Because I’m happy

I don’t know anyone who doesn’t love a bargain but often they aren’t all they’re cracked up to be.

The price of free

People will happily queue up for ages for a free coffee from Starbucks but would they queue quite so readily if what they got at the head of the queue was the £3 in cash that the coffee was worth?

When thinking about products how does the price difference compare to the difference in quality?

When offered either a 25p truffle or a 1p chocolate, most people go for the truffle but if offered a 24p truffle or the same cheap chocolate for free, most people choose the chocolate.

We are over-excited by ‘free’. Why? Because we only see the benefits, not the costs if things are free.

 

For example you compare the same book from three vendors:

  1. book – £10 + shipping – £10     this is seems the worst deal
  2. book – £20 + shipping – free     this seems the best deal
  3. book – free + shipping – £20     this just seems crazy

The perfect example of how to manage the price of free would be a group of friends who meet regularly for a meal in a restaurant together – how should they split the bill?

  • split it exactly when the bill arrives – this ruins the end of the meal when everyone has to get their phones out to work out how much to pay
  • split the bill evenly – this can cause resentment when some didn’t have a starter or someone had a large glass of wine when the rest just had Coke
  • each person pays the whole bill on a rota – this eliminates the pain of paying, you get a free meal more often than you pay, the payer feels good, although the pain of paying has diminishing returns as the price increases

Micro-payments

Micro-pricing breaks up the cost of a purchase into smaller compartments. iTunes is a great example of this where you can pay for just the tracks you want rather than a whole album. Personally I think this is ruining the stories that used to run through albums but then I’m a vinyl junkie – what can I say?

However, sometimes micro-payments are a bad idea – 100p does not always equal £1. Dan ran an experiment to see how people would read articles depending on how they had to pay for them. There were four methods of payment:

  1. pay on demand to read them
  2. pay at the end once you’ve read them
  3. deduct payment from a pre-paid account
  4. pay a subscription to read as mush as you want

In fact people read the least when they had to pay on demand and not much more when they had to pay at the end. Things got slightly better with deducting from a pre-paid account but people felt happier and read more when they paid a subscription.

Keeping prices equal simplifies the decision-making process, making us more likely to pay – a good example of this would be pound shops.

Consolidating multiple purchases into one invoice reduces the pain of paying.

Gift certificates and pre-payment options reduce micro-payments and therefore the pain of paying. An example of this not working would be offering free apps as this reduces the number that can be sold for profit.

The psychology of money is a topic where our intuitions aren’t always correct.

We had a guest lecture by Mike Norton from Harvard Business School telling us about his studies of time, money and happiness.

 

Time versus money

What are the best ways to use these for ultimate happiness?

Money – we all think more money will make us happier than it actually does. We try to make more and more of it but experiments have shown that getting more money makes us more selfish and happiness tails off. Giving money away makes people happier than spending it on themselves, no matter how poor they are.

Time – this is the same as money. Most of us spend time on ourselves but giving time away makes you feel like you have more time. How? When we give to other people, it signals to us that we have more than enough for ourselves and can afford to give some away.

If you want to hear more from Mike there’s a lot out there but he did a TEDx talk on this very thing.

If you want to know more about the behavioural economics MOOC I’m talking about over the next few posts you should sign up for Dan Ariely’s Beginners Guide to Irrationality course on Coursera.

Tune of the week

Northern Soul Girl Levanna

As you all know I love a bit of Northern Soul – I just wish I could do the dance. Levanna dances in her front room and all around town sharing the Northern Love. In this she dances in the street to Pharrell’s Happy and Velvet Hammer’s Happy. This makes me happy 🙂

 

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Gifts that keep giving

When I was doing Dan Ariely’s Beginners Guide to Irrationality course on Coursera, there were lots of little Eureka moments and this was one of them. Human irrationality at its best or worst depending on how you look at it can be hilarious and embarrassing when someone like Dan points out some of the bad decisions we make every day. Luckily some of the ways to make us stop and think are covered in the course but better still for those of us who work in the public sector and depend on people making good decisions, some of it can be achieved without people realising that their behaviour has been subtly changed for the better.

Fairness and reciprocity

It’s easy for us to pay for something that requires conspicuous effort but much harder to pay for an expert who performs the job effortlessly. A good example of this would be a joiner, toiling over replacing a broken lock, huffing and puffing and taking a long time. Two streets down a better joiner does the same job but in half the time with much less obvious effort. Both charge for their services by the hour so we’re basically paying for or rewarding incompetence!

 

Our ideas about fairness are based on marginal cost rather than fixed cost – we are willing to pay more when we see the costs involved. Purchasing decisions should be based on weighing pleasure against price but we have difficulty calculating these trade-offs. Judgement of a fair price depends on perceived costs. Because determining value is so difficult we use shortcuts – like assessing the level of effort required to produce something.

Loss aversion

Basically we get:

  • happy when we make money
  • really unhappy when we lose money

Loss aversion is the asymmetry around a neutral point, where losses are perceived at 2.5 times more powerful than gains. An example of this would be that sales people sell more when their commission is paid in advance because they don’t want to have to give the money back. Once you give people money they value it to a higher degree.

