economy.

Take the New York Times for example, which makes cancellation as inconvenient as possible, despite explicitly claiming that they “offer many ways to cancel your subscription”. NYT has ~10 million subscribers. Their churn rate is about 25%, meaning 2.5 M people cancelled their subscriptions. Let’s say their cancellation policy on average extends subscription length by about 1 month (a conservative assumption). At $4 a month, that’s 10M dollars of negative consumer surplus that’s being pocketed by the New York Times - 10M dollars that could’ve been spent on something consumers actually wanted and into businesses that earned it by actually creating value. If the New York Times has been doing this for 5 years and will continue doing it for another 5 (before most states follow New York and California), that’s 100M in economic impact, roughly the scale of fraud that the founders of Bitwise have recently been accused of. 

Now consider a very different case - Planet Fitness. Planet Fitness offers ridiculously cheap gym memberships, starting at $10 a month. The accusation levelled against Planet Fitness often is that while their nominal fee reduces the barrier to join, it also reduces the incentive to cancel the membership if you find yourself underutilizing the service you’ve paid for. Planet fitness doesn’t disclose its total visits so we can’t calculate the average utilization rate for members. So far, this doesn’t seem problematic. A business figured out the optimal price point that maximizes profits, and is reasonably transparent about the service on offer. 

But what if the viability of the model itself hinges on negative consumer surplus? Let’s say the average member pays an annual fee of $120, on the assumption that going to the gym 2x a week would make the membership worth the money. Assume the average member actually ends up using the gym 0.5x a week. Now, what would happen if the average Planet fitness member actually used the gym twice a week? If the consumer actually behaved rationally, would Planet Fitness be able to deliver on the spirit of its offer or would they end up with barely usable gyms with 4 guys sharing the bench at any given time? In other words, are they representing the offering faithfully or are they counting on the collective irrationality of members to be able to fulfil their obligations? I’m not sure but seems worth finding out since other businesses such as timeshares might also be guilty of this practice.

At the least, it seems reasonable to punish companies who intentionally misrepresent their offering or make it prohibitively difficult for consumers to exercise choice. In the instances in which companies aren’t necessarily being deceptive but are profiting off of systematic behavioral biases, it still seems reasonable for governments to necessitate defaults that maximize consumer choice. I support this precisely because I have a hard-on for markets and institutions that support a capitalist system shouldn’t be sanguine about billions in opportunity cost.