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How companies use behavioral economics to squeeze your wallet — Pop Economics

How companies use behavioral economics to squeeze your wallet

by Pop on September 10, 2010

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And sadly, they’re on the bleeding edge of research.

You might have heard about all those little tweaks government officials have thought about implementing in order to make you healthier and save more. You could have companies automatically enroll employees in a 401(k) plan, rather than have them opt in, for example. Companies that have implemented that little change have seen 401(k) participation jump to 93% from 76%.

But, of course, the very best behavioral economic “parlor tricks” aren’t all used for good. In fact, it’s often the marketing departments of consumer goods companies that implement new research the fastest. Here are a few to look out for.

“On sale”, “50% off”, and anchoring

I got painfully close to buying a web marketer’s extremely expensive online course just a few weeks ago. I didn’t end up buying, and this isn’t a commentary on the quality of that course—who knows, it might have been worth $1,000. But a few moments after my decision not to buy, I went back to see how he almost got me. After all, I don’t even know the guy. I don’t have any friends who took the course and could recommend it. And yet, I almost bit.

One clever strategy the marketer employed was to set his course price extremely high in the beginning, but offer a seemingly steep discount promotion after a couple weeks. The course started at $1,000, but by the next month, it dropped to $500. Since I, and his other targets, already thought of his course as a $1,000 investment. Five hundred seemed like a great deal.

The technique is called anchoring, and it’s one of the older tricks in the book. You give the target a “reference point”, and then negotiate around that reference point to achieve your desired effect.

To better understand the trick, imagine what my feelings would have been had he started his pricing at $250 and later e-mailed to say the price had increased to $500. I would have laughed in his face.

Drip pricing: Pile on the little charges after the decision to buy

Ever bought a car? Maybe you negotiated hard down from the sticker price (probably already facing anchoring bias). But after the dealer shook your hand and said “We have a deal”, the extra charges started to pile up. Water-proof seat treatments, a delivery charge, rust-proofing…you name it. The charges didn’t seem big relative to the overall purchase, but they probably added up to several hundred dollars.

You see, the best time to hit someone with nasty surprises like that is after they’ve already decided to buy. Once that decision is made, the target starts to think as if he already owns the car. Even though no money or product has been exchanged yet, it’s hard to back away from that decision in the face of new information.

In the U.K., the Office of Fair Trading, which is in the business of consumer protection, played several marketing tricks on students, to see which they were most likely to fall for. Hitting them with a shipping fee first and then a handling fee was the most likely to confuse them as to what was a good deal.

So why don’t we get it? Two things could be going on. First, even though you don’t own the product, once you make the decision to buy, you start to feel some of the pleasure that goes along with owning it. That sporty red car feels like yours, even though you haven’t bought it yet. So making a decision later not to buy it can be a painful loss.

But second, we also tend to have trouble with “complex pricing.” Unless it’s added up for us, we don’t make the connection that a $500 purchase—with $15 S&H, a $40 warranty, and a $50 required battery charger—is actually a $595 $605 purchase.

Creating a sense of urgency

This was also something the guy with the $1,000 course employed. “This course becomes unavailable at midnight. I’ll probably never sell it again, but if I do, the price will only go up.”

Of course, that was a few days before he cut the price in half, but putting that aside…

Loss aversion also extends to a perceived lack of availability or exclusivity of a product. On T.V., you’ve probably seen dozens of products “not available in stores.” The Nintendo Wii stayed hard to buy for years after its debut (though Nintendo would argue that was because they couldn’t keep up, not because they wanted to create a sense of urgency to buy).

Right now, it’s very in vogue for tech start-ups to only allow a small number of subscribers to try a product at first, before expanding to the general populace. Remember when Gmail was available by invite only? Somehow, I doubt they did that just to avoid a stress on their massive servers.

Unfortunately, I don’t think it’s ever going to be possible to completely avoid this marketing tricks. Sometimes, it might not even be advisable. I remember when I got my early-adopter Gmail account. It actually felt really good to have something that other people had so much trouble getting. And while ephemeral, that nice feeling still has value.

But next time you’re faced with an experienced salesman or see an ad on television, try to picture the training and thought that went into that advertisement. I guarantee you that any company worth its salt is using all of the great behavioral knowledge we’ve developed in the last couple decades to squeeze your wallet.

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{ 5 comments… read them below or add one }

Jeff @ Sustainable Life Blog September 10, 2010 at 10:17 am

Hi Pop.
I Bought a car recently (December) and definately felt the dealership try to put the squeeze on me. They had the sticker price of the car for an anchor, so when I took the cash back and the recent grad discount off, what I got was a 4k reduction (almost 20%) and it seemed like a great price to me. Once we agreed on that however, came the pushing for the extended warranty, the maintenance plan, the oil changes for a year for X dollars (that may have been worth it). Unfortunately for them, I broke out a piece of paper and started adding all the stuff up then calculating the difference between the financing and the cash back. It all came out in the wash and I took the cash back, but I still think I got a good deal.

jim September 10, 2010 at 7:37 pm

500 + 50 + 40 + 15 = 605 :-) That marketing is so good you even tricked yourself to think it was $10 cheaper.

I think Gmails limited rollout was more born in the way that software development works than a marketing ploy. In the high tech world testing a product early on a handful of consumers is called a “beta”. That is what Google calls their early roll outs. That generally means you invite some customers to test out the product before its actually finished. It is probably full of bugs at that point and the customers end up doing free testing and debug work for the company for the benefit of early access to the product.

Pop September 10, 2010 at 8:10 pm

Hah, thanks for pointing that out!

Gmail, which started in 2004, was invite-only from its launch until 2007. That’s three years! Even though pretty much anyone could get an invite by the end of the launch phase, you still had to be invited. I don’t think you’re going to convince me that Gmail wasn’t ready for the masses in 2006. Here’s a story on the hysteria the exclusivity created toward the beginning of launch: http://www.pcworld.com/article/116293/gmail_hits_the_auction_block.html

Separately, Gmail didn’t officially leave “beta” until mid 2009. Its endless beta status was the butt of jokes, even at Google: http://gmailblog.blogspot.com/2009/07/gmail-leaves-beta-launches-back-to-beta.html

Pop September 10, 2010 at 11:18 pm

Hey Jeff, thanks for sharing the dealership story. I think we’re especially susceptible to circumstances such as car negotiations since few people have experience buying cars more than a few times in a lifetime. Also, sorry it took your comment so long to get through. Got caught in the spam filter.

Farnam Street September 11, 2010 at 4:21 pm

Great article. I love the dark side of psychology. One of my favoriate examples of complex pricing is in airlines now — see what airlines have learned from cell companies
http://www.farnamstreetblog.com/2010/03/manufactured-uncertainty-what-airlines.html

Also, with anchoring — subway is using that to raise prices.
http://www.farnamstreetblog.com/2010/07/9-footlong-how-subway-is-raising-prices.html

F.

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