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).

Cold Beer

The following question was originally posed by Richard Thaler (1985):

You are lying on the beach on a hot day. All you have to drink is ice water. For the last hour you have been thinking about how much you would enjoy a nice cold bottle of your favourite brand of beer. A companion gets up to go make a phone call and offers to bring back a beer from the only nearby place where beer is sold (a fancy hotel). He says that the beer might be expensive and so asks how much you are willing to pay for the beer. He says that he will buy the beer if it costs as much or less than the price you state. But if it costs more than the price you state he will not buy it. You trust your friend, and there is no possibility of him bargaining with the bartender. What price do you tell him?

Now imagine instead of there being a fancy hotel there is only a small, run down grocery store. What price do you tell him?

In the experiment half those questioned were told it was a fancy hotel, half were told the grocery store. Interestingly, the answers differed.

The median response for the hotel was $2.65 while for the store it was only $1.50 (in 1984 dollars).

This contradicts standard economic theory where our preferences are supposed to be stable, regardless of who we interact with. I should value a beer the same regardless of who sells it to me. But as the example above shows, we use reference points. What we are willing to pay for a beer is not only based on our thirst, but also on our perception of a fair price or a good deal.

Passport Prices

I recently went through the process of getting a new passport and was interested to see the government using some price discrimination: different prices for different people. People self-selected into the different pricing categories. Why? Because the government charged different prices according to how quickly you wanted your passport:

4 weeks - £72.50
1 week - £103
1 day - £128

Thus those who are in a rush and thus prepared to pay more, pay more. While those who are in no hurry and thus prepared to pay less, pay less. Clever. Much cleverer than just one standard price. And it is used by firms/governments all the time. Price discrimination by time is ubiquitous because there will always be some impatient people.

Book Review: Basic Instincts

 Basic Instincts by Pete Lunn is an interesting take on behavioural economics that's gets better as it goes on, with applications to marketing and pricing being the highlights. It is not the best introduction to behavioural economics. It is not the best introduction to the psychology of decision making. But it is useful. (It is also full of incredibly interesting meta economics which I lay out in a seperate post.)

Here are some of the most useful highlights regarding marketing:

• Relationship marketing, where companies intentionally build relationships with consumers, is built on an accurate understanding of both the "perceptions and behaviours of existing and potential consumers". Also part of relationship marketing is the importance of likeability - brands try to be funny or irreverent in an attempt to get consumers to like them.
• The intrinsic desire for familiarity is why people are more likely to choose what they feel they already know. This manifests itself in marketing with firms trying to make their products familiar with consumers. Amongst other things, this explains why household names are used to voice commercials.
• The desire to belong manifests itself in marketing too. For example, car adverts portray ownership as membership of an exclusive club, reinforced by paraphernalia proudly bearing the logo or slogan. To summarise, "it's what your says about you..." 

 
Regarding pricing:

• Firms should beware price hikes as "People think a price should fairly reflect costs of production, not an equilibrium between supply and demand." (p.199)
• Fairness is highly valued by consumers, and woe betide any firm that is perceived to be acting unfairly. For example, in July 2007 Apple released a new iPhone for $599. In September 2007 they reduced the price to $399. This is just a textbook example of price discrimination - making those who were desperate for the iPhone pay more - but it was judged by many to be unfair. After a public backlash Apple offered the original customers $100 back, but the damage to their reputation had been done.
• People care more about the present than the future. Thus the Gillette pricing model is genius: a small upfront cost followed by regular expensive payments. Once you've bought the razor you're unlikely to change, despite the expensive blades which you probably didn't think too much about when you first bought the razor.

And a nugget of wisdom regarding management:

"Human organisation is based on our unique ability to trade favours. Effective organisations create a good climate for such social exchanges. This is the defining characteristic of successful organisations, just as it is of successful human societies." (p.164)
 
But I leave you with some political economy that succinctly details a good reason to doubt free market economics:

"Markets are not deterministic and efficient allocation machines. They behave differently according to levels of trust, common identity, the availability of information, perceptions of fair prices, and uncertainty about value and about the future." (p.268)

Genre: Behavioural Economics
Accessibility: 7/10
Accuracy: 7/10
Readability: 7/10
Usefulness: 9/10
Verdict: A Useful Read

Plus Shipping Costs

For Christmas I gave various different family members a calendar of my photos (ever to my surprise this always goes down well). To create my 2013 calendar I used Vistaprint. They are very good - all I have to do is upload the photos onto their website, choose the exact format I want and the delivery address. However, their pricing strategy is annoying.

The headline figure to print one calendar is £7.

I wanted 7, which cost about £4 per calendar. So far, so good. They encouraged me to buy in bulk.

The bad news...

These prices did not include shipping costs. Or VAT. But by the time I had discovered this, I had already invested too much time and effort on the Vistaprint website to bother going elsewhere. So I paid up the additional £20. Yes, £20.

