LI promo: _We buy things we may not have use for just because they’re available at a price lower than we expect. We reject perfectly useful things we need simply because we believe their correct price in our judgment should be lower. _
_Understanding bargains and rip-offs is understanding how we choose. It tells us that we have two responses—one utilitarian and one emotional. It tells us how consumers think. It also holds the key to how sellers behave. It tells us about human rationality. That it is a mirage. _
_Any serious investigation into the ways we think about money can turn funny. This week I explore bargains and rip-offs. _
Consumers do not just buy goods (or services) for their value to them. They also pay for the pleasure of a good deal. And everybody—rich and poor alike—loves a good deal. The idea behind the value of the deal is at the heart of purchase decisions and understanding this psychology is key to selling successfully and buying judiciously.
To illustrate this with an example, I offer you this scenario first outlined by 2017 Nobel Laureate Richard Thaler in his 1985 paper titled ‘Mental Accounting and Consumer Choice’:
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When two versions of the question were put out, one using the phrases in parentheses and the other using the phrases in brackets, the median responses revealed that participants were willing to pay a lot more, $7.25 compared to $4.10 adjusted for inflation as of 2015, for the beer from the resort than from the convenience store.
The beer is exactly the same. There’s no difference in service or ambience or in the consumption experience. In both cases, you’re lying on the beach on a hot day. Yet, you are willing to pay vastly more or less depending on just where the beer was bought from.
Let that sink in.
You perhaps intuitively already _get _this difference but how can you explain it without appearing kooky?
Let’s dive in.
The ingenuity of Richard Thaler
Let’s see how Thaler’s beer-on-the-beach example plays out.
Suppose you say you would only pay up to $4.10 for the beer from the bodega, and up to $7.25 (sticking to the median figures from the study) from the resort. Turns out that the bodega owner wants to make a quick buck and prices his beer at $5. Your friend has to return empty-handed as it is beyond the budget you’ve set. Now, were the same beer available at exactly the same price at not the bodega but at the resort, your friend would’ve gladly bought it for you as it was well below the price limit set by you.
Say this friend of yours cares about you. He wants to see you happy so he lies about the source of the beer. He tells you he bought it from the hotel. You’re thrilled at the prospect of guzzling down the chilled beer procured at a very reasonable price.
The same beer, with merely the source of purchase altered, could feel like a bargain or a rip-off to you. Why do you care where the beer was bought from if the beer’s the same?
Implicit in your price thresholds are certain expectations. You expect beer from a resort to cost more than beer from a bodega. You may not be in the habit of buying drinks from fancy resorts but you understand why a drink from there would pinch your pockets more than one from a bodega. But forking up resort pricing for a bodega drink is being robbed in daylight.
Thaler comes up with a spark of genius to explain this choice.
He defines two kinds of utility. One you know about, and one you know intuitively about but perhaps cannot fully explain.
The utility you know about is the value of the good or service bought minus the price paid. It is the subjective value you associate with the purchase. Is the thing you bought useful to you relative to what you paid for it? In the example, a parched you on a hot day at the beach pines for a cold beer. This would be, as Thaler describes, ‘a utility windfall.’ For the price of $4.10, there’s nothing better for you at that moment than a cold beer. This kind of utility he calls acquisition utility.
So you acquire/own something valuable to you at a price that makes sense to you. That is, you cannot think of an alternative use for that price that betters your purchase. This should be all there’s to it. Right? Wrong.
You also care about the _perceived _quality of the deal. It matters how you feel about the transaction. Do you feel good? Do you feel cheated? That is captured by something called transaction utility.
Transaction utility depends on the difference between the selling price and your own reference price for the item. If you think you paid more than the price you normally expect to pay, which is your reference price, you’re bummed. If, on the other hand, you think you got what you wanted for _less than _what you were okay shelling out, you feel good.
Newsflash: this reference point changes depending on, as in the case of Thaler’s example, the source of purchase. Said simply, what you expect to pay changes with whom or where you’re buying from.
💡Because the perception of the value of the deal _also _matters—meaning in addition to the value of the acquired item—a good deal has the power to make an item/service of questionable value a must buy and a bad deal means you can willingly forgo something of unquestionable value to you.
Think about it. You were okay with giving up a delicious pint of beer because it was too expensive for a bodega but would have enjoyed the same pint at the same price if you thought it came from a fancy resort.
**Some things are nicer to pay for than to own **
I once bought a pair of leather shoes that were on an attractive discount at a San Diego store. I was chuffed. Owning the shoes brought a bounce to my step until it was time for me to walk in them. It was half a size too small! I couldn’t slip into them without also sporting a limp. (I still have the pair with me in near pristine condition in the hope that my feet will downsize.)
