Promotions: The Effect of ‘Labelling’ on Customer Behaviour

I've just had the great pleasure of writing a guest blog for The Marketing Directors (the marketing consultancy) and here it is: Promotions: The Effect of ‘Labelling’ on Customer Behaviour

How not to play Poker

Demonstrating that behavioural economists are no more rational than anyone else I committed the same mistake playing poker that I did about a year ago...

I acted irrationally by seeing different colour chips as qualitatively different as well as quantitatively different. Despite the fact that one black chip was worth five white chips, I preferred betting five white chips than one black chip because I saw the higher value black chips as in some way better. This led me to be more risk averse when I had lost my white chips and had only black chips to bet.

Because I saw equivalent amounts of money as different I acted in a non-fungible manner. I'm not blaming this violation of fungibility for my poor performance (I lost, badly) but I am surprised to see myself commit the exact same mistake that I even wrote a blog about before. Some people never learn...

Winter Fuel Payment

In the UK everyone over the age of 60 is given the Winter Fuel Payment each year by the government. ('Winter Fuel' refers to heating and electricity costs.) Over the last 10 years the Winter Fuel Payment has varied between £200 and £250 per person over 60, with the payment for those over 80 varying between £300 and £400. The Winter Fuel Payment is usually paid in one lump sum in November or December. There are no legal requirements or official guidelines over how the Winter Fuel Payment should be spent by the recipients.

On average, what percentage of the Winter Fuel Payment do you think is spent on fuel? 

Imagine the hypothetical scenario where everything stayed the same, but the Winter Fuel Payment was called 'The Annual Payment'. On average, what percentage of the Winter Fuel Payment (now called The Annual Payment) do you think would be spent on fuel?

The answers are 41% and 3%, respectively! (according to Beatty, Blow, Crossley and O'Dea, 2011) The label 'Winter Fuel' alone causes 38% of the Payment to be spent on fuel. This is called the labelling effect and it is another example of non-fungibility.

Does this information change whether you think pensioners should receive the Winter Fuel Payment?

Does the Child Benefit?

In the UK all parents receive Child Benefit from the government (equivalent to Child Tax Credit in the US). It's worth £20.30 per week for the eldest child and £13.40 per week for other children. The government spends 1% of GNP of Child Benefit. So it seems relevant to ask how Child Benefit is actually used by parents...

a) Parents spend a greater proportion of the Child Benefit on their children than they do with other sources of income
b) Parents spend the same proportion of the Child Benefit on their children as they do with other sources of income
c) Parents spend a lower proportion of the Child Benefit on their children than they do with other sources of income

(This data is accurate for the years previous to the recent change: all parents got the whole Child Benefit regardless of income)

The answer is c!

Blow, Walker and Zhu (2012) found that parents spent less of the Child Benefit on their kids than they do with other sources of income. Does this mean that British parents are uncaring?

Well, it gets worse... Parents typically spend nearly half of the Child Benefit on alcohol!

Oh dear. That's what children drive you to. 

- My Dad

But, in fairness, upon delving into the data Blow et al. discovered that parents have already insured their children's consumption out of primary sources of income. So an alternative explanation of the data is that parents don't count the Child Benefit when doing their budgeting and then treat it as an extra to be spent frivolously, safe in the knowledge that their children are cared for.

This is non-fungibility, but just not in the expected direction. The label 'Child Benefit' has a rather perverse effect. 

So, what do you think, does this prove Child Benefit should be axed?

Easy Money

Does the way you spend your money differ according to how it came your way?

More specifically, are you more or less prudent with income that you didn't directly earn (such as an inheritance or a government grant)?

A recent paper by Christiaensen and Pan (2012) analysed household spending in rural China and Tanzania and found that different sources of income are used differently. 

Earned income is more likely to be spent on food staples or education, while unearned income is more likely to be spent on more luxury goods such as alcohol, tobacco or clothing. While money is quantitatively the same, it is viewed as qualitatively different. This non-fungibility has implications for whether government money is distributed by employment generating programmes or cash transfers.