Conclusion: Vistaprint cleverly induced me to use their product with a low headline price, but I finished the transaction in a bitter state of mind; reducing the likelihood that I would use Vistaprint again. Keeping customers can be hard when you follow the surcharge strategy.

BOGOF

We all like a good deal. Getting something for less than it should be is great feeling. And some deals are just too good to turn down.

So it is with good reason that retailers obsess about making us perceive their goods as a good deal. A myriad of 'special offers' and 'bargains' are out there, each one trying desperately to lure us into a different shop. Each one trying to make us think that it is an offer simply too good to refuse. I dread to think how many times we will read Buy One Get One Free! over the course of our lifetimes.

Another example is Boots which recently ran

Every Third Item Free!

For once, the small print was interesting. 

All the items you are buying are ranked in price order, high to low. Then every third item is free. So if you were buying three things, the cheapest would be free. If you were buying six things, the third most expensive and the cheapest item would be free. So it is a better deal than getting the two cheapest items free from six. 

But I'm not sure many people would bother to read the small print on an offer for toiletries. On more expensive products, such as electronic goods, I would expect consumers to spend time understanding small print. But not when it comes to low cost items such as shampoo and razor blades. 

In conclusion, Every Third Item Free! is a good eye catching offer, but it is also complicated. Simplicity was sacrificed.

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...

Minimum Price for Alcohol

The UK government laid out proposals today to raise the price of alcohol, or rather, set a minimum price per unit. This minimum price will be 45p. Meanwhile the Scottish parliament is trying to introduce a minimum price of 50p per unit. Will it make any difference?

The responsiveness of demand to changes in price is called 'elasticity' by economists, and there is much debate over how 'elastic' consumers' preferences are. If you respond to a small increase in the price of alcohol by drastically cutting back how much you consume, you are displaying highly elastic preferences for alcohol. If, on the hand, a small price rise wont impact what you consume at all, then you are displaying highly inelastic preferences for alcohol.

The government clearly thinks people's preferences over alcohol are elastic, or there would no point introducing the new minimum price. But the issue has other ramifications. I may consume less cheap supermarket lager but more in the local pub instead. Or I may even buy black market alcohol. In other words, the change in the price of alcohol will impact demand for other goods. Measuring the total impact of a price change gets very complicated very quickly.

How consumers react to the minimum price is crucial. Research by the University of Sheffield suggests people will buy 4.3% less alcohol (see BBC article), a small but not insignificant reduction. The government has decided that on the back of such research the best way to change behaviour is through prices. Only time will tell whether people will respond by drinking less...

Fair Coffee?

As a Masters student I am frequent visitor to the Arts and Social Science Graduate Centre at the University of Nottingham. Possibly the best thing about the Grad Centre (other than the absence of pesky undergrads, obviously) is the coffee machine which offers all types of tea and coffee for 25p. This makes it a hot attraction compared to the other machines of campus which charge at least 90p and especially compared to Costa which charges anything over £2.50.

Apparently in the first five weeks of term the Grad Centre machine served 5000 drinks, making it the busiest machine on campus.

Then, this week, the price doubled to 50p. No warning. No apology. The cost of coffee just doubled overnight. Outrageous! So unfair!

My reaction was probably not dissimilar to many. But why is it unfair for the price to rise? I have happily paid £3 for a coffee elsewhere, and it's not like going without coffee will kill me (I'm not an Arts student). If the price had always been 50p I would have had no complaints. It's just supply and demand.

People's perception of fairness is a very interesting area of study within behavioural economics.

For example, is it unfair for a shop to put up the price of shovels when it snows? An economist would answer no and point to the laws of supply and demand. A consumer, however, might think it exploitation.

Behavioural economics has shed a lot of light on what people consider fair and what they do not, but for now I'll conclude by simply noting that my degree in economics was not enough to stop me thinking a rise in the price of coffee was fair.

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

Blu-tack Signals

Picture the scene...

You are an inventor. You have just invented an amazing new type of blu-tack; twice as sticky as normal blu-tack. How do you communicate the awesome stickiness of this new blu-tack to consumers?

You could launch adverts with the slogan "twice as sticky". You could put "twice as sticky" on the packaging.

One of the most powerful ways to signal quality is price. If something is expensive it must be good. If it is cheap, well, you get what you pay for.

If I were the blu-tack inventor I would attempt to signal the greater stickiness by charging more.

This kind of thinking is contrary to the idea that lower prices increases demand. Why? Because consumers like you and me do not know the quality before purchase. We do not have perfect information. We respond to signals, even about blu-tack.

And the power of price doesn't end there. If we expect the blu-tack to be twice as good, we are more likely to think it is after using it, regardless of whether it actually is. Paradoxically, if we pay more for a product our enjoyment of said product may increase. Funny old world.

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