Some things, as Ogilvy ad man Rory Sutherland says, are nicer to pay for than to own. Those shoes are one of those things.
If the utility to the buyer, as per Thaler’s formulation, is split between the value of owning the good (acquisition) and the satisfaction of having driven home a good bargain (transaction), both have to be considered in a purchase decision.
My acquisition utility for the shoes was zero. I couldn’t—can’t—wear them. But there was plenty of transaction utility. I was convinced I had landed myself a sweet deal by bagging those shoes at that price (which was substantially lower than my internal reference point for what a pair of good leather shoes should cost).
Now that you get that your purchase decision considers the value of the deal in addition to the value of the item, you can understand why you sometimes feel lucky and at other times robbed.
A bargain hunter is addicted to the pleasure of the deal
My wife tells me this childhood story of hers from Mumbai in the early 1990’s. Once a month, her father would put her six-year-old self on his bicycle and cross the train tracks to buy eggs in bulk at wholesale prices. Each such trip would last a few hours, and they would return pushing a cycle loaded not just with eggs but other items on the grocery list (shampoo, conditioner, sanitary pad, etc.)
My father-in-law worked in the procurement department of a big construction company. For close to forty years, he pursued good deals. Not surprisingly, for domestic matters too, he did the same. Despite their cramped living quarters, my wife’s family would at any time be stocked up for the apocalypse. My father-in-law was happy as long as he paid less than the suggested retail price, be it at the grocery store or even (initially, as my wife tells me) at the mall.
But if there are savvy consumers like my father-in-law, sellers who spot and manipulate this hunger for a bargain in consumers cannot be far behind. And they aren’t. Most of the time they’re a step ahead. They’re pros at creating the illusion of a deal.
The perception of a deal
A few years ago, when I was incubating a new product unit, one of the early products we rolled out was a grammar checker for scientific writing. Scientists before submitting their manuscripts to journals would run them on our grammar checker. They could have their papers reviewed for free and if they wanted an edited file with marked-up corrections, they had to pay a fee.
At that time, the grammar checker was the only such product (or one of very few) in its category. So we had to set a reference price. We did that but we also decided to strike through that retail price to offer a lower, more attractive, discounted price. The purpose of the struck-through price was to create a number to which the buyer’s thinking would be anchored to. And anchor it did, creating the perception of a deal in the buyer’s mind.
Without explicitly knowing it, we answered questions around both acquisition and transaction utility for our grammar checker. By offering a free walkthrough of the corrections, we allowed customers to assess the product’s quality for themselves. By discounting, we let customers take home the pleasure of a good deal.
Retailers get that customers love bagging good deals, so they see value in creating the illusion of a deal through frequent discounting, holiday sales, and so on. But oftentimes, quality is hard to assess. Consumers cannot take mattresses or televisions for a walkthrough. Social proofing and online reviews aside, sellers can nudge buyers, as Thaler writes in Misbehaving, by ‘announcing a largely fictional “suggested retail price,” which actually just serves as a misleading suggested reference price.’
Hamstrung by a paucity of information on the acquisition utility (quality of the item), buyers overweight the quality of the deal. By advertising discounts, sellers ‘simultaneously suggest that quality is high (thus increasing perceived acquisition utility) and imply that there is transaction utility to be had because the product is “on sale.”’
But what about purchase situations when the stakes of siding with transaction utility may be high? Employers can drive a hard bargain while hiring talent yet not have thought through utilization of the newly purchased capacity. Such emphasis on pursuing hires that offer high transaction utility may leave companies with underused inventory just because it came cheap.
**What does it mean to waste money? **
The perception of a poor deal is what stops many of us from having a good time at Mumbai multiplexes. Post COVID, watching a movie at the theater has elevated itself to a luxury. While patrons are okay with coughing up big bucks to catch an MI movie or a Christopher Nolan masterpiece, they feel squeamish about shelling out the same or more on popcorn and beverages. Going hungry and thirsty for three hours is not for the faint-hearted and distinctly reduces the quality of the movie-going experience, yet the idea of handing over their hard-earned money to the multiplexes pains patrons more. It is akin to wasting money. So much so that the Indian Supreme Court had to intervene to stipulate that while the cinema reserves the right to admission and set prices for food, they have to provide free drinking water.
To waste money means to opt for a purchase with negative acquisition utility. You could’ve had a lot more for the price you paid for the item. You overspent. When that happens, you may experience a sense of regret called buyer’s remorse.
Buyer’s remorse springs from a difficulty in assessing the next-best thing you could’ve done with the same amount of time and money—in other words, the opportunity cost. Anyone who has worked on mergers and acquisitions understands that the question of opportunity cost _should _loom large over investment decisions. Yet, despite the high stakes, it is not natural for people to think in those terms. It is not typical for business decisions to be framed thus:
Option 1: Invest in company A.
