Vivek Kaul
The sale season is currently on. If you are the kind who likes to frequent malls on weekends (or even weekdays for that matter) you might have realised by now that discounts are on offer, almost everywhere.
The question is why do retail stores do this? As Tim Harford writes in The Undercover Economist “We’re all so used to seeing a store-wide sale with hundreds of items reduced in price that we don’t pause and ask ourselves why on earth shops do this. When you think hard about it, it becomes quite a puzzling way of setting prices.”
And why is that? “The effect of a sale is to lower the average price a store charges. But why knock 30 percent off many of your prices twice a year, when you could knock 5 percent off year around? Varying prices is a lot of hassle for stores because they need to change their labels and their advertising, so why does it make sense for them to go to the trouble of mixing things up?,” asks Harford.
There are multiple reasons for the same. As Harford writes “One explanation is that sales are an effective form of self targeting. If some customers shop around for a good deal and some customers do not, it’s best for stores to have either high prices to prise cash from loyal(or lazy) customers, or kow prices to win business from the bargain-hunters. Middle-of-the-road prices are not good: not high enough to exploit loyal customers, not low enough to attract bargain-hunters.”
Also, if the firm were to offer a fixed discount (say 5%) all through the year, it wouldn’t be regarded as a discount by consumers at all. This would happen simply because consumers would not have anything to compare a regular discount of 5% with. A regular discount of 5% compared with a regular discount of 5%, essentially implies no discount at all.
For any bargain to look like a bargain what economists call the “anchoring effect” needs to come into play. As John Allen Paulos writes in A Mathematician Plays the Stock Market “Most of us suffer from a common psychological failing. We credit and easily become attached to any number we hear. This tendency is called “anchoring effect”.”
The normal price of any product is the “price” a consumer is anchored to. As Barry Schwartz writes in The Paradox of Choice: Why More is Less “The original ticket price becomes an anchor against which the sale price is compared.”
This comparison tells the bargain hunters that a bargain is available and encourages them to get their credit cards out. Interestingly, research shows that people end up spending much more when they use their credit cards than when they spend cash.
Gary Belsky and Thomas Gilovich point this out in Why Smart People Make Big Money Mistakes and How to Correct Them, “Credit card dollars are cheapened because there is seemingly no loss at the moment at the purchase, at least on a visceral level. Think of it this way: If you have $100 cash in your pocket and you pay $50 for a toaster, you experience the purchase as cutting your pocket money in half. If you charge that toaster though, you don’t experience the same loss of buying power that your wallet of $50 brings.”
“In fact, the money we charge on plastic is devalued because it seems as if we’re not actually spending anything when we use cards. Sort of like Monopoly money,” the authors add. Given this, when people do not feel the pain of spending money, they are likely to spend more. “You may be surprised to learn that by using credit cards, you not only increase your chances of spending to begin with, you also increase the likelihood that you will pay more when you spend than you would if you were paying cash,”Belky and Gilovich write.
This benefits the retailer offering the discount. What he loses out on by offering a discount on the product, he more than makes up for through an increase in volumes.
Of course, there are other reasons like trying to get rid of inventory, before a new season comes on. If the retailer has not been able to sell too many jackets during the winter season, he might try to offload it at a discount before the summer season comes on, instead of holding it back till the next winter season. High end designer stores face the risk of styles going out of fashion. Hence, they need to get rid of their inventory pretty quickly. But this doesn’t really hold for everyone (Think about this: how many of us wear clothes that are radically different in style when compared to last year?).
Hence, retailers essentially have sales to get the anchoring effect going, which, in turn, encourages people to get their credit cards out, and spend more money than they normally would. To conclude, here is a tip to avoid the crowds during the sale season. One day before the sale opens, go the store and check out what you want to buy. If you are buying clothes, figure out what you like and check out whether they fit. Visit the store again the next day, and simply pick up the clothes you liked (to the condition that they are on discount). This will ensure you may not have to spend time standing in a queue before the trial room, waiting for your turn.
The article originally appeared on www.firstbiz.com on February 5, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Discount
The psychology of discounts
Vivek Kaul
The power discounts have over consumer spending became apparent to me on a recent visit to Delhi. An aunt of mine decided to travel nearly twenty five kilometres in a DTC (Delhi Transport Corporation) bus to have lunch in a restaurant in Connaught Place, which was offering a 20% discount. And this was a time when the heat in Delhi was killing, with the temperature being greater than 40 degrees Celsius.
After coming back to Mumbai I heard about a high end lifestyle brand putting its goods on sale. And women queued up for it from 6.30am in the morning, despite the heavy rains.
That’s the power the words discount and sale have on the human mind. They can really get people out there to shop, despite the rains and the heat.
