Coca Cola

I recently noticed an interesting pricing strategy followed by Coca Cola: at my local One Stop grocery store, a 2 litre bottle costs £1.99. But if you buy two bottles, together they cost just £2.50. The second bottle cost 51p - a quarter of the first one!

Needless to say, I bought two. Who wouldn't? 51p for two litres of coke is a great deal! How do we know it's a great deal? Because it would usually cost £1.99!

Very, very clever pricing strategy. (Charging £1.25 per bottle, regardless of quantity, would probably result if far fewer sales.)

They increase sales by anchoring our view of the innate value of a bottle of coke high (£1.99) before smashing it with a 51p deal - of course it's a great deal! (And the great deal feeling will probably increase the likelihood of buying coke again.) Additionally, I knew I only needed one bottle, but I felt that after investing £1.99 I might as well reap the rewards and put in another 51p. (The sunk cost fallacy).

Why Three Options?

I'm going to start with a confession: Over the course of my time as a student I have spent a lot of time in coffee shops. Starbucks. Costa. Nero. You name it, I've been there. One of the things which intrigues me about said coffee shops is that they tend to offer three different sizes of hot beverage. Small, Medium, Large. Tall, Grande, Venti. Primo, Medio, Massimo.

Why three?

 

Could it be that there are precisely three different types of people who buy coffee, each preferring their own exact drink size? 

Given that the actual sizes of mugs differ between the franchises, I think not.

Could it be that the manufacturers of mugs only do precisely three sizes?

Unlikely.

Or, could it be that coffee shops know some behavioural economics?

When offered three options we are likely to prefer the middle one. This is because we are risk-averse and regret-averse; we want to avoid being on an extreme. If offered two sizes of drink, we'll choose whichever one we like. If offered ten, we'll be overwhelmed by the choice. If offered three, we're likely to choose Medium; Grande; Medio.

Of course the thirsty will still go for the Large, and the thrifty for the Small. But by offering three options Starbucks, Costa and Nero maximise their revenue. They cater for all and simultaneously nudge people who would have bought Small into purchasing more coffee. 

So there you go: not all my time in coffee shops was wasted...

Book Review - Priceless

I have a huge amount of affection for Priceless by William Poundstone because it was the book that first introduced me to behavioural economics. It prompted me to study all things behavioural at university, and I haven't looked back. For this reason I may be a little biased in favour of Priceless but the bias is, at root, caused by the book being brilliant.

William Poundstone expertly explores how shops constantly use behavioural economics to encourage you to buy their goods, while simultaneously telling the story of how behavioural economics came to be. It is an utterly gripping read, written by an accomplished journalist who knows how to keep you hooked. It will have you doing little experiments on your friends all the time (as my housemates at the time can testify).

Priceless lifts the lid on the art of pricing, advertising and marketing. You will finish it a wiser consumer, potentially less like a hapless wave; driven and tossed by the winds of capitalism.

My favourite example that he uses is of the free 72 ounce steak. Some American burger joints are famous for offering 72 ounce  steaks for $72 unless you can finish it in one sitting, in which case there is no charge. People travel miles to take the challenge, and when they do they are placed on a high table, with all their friends looking on from the rest of the restaurant. Poundstone reveals that the way these burger joints make their money is not from people failing the challenge (which is most of the time), but from their friends paying over the odds for a normal steak. Their friends' perception of value is anchored on the $72 steak, and so the $19.99 steak seems cheap, even though it might only be $9.99 elsewhere. The moral of the story is don't buy a normal steak at one of these places!

My one gripe with Priceless is that it focuses on the psychologists at the cost of behavioural economists. The two groups do not always agree and in some cases the story is rather one-sided. This, however, is a minor complaint; Priceless has so many outstanding features that make it just fantastic.

It is A Very Good Read. I can't remember what the price was, but I know how much it's worth; quite simply...

Priceless by William Poundstone
Genre: Psychology/Behavioural Economics
Accessibility: 10/10
Accuracy: 7/10
Readability: 10/10
Usefulness: 8/10
Verdict: A Very Good Read

Book Review - Predictably Irrational

Predictably Irrational is a fantastic name for a book about behavioural economics. If you are looking for an easy read that will introduce you to many behavioural concepts using quirky yet illuminating stories, then this is the book for you. Dan Ariely takes us through all his research in a gripping tour of the wacky world of behavioural economics, finishing with an insightful take on the credit crunch. If nothing else, Predictably Irrational will convince you of the need for behavioural economics.

Predictably Irrational will not, however, give you a solid academic overview of the subject. The author's approach is to take us through his own wide-ranging research, but this means that genuinely ground-breaking stuff from other authors is sometimes omitted. For example, his chapter on anchors is well-written but illustrate matters with a flawed experiment (incentives were purely hypothetical - see Incentives - Ante Up). (Daniel Kahneman did not have this problem with his book.)

Ariely also includes the single most stupid experiment I've ever seen: it turn out that men, when sexually aroused, are less rational... well, DUH!

Another issue is one of his pieces of advice: hang around with a friend that is slightly less attractive than you in order to make yourself look more attractive (and whatever you do don't tell them, because that ends badly according to one of his readers). While this probably works, it is manipulative. I would not advise following all of the advice in Predictably Irrational. I do not advocate people using and manipulating their friends (or anyone)!

I will, however, end on a positive note. The chapters on cheating and honesty were genuinely new to me. Ariely's research showing that people cheat less shortly after being asked to recall the 10 commandments (or similar) is both credible and important.

