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)