Option 2: Let the opportunity pass. Invest the amount into existing product line Y and offer more competitive pricing in a key market to undercut competition.
Finding competing alternatives that merit consideration (like the italicized bit) should be obvious, yet often isn’t. Business questions when reframed can lead to vastly different decisions, with all facts remaining the same, thanks to an acknowledgment of opportunity costs.
Can you waste ‘free’ money?
If wasting money stokes in us an intense aversion to loss, can free money unshackle us from the math of utility?
For the company’s fifteenth anniversary, my employers took every single employee out of town for a two-night stay at a luxury resort. Even now, six years on, those who were there talk about it. Imagine if instead of organizing this extravaganza, the founders had decided to simply give everyone a cash bonus for the same amount. Had they done that they would also have unwittingly gifted an unhealthy serving of guilt.
An all-expenses-paid trip is a transaction utility jackpot. You pay nothing for an experience that normally would cost an arm and a leg. However, with the equivalent amount in your checking account, you would be hard pressed to ignore all the utility-enhancing purchases you could make with the money instead of indulging yourself. You would be hard pressed to ignore the guilt.
So, there are gifts in kind and then there’s gifts in cash. But the latter isn’t free money. Perhaps guilt money is more like it.
Some things are better to own than to pay for.
Do you feel first, value later?
Sasha Aickin, former CTO of Redfin, quotes this piece of advice from his grandmother.
‘When you buy something cheap and bad, the best you’re going to feel about it is when you buy it. When you buy something expensive and good, the worst you’re going to feel about it is when you buy it.’
Of course, when we’re buying something below our reference price (that is, cheap), we don’t necessarily believe that it has no or little utility (that is, bad). And when we splurge on something, we are probably overestimating the value of the item. Yet, captured in Aickin’s grandmother’s pithy words is the essence of human thinking behind purchase decisions.
The operative word for me—and I’ve a hunch Richard Thaler would agree—is feel. It is not just about what we buy. It matters to our purchase decisions how we feel about the buy. A rational actor would view all costs as losses. Yet we eagerly incur costs (= pay for deals) for items available at prices lower than our personal reference point. At the same time, we refuse acquisition-utility-rich purchases, like cold beer on the beach, when we think the purchase yields no transaction utility.
This begs the question: Do we judge a purchase by transaction utility first, and acquisition utility thereafter? Do we experience the pleasure or pain of a purchase first, and then upon completing the purchase experience the utility of the acquired item?
If so, it means that we covet a good deal first, followed by a good experience of consuming the item purchased as an outcome of the deal. The more we’ve paid for something, the more fully we desire to use the purchased item so as to feel better about the transaction. Had I paid full price for those leather shoes, I would have been strongly tempted to wear them despite the limp they produced. Maybe I would’ve worn them and faked an injury to explain the limp.
This may sound desperate, yet it is rather common. We want to square up the mental account opened up by a purchase. We dislike it when the account is in the red and we’re willing to go to great lengths to change that.
Richard Thaler spent his career first understanding, then explaining how we think about money. What he distilled it down to, he called mental accounting. That breakthrough shook up classical economics that had laid down in neat axioms how humans always make rational choices.
But mostly it helped us understand the world around us, and our own selves, better. Instead of making much of ourselves as perfectly rational, we began to see ourselves for what we are: predictably irrational.
Extra
Bargains and rip-offs
My discounted San Diego shoes felt like a bargain, so I bought them only to question my sanity later. You on a hot day at the beach felt ripped off by the bodega owner, and were left thirsty and cranky.
Seems like the purchase location is linked to the location of our pleasure and pain buttons. That’s a strange thing to say. How can _where we buy from _be so important? Shouldn’t it be irrelevant? It should be to a perfectly rational actor but we seem to not measure up to that definition.
Consider this situation. (Those familiar with traffic in India will relate to this deeply.)
You’re driving in the city. You’re inching forward actually. In the past hour you’ve only covered what would normally take ten minutes. You’ve been at this intersection for what seems like forever. You jump the light. Before you can say Charlie Brown, a cop appears out of nowhere and flags you down. He has a smirk on his face. He has got your number.
In the next few minutes, you launch a charm offensive on the cop. You somehow convince him to not write you a ticket. He lets you off with a small fine, down to a few hundreds from a hefty couple of thousand rupees, that goes into his pocket. You get back into the car feeling good, feeling like you got off paying a lot less than what anyone in your situation would’ve had to pay up. You feel like you got a good deal. You feel good.
The example above may seem like a bizarre preoccupation with getting a good bargain but it only underscores the importance of transaction utility.