Thus Predictably Irrational, while being occasionally frustrating, is well-written, easily accessible, often amusing and incredibly interesting. It is a good read, but it could be better.

Genre: Behavioural Economics
Accessibility: 9/10
Accuracy: 6/10
Readability: 9/10
Usefulness: 6/10
Verdict: A Good Read

PS Ariely has a blog, too: danariely.com

How Much Would You Pay For Facebook? - Time Will Tell

In the first quarter of 2012 the average UK house price was £226,887 (BBC)

How much would you pay for Facebook?

• £1000 a year
• £500 a year
• £100 a year
• £10 a year
• £1 a year
• Nothing

Just £2 a week for one year is enough to equip two African villagers with the skills to work their way out of poverty (Tearfund).

How much would you pay for Facebook?

• £1000 a year
• £500 a year
• £100 a year
• £10 a year
• £1 a year
• Nothing

Now I'm guessing that as you're reading a blog about behavioural economics you're probably on your toes, but similar techniques are used by shops all the time. The next time you go shopping try looking out for them...

Recommended listening:
Time Will Tell by Bob Marley

How To Design A Wedding Gift List - Give Me Everything

I'm now at the age where my friends start getting married and last weekend I had the awesome privilege of being a Best Man. I must be very cool, because throughout the Best Man process behavioural economics kept on coming to mind.

Most couples now put up a wedding gift list online, which friends and family can use to guide their gift choices. I think this is a great innovation, allowing couples to easily communicate what would be useful as they embark upon married life together. As I perused these lists I got thinking about how to design them.

I'm going to make an assumption at this point: newlyweds would like their friends to be generous. So, how does one persuade one's friends to be generous?

One particular insight from behavioural economics called anchoring is likely to be useful (anchoring being the principle that people's opinions of what is a reasonable can be easily affected).

For example, say someone thinks £20 would be a reasonable wedding gift. How might one change that? I have two pieces of advice:

• Make the top item on the list uber-expensive. If the first gift people see is a £500 plasma screen, their opinion of what would be a reasonable gift may rise. Obviously not by £480, but some increase is not unlikely. No-one may actually buy the TV, but that's not the point, and hey it's no big disaster if they do!

• Create a way of communicating what previous people have given. For example, putting "bought" on an item that has been given already. Showing what others think is a reasonable gift is a surefire way of affecting what we think of as reasonable. Of course the risk is that if people give small gifts then this may decrease future gifts (if you were sneaky you could probably find a way of highlighting previous expensive gifts more).

Anyway, I would just like to say that when it comes to my wedding (which wont be anytime soon - all offers welcome...) I wont use either of the above methods. Why? Because manipulating my friends into giving me more is not something that I'm comfortable with. Thus I venture to suggest that the real lesson from this blog is that the use behavioural economics can throw up moral questions.

PS If I did see a friend trying to use behavioural economics to get me to give them more I would probably give them less out of principle!

PPS I hasten to add that the couple for which I was Best Man did not use any behavioural economics!

Recommended listening:
Give Me Everything by Pitbull

Anchors – The Chain

• Is Wayne Rooney 45 years old?

• How old is Wayne Rooney?

http://i.telegraph.co.uk/multimedia/archive/01837/wayne-rooney_1837352b.jpg

The answer is... 

26 (b. 1985), hair transplant aside.

It’s very likely (although you may struggle to believe it) that your guess was affected by the number 45 in the first question. The number 45 acted as an ‘anchor’.

The theory goes as thus: in your thinking you started by briefly considering whether Rooney is 45 (clearly not). Then you adjusted down until you reached a reasonable figure, and settled on that being your guess. If the age in the first question was 15 you would have started by considering whether Rooney is that young (again, clearly not). You would then have adjusted up until you reached a reasonable figure.

In 1974 two Israeli psychologists named Amos Tversky and Daniel Kahneman published an article called ‘Judgement under Uncertainty: Heuristics and Biases’ (a heuristics is just a ‘rule of thumb’). It was a seminal work which demonstrated how people make systematic errors.  One of their key findings was that when people estimate something unknown, they start at an initial point and then adjust their answer. But people systematically use insufficient adjustment from that starting point: thus there is a ‘bias’ towards the initial point.

Even if we are made aware of the fact that anchors have an effect, and even if the anchor is plainly ridiculous, we are unable to completely rid ourselves of this bias. For example, anchoring may have an effect on your following answers

• Has Wayne Rooney scored 10,000 goals for Manchester United?

• How many goals has Wayne Rooney scored for Manchester United?

Aside from the obvious own goal that is his hair, he’s scored (as of April 2012) 180 goals for Man U.

Given that you are probably not reading this while on a TV quiz game show you would be forgiven for thinking ‘so far, so irrelevant’. 

But it might interest you to know that shops have been using anchors for years. Ever wondered why the most expensive car is the first thing you see when you enter the showroom? Or why the most expensive house is on the cover of the real estate magazine?

They’re trying to influence your estimate of what a reasonable price is by anchoring your mind at their highest price (i.e. an expensive convertible makes everything else look like a bargain). That way, you buy more expensive stuff. Clever eh?

So the next time you shopping don’t be influenced by the highest price in the shop. It's just a trick!

Footnote: 

Confusingly, in a chandlery an anchor may not be an anchor while literally anything that clearly isn’t an anchor could be an anchor. Funny old world.

Recommended listening:

The Chain by Fleetwood Mac