The endowment effect

This is when we adjust our level of ownership and that becomes the new baseline by which we judge gains and losses. When we know we are about to get a pay rise we think that it will sort out or debts, pay for better holidays, change our lives but once we have it we very quickly get used to it and nothing much about our lives changes.

Once ownership is established, people favour the object that they own, and when we own something we focus on what we would have to give up rather than what we could gain. After taking possession of an object people consider themselves the owner and like the object more, making it difficult to give up. A good example of this would be 30-day money back guarantees on things like sofas – once that sofa is in your front room you consider it yours and the chances are it won’t go back to the showroom.

Marketing and social norms

In some situations adding money to the equation makes things worse – imaging turning up at a dinner party and handing the host £20 instead of a great bottle of Chateauneuf Du Pape. Once financial motivation is added to the equation the social motivation disappears.

We live in a continuum between market norms and social norms. Imaging a work colleague’s car tyre blew and they phone you and asked for help. Would you help just because it’s someone you know? Yes – social norms. Would you help if they offered you £3? No – downright cheeky! Would you help if they offered you £300? Yes – market norms.

Gifts are in the social domain – if tell the recipient the value of the gift you violate social norms. Social norms often dictate when money is an appropriate gift for example a wedding or a birthday but it would be inappropriate as a get well gift or a thank you for looking after the dog while you were on holiday.

 

In the workplace this translates into the fact that the social benefits of things like health care or holiday schemes work better than cash commission.

Cash doesn’t build social capital whereas gifts create a greater sense of reciprocity. It is gifts rather than money that help nourish friendship.

Next time I’ll be looking at the price of free, micro payments and balancing money, time and happiness.

Tune of the week

Nouvelle Vague – The Killing Moon

Do you want ibuprofen with the bill sir?

This behavioural economics series is turning into an epic.

This week’s hot topics are the pain of paying and mental accounting – those who know me realise that my accounting skills are a bit off the wall but I don’t think that’s what we mean here.

The pain of paying

The pain we feel when paying for something is magnified when our feelings about spending money are coupled with consumption:

  • paying per bite for a meal makes economic sense but you wouldn’t enjoy the meal with the waiter hovering over you counting every mouthful
  • paying for a holiday on the day you come home makes more financial sense than paying the balance three months before you leave as you’d accrue more interest with the money in your own account. But you probably wouldn’t enjoy the holiday as much, especially the last day.

The pain of paying adds a moral tax to consumption and the timing and method of payment changes our enjoyment.

If you want to increase the pain of paying:

  • pay with cash
  • receive notification whenever money is spent
  • increase salience i.e. watch the petrol pump meter spin round as you fill your car, use an electricity coin meter or add consumption meters to all your household appliances

To decrease the pain of paying:

  • pay with credit cards
  • keep payments hidden
  • prepay before you consume

Prepayment can focus our attention on the enjoyment of an experience – think of all-inclusive holidays.

All the men out there if you’re looking for the perfect gift you need to know two things:

  1. it should remove the pain of paying
  2. it should be something that she wants but the pain of paying is preventing her from buying it

So, the pain of paying involves the opportunity cost, the hassle component, the moral tax with its associated guilt, the method of payment and the timing of the payment.

We experience less pain of paying when the form of payment is distanced from the pure representation of money, e.g. credit cards, casino chips as prepaid money is easier to spend.

That’s all from the perspective of a customer but organisations, especially local authorities should consider the pain of paying because let’s face it, who actually wants to pay their council tax or a parking fine.

Mental accounting

Once money is assigned to a certain category it is non-transferable. In our heads we assign money to certain categories and spend it accordingly. Assigning money to categories controls how we feel about that money and we treat unassigned money differently. Just the other day I lent HimIndoors £40 at the cashline. In my head that became lost money so when he gave me it back I spent it on rubbish instead of holding onto it and paying for food shopping or something useful. It is mental accounting that allows us to have a low interest savings account yet at the same time have a high interest loan because we see them as two different domains – spending and saving.
If we were all perfectly rational, mental accounting wouldn’t make sense. However, it can be an adoptive strategy. It allows us to partition our spending and make financial decisions more manageable.

So, there are two approaches for helping people think about their money:

  • assume they are rational and can effectively manage money between categories
  • optimise existing mental accounting techniques, even if they are irrational

If you want people to pay their bills instead of spending it on chocolate and wine get them to compartmentalise their money into funds. Make it as easy and as painless to pay – this is tricky for councils though. Credit cards may be the pain-free method but removing people completely from money and the pain of paying makes it too easy to buy unnecessary items on the never-never and so the debt spiral begins.

The council I work for is closing its cash halls and removing the ability to pay council bills in cash in council offices. Our preferred way to receive money is by direct debit or online payment but for a lot of people cash is simply the safest method to keep it all real and prevent money becoming some airy fairy notion and credit considered there to be spent, whether the monthly balance can be paid or not. Cash at a PayPoint or a Post Office may be the best option in the long-run for these people. otherwise we run the risk of future rent and council tax arrears because financially vulnerable people think we’re encouraging them to get debit cards and the overdrafts that go with them or worse, credit cards to pay council bills.

You can sign up to a watch list for Dan Ariely’s Beginners Guide to Irrationality course on Coursera but next time I’ll be sharing his thoughts on fairness and reciprocity, loss aversion and the endowment effect.

Tune of the week

Gentleman June Gardner – It’s Gonna Rain