In fact Eric Anderson and Duncan Simester carried out an experiment to test whether just labelling something to be “on sale” lead to higher sales. Jonah Berger discusses this experiment in his book Contagious – Why Things Catch on. As he writes “Anderson and Simester, created two different versions of the catalogue and mailed each to more than fifty thousand people. In one version some of the products(let’s call them dresses) were marked with signs that said “Pre-Season SALE.” In other version the dresses were not marked as on sale.”
The results were very interesting. The items on which a sale sign had been marked, saw the demand go up by more than 50%. “The prices of the dresses (i.e. the items marked to be on sale) were the same in both versions of the catalogue. So using the word ‘sale’ beside a price increased sales even though the price itself stayed the same.”
While just mention of the world ‘sale’ is likely to increase sales, the trick is not to overuse it. As Anderson and Simester point out in a research paper titled The Role of Sale Signs “if customers’ price expectations are sensitive to the number of products that have sale signs, this strategy is not without cost. Using additional sale signs may reduce demand for other products that already have sale signs.” Also, if a product is always on sale then there is a problem because people can’t compare it with anything.
Despite these negatives, the fact is that everyone wants a good deal. In fact such is people’s fascination for getting a good deal that in some cases they are even willing to pay more. Berger carried out a small experiment in which a barbecue grill is on sale. Originally priced at $350, now its being sold at $250, a saving of $100. He ran this ‘deal’ through 100 people and 75% of the people said that they would buy the grill.
There was another scenario in which the same grill was on sale but at a different store. Originally it had been priced at $255 and was now selling at $240. Berger ran this ‘deal’ through 100 people and only 22% of the people said they would buy the grill.
And this is what made things really interesting. “Both stores were selling the same grill. So if anything, people should have been more likely to say they would buy it at the store where the price was lower….More people said they would purchase the grill in scenario A (the first scenario where a $350 grill was being sold for $250), even though they would have to pay a higher price ($250 rather than $240) to get it,” writes Berger.
Discount and sales offers play tricks on the human mind leading it to make irrational decisions, which are exploited by marketers. Akshay Rao of the University of Minnesota carried out a research on discounts and offering something extra for the same price, which he published in a paper titled When More Is Less: The Impact of Base Value Neglect on Consumer Preferences for Bonus Packs over Price Discounts.
In this paper Rao came to the conclusion that “shoppers prefer getting something extra free to getting something cheaper.”He explains this through an example of coffee beans. On a normal day, 100 coffee beans are being sold for Rs 100. One day, a discount of 33% is on offer. This means 100 coffee beans are sold for Rs 67.
Another day, a 50% extra offer is on. This means 150 coffee beans can now be bought for Rs 100. But what this also means is that 100 coffee beans can be bought for Rs 67. So a 33% discount offer and a 50% extra offer are economically equivalent. There is no difference between them, at least theoretically.
But real life turned out to be different from theory as usual. Rao and his team carried out an experiment and found that they managed to increase sales of a consumer packed good by over 70% in a retail store, when they used the extra/free bonus pack format in comparison to offering a discount on the product. Rao attributes this to the fact that the human mind is not good at performing arithmetic with complex forms such as logarithms, fractions, probability and percentages.
So if you have ever wondered why everyone from biscuit companies to mobile phone operators wants to give out something extra, rather than offer a discount, you now know why.
The inability to handle basic maths leads to marketers exploiting it in other ways as well. One such way is to express discount in a way where it seems larger than it actually is. As Berger writes “Twenty percent off on that $25 shirt seems like a better deal than $5 off. For high-priced big-ticket-items, framing price reductions in dollar terms (rather than percentage terms) makes them seem like a better offer. The laptop seems like a better deal when it is $200 off rather than 10 percent off.”
Whether marketers express discount in absolute terms or in percentage terms depends on the rule of 100. If the price of a product is less than $100 (or Rs 100 or any other currency) the percentage discount will seem bigger. Vice versa is true, if the price of a product is higher than $100. “For a $30 shirt…even a $3 discount is still a relatively small number. But percentage wise (10 percent), that same discount looks much bigger…Take a $750 vacation package or the $2,000 laptop. While a 10 percent discount may seem like a relatively small number, it immediately seems much bigger when translated into dollars ($75 or $200),” writes Berger.
The interesting thing is that the rule of 100 doesn’t seem to have caught on in India as yet. This could be a killer application for discount websites, which still focus on expressing discounts in percentage terms. As I write this the Bangla version of Amish’s The Immortals of Melhua is selling for Rs 130, a 33% discount on a price of Rs 195, on one of the discount websites. Now wouldn’t Rs 65 off have sounded so much more better?
While marketers are quick to latch on to these tricks, in this case they seem to have missed out on something rather obvious. Rest assured this anomaly will be corrected in the days to come.
The article originally appeared in the Wealth Insight magazine dated July 1, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)