Where should we draw the line on misleading advertising?

When does marketing spin cross the line to become misleading advertising? Flickr\Just1of7billion

Two recent cases highlight the problem of misleading advertising.

In the United States, the Federal Trade Commission (FTC) has dismissed an appeal by POM Wonderful about health claims for their juice.

The FTC’s decision sets a clear standard for business.

If manufacturers make medical or health claims about their products, then they need evidence that meets normal medical standards: “well-designed, well-conducted, double-blind, randomized controlled clinical trials”.

In Australia, the Australian Competition and Consumer Commission (ACCC) is appealing a decision by the Full Federal Court on a variety of advertisements by internet provider TPG.

The Full Court overturned a lower Court, deciding that a variety of “small print” disclaimers used by TPG were not misleading or deceptive.

The key criterion for the Court was whether, when the advertisements were taken as a whole, the “qualifying” fine-print material was “sufficiently prominent or conspicuous to prevent the primary statement from being misleading”.

Readers can make up their own mind. The TPG advertisements are appended to the Court decision.

The Full Court decision highlights the subjective nature of our current laws on misleading advertising. If an advertisement is false or misleading, then it is illegal. But where does marketing spin cross the legal line to become misleading?

The law in Australia considers a “hypothetical ordinary or reasonable member of the class to whom the advertisements were directed”. This “reasonable person” test makes good sense in many situations, for example, when trying to judge if a person is negligent. But it makes little sense for the “fine print” in advertising.

A business controls its advertising. If it designs a print advertisement with a large statement designed to attract the reader, followed by smaller qualifying statements, then the intent of the advertisement is to mislead consumers – at least temporarily. The aim is to get consumers to pay attention to your advertisement. Once “drawn in”, many (perhaps most) readers will notice the fine print and “move on”. But some will not — and that is where the harm is done.

Some customers will be misled and will purchase the product on the basis of their mistake. The business will make more profit and the customer will be harmed.

This harm is easily avoidable. A business does not have to use fine print; using a dubious headline to catch readers’ attention is a deliberate choice.

Rather than using the “reasonable person” test to inform a legal definition of a misleading advertisement, perhaps a better measurement would be a test that determined whether a person — who is likely to be glancing quickly at an advertisement, without any specific background knowledge of a product — will be misled.

New pricing laws, introduced in 2010, are a move towards this tighter standard. For example, section 48 of the Australian Consumer Law requires that the single “final” price of a good be as prominent as the component prices.

Consumers are not expected to add up the components or search small print for a final price. So why don’t we have this same tighter standard for all advertising?

One counter argument is that tighter standards are not needed because the market will work it out.

This argument fails on two grounds.

First, while the market may work it out, this can take time. Zinman and Zitzewitz, of Dartmouth College, illustrate this process in a study of misleading “snow reports” by private ski fields in the US.

Their study highlights the systematic distortion of reported snowfalls as each resort tries to make itself look a bit better than the competition. Further, they show how this deceptive conduct was undermined by a smart phone application that allowed skiers to report the true conditions – if the resort had mobile phone coverage!

The bottom line from Zinman and Zitzewitz is simple:

“In all, the results suggest that deceptive advertising varies sharply with incentives, both within resorts (over time, at high-frequencies), and across resorts”.

At best, the market sorted it out — eventually.

Second, misleading advertising represents a classic case of dysfunctional market conduct. Each business is tempted to push the boundaries of misleading marketing because they know that their rivals will do the same thing. They know that this upsets consumers in the longer term, but if they do not do it, then they will lose business in the short term. All legitimate businesses — as well as their customers — can gain by tighter advertising standards. It is only the charlatans who lose out.

The High Court will have an opportunity to revisit our standards for misleading advertising when it hears the ACCC’s appeal. If it can draw sharp, clear rules, like the FTC in the POM Wonderful case, then we will all be better off.