So have a think, are you less careful with unearned income? Could you better manage your finances by paying more attention to how you spend 'easy' money?

The Disposition Effect

A person who has not made peace with his losses is likely to accept gambles that would be unacceptable to him otherwise.

(Kahneman and Tversky, 1979) 

Stock brokers prefer to sell stocks that rise in price than stocks that fall in price. The preference for 'winners' over 'losers' is driven only by the desire to realise gains over losses. This is called the disposition effect, and it is likely to lead to lower profits.

This is because attitude to risk is different for losses than gains. Behavioural economics has shown that people tend to be risk seeking when it comes to losses, but risk averse when it comes to gains. For example, a stock that depreciates in value will be seen as a loss, making the stock broker more risk seeking and therefore more likely not to sell it (it may go up in value again). But if the stock rises in value then the stock broker is more risk averse and therefore more likely to sell it (to avoid the risk of it falling in value).

The disposition effect increases taxable income (Odean, 1998). If stock brokers realise 'winners' they have to pay tax on the gain. But stock brokers do not have to pay tax on 'losers'. Thus stock brokers could put off paying tax (and thus earn money) by holding 'winners' for longer. And by selling 'losers' taxable income reduces; if stock brokers sell the 'losers' and buy almost identical stocks taxable income actually falls. Thus the disposition effect is irrational for stock brokers (but good for the Inland Revenue!).

The disposition effect is a violation of fungibility because investors view units of money either side of the gain/loss boundary as qualitatively different. This is an example of non-fungibility causing market failure. If investors were aware of this non-fungibility they might be less likely to exhibit it.

Putting the Fun into Fungibility

My apologies for my recent silence, I've been working hard on my MSc dissertation (now successfully finished). The topic of my dissertation was 'fungibility'. My next few posts will explore fungibility and why being aware of it may help you make more rational decisions.

Fungibility is the principle whereby economic agents treat all units of money as equal and as perfect
substitutes, regardless of where they came from.

Violations of fungibility occur when individuals use money differently because of the way it was earned, stored or labelled. Violations of fungibility can cause us to make suboptimal decisions and are thus termed irrational.

Take the example of an €8 gift voucher at an expensive restaurant. For some customers the voucher can be spent on beverages (the 'labelled' voucher) while for others the voucher can be spent on either food or beverages (the 'unlabelled' voucher). As almost all customers spend at least €8 on beverages the gift is 'nondistortionary'.

Johannes Abeler and Felix Marklein (2013) ran this field experiment and found that customers who had the labelled voucher spent on average €3.90 more on beverages than those with the unlabelled voucher.

The label attached to the money had changed behaviour (even though, rationally speaking, both groups should have spent the same amount on beverages as the voucher was nondistortionary). This 'labelling effect' violates the principle of fungibility.

So the next time you receive a labelled voucher think to yourself 'Would I have spent that much on ... anyway?' 'How much was I originally prepared to spend on ...?'

It might just help you avoid be more rational in how you spend your money.

Taxing Rebate

If people are rational they know how to best spend their money, regardless of how and when they get it. So a recent study by Naomi Feldman (2010) raises some interesting questions.

Feldman examined whether a seemingly unimportant change in US tax law changed savings rates. In 1992 the George H. W. Bush administration changed how income taxes were collected. The amount of the taxes stayed the same, but less was collected each month. This tended to reduce tax rebates at the end of the financial year, but increase monthly net income. It didn't change the amount anyone paid in tax, but changed when they pay it. It meant there was a shift in income. Instead of receiving a sizeable yearly tax rebate, households had a larger net monthly income. Traditional economics would not predict any change in behaviour.

However, Feldman found that people saved significantly less after the change.

The yearly rebate was large enough to be seen as special and so people carefully considered how to spend it, typically saving a high percentage. The small monthly increase in income, however, was just added to household consumption budgets and so typically not saved. This is an example of mental accounting - the process by which people sort income into different budgets and tend not to shift money between budgets.

Thus we have a textbook example of the law of unintended consequences - a minor change in tax law causing huge shifts in behaviour. An argument, if ever there was one, for the use of behavioural economics in policy making!