## What is the right price of anything?

Vivek Kaul
A few years back when I went to get a new pair of spectacles made, I was given an estimate of Rs 5,700. “Chashma khareedna hai, dukan nahi (I want to buy a pair of spectacles, not the shop),” I quipped immediately.
The shopkeeper heard this and quickly moved into damage control mode. He showed me a new frame and we finally agreed on a price of Rs 2,700. The frame I ended up buying was not very different from the one that I had originally chosen. The shopkeeper tried to tell me that the earlier one was more sturdy, easy on the eyes, etc.
But to me both the frames looked the same. I have thought about this incident a few times since it happened, and come to the conclusion, that the shopkeeper was essentially trying to figure out the upper end of what I was ready to pay. In the end he sold me more or less the same product for Rs 2,700 even though he had started at Rs 5,700. He was playing mind games.
Was he successful at it? Prima facie it might seem that I saved Rs 3,000. (Rs 5,700 minus Rs 2,700). But is that the case? One of the selling tricks involves making the customer feel that he has got a good deal. Barry Schwartz provides a excellent example of this phenomenon in his book The Paradox of Choice: Why More is Less.
He gives the example of a high-end catalog seller who largely sold kitchen equipment. The seller offered an automatic bread maker for \$279. “Sometime later, the catalog seller began to offer a large capacity, deluxe version for \$429. They didn’t sell too many of these expensive bread makers, but sales of the less expensive one almost doubled! With the expensive bread maker serving as anchor, the \$279 machine had become a bargain,” writes Scwartz.
Now compare this situation to what I went through. Before you do that, let me give you one more piece of information. When I went to the shop looking to buy a pair of spectacles, I had thought that I won’t spent more than Rs 2,000 on it. But I ended up spending Rs 2,700.
The shopkeeper’s first prize of Rs 5,700 gamed me into thinking that I was getting a good price. Thus, I ended up spending Rs 700 more than what I had initially thought. Behavioural economists refer to this as the “anchoring effect”. 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”.”
Marketers use “anchoring” very well to make people buy things that they normally won’t. As Schwartz points out “When we see outdoor gas grills on the market for \$8,000, it seems quite reasonable to buy one for \$1,200. When a wristwatch that is no more accurate than one you can buy for \$50 sells for \$20,000, it seems reasonable to buy one for \$2,000. Even if companies sell almost none of their highest-priced models, they can reap enormous benefits from producing such models because they help induce people to buy cheaper ( but still extremely expensive) ones.”
Anchoring is used by insurance agents as well to get prospective customers to pay higher premiums than they normally would. As Gary Belsky and Thomas Gilovich write in Why Smart People Make Big Money Mistakes and How to Correct Them “If you’re on the “buy side” purchasing life insurance, for example you’ll be susceptible to any suggestions about normal levels of coverage and premiums. All that an enterprising agent need to tell you is that most of people at your age have, say, \$2 million worth of coverage, which needs \$4,000 a year and that will likely become your starting point of negotiations.”
Hence, it is important for consumers seeking a good deal to keep this in mind, whenever they are thinking of buying something.
The column originally appeared in the Mutual Fund Insight magazine, March 2014

(Vivek Kaul is the author of Easy Money. He can be reached at [email protected]

## Shopping lesson from Calvin and Hobbes: So much selection, and so little choice

Vivek Kaul
A few months back I stopped going to the local supermarket. There were two reasons for the same. The first reason was the fact that finding a cab that would drop me home, proved to be a tad difficult on occasions in the evenings. Like the autowallahs of Delhi, the taxiwallahs of Mumbai are also a little finicky, when it comes to small distances (though I must add that this happens only in the evenings in Mumbai, unlike Delhi, where it is a perpetual phenomenon). Given this, I had to walk home on occasions, carrying the stuff that I had bought. And that was not very pleasant.
The second reason was the fact that the amount of choice overwhelmed me. It left me confused on what to buy and what not to buy. Even buying something as simple as biscuits could involve a few minutes of decision making. I figured out that calling up my local
banya and getting stuff home delivered was easier.
In fact the situation reminded me of a Calvin and Hobbes comic strip that I had read a while back. And this is how the rant from the comic strip goes:
Look at this peanut butter! There must be three sizes of five brands of four consistencies! Who demands this much choice? I know! I’ll quit my job and devote my life to choosing peanut butter! Is “chunky” chunky enough or do I need EXTRA chunky? I’ll compare ingredients! I’ll compare brands! I’ll compare sizes and prices! Maybe I’ll drive around and see what other stores have! So much selection, and so little time.
But this set me thinking on whether I was the only one having problems with more choice or was there something more to it? At a basic level we call love more choice, there is no doubt about that. As Sheena Iyengar writes in
The Art of Choosing “Whatever our reservations about choice, we have continued to demand more of it.”
But is more choice helpful? “An abundance of choice doesn’t always benefit us…The expansion of choice has become the explosion of choice, and while there is something beautiful and immensely satisfying about having all this variety at our fingertips, we also find ourselves beset by it,” writes Iyengar.
She says this on the basis of a very interesting experiment on jams, she carried out with Mark R. Lepper . This study was finally published under the title
When Choice is Demotivating: Can One Desire Too Much of a Good Thing?
Barry Schwartz summarises this experiment in The Paradox of Choice: Why More is Less, very well. As he writes “Researchers set up a display featuring a line of exotic, high-quality jams, customers who came by could taste samples, and they were given a coupon for a dollar off if they bought a jar. In one condition of the study, 6 varieties of the jam were available for tasting. In another 24 varieties were available. In either case, the entire set of 24 varieties was available for purchase.”
The results were surprising and conclusively proved that choice beyond a point essentially ends up confusing people, rather than making their lives easy, which should be the case. As Schwartz points out “The large array of jams attracted more people to the table rather than the small array, though in both cases people tasted about the same number of jams on average. When it came to buying, however, a huge difference became evident. Thirty percent of the people exposed to the small array of jams actually bought a jar; only 3 percent of those exposed to the large array of jams did so.”
As Iyengar and Lepper conclude in their research paper “. Thus, consumers initially exposed to limited choices proved considerably more likely to purchase the product than consumers who had initially encountered a much larger set of options.”
The logical question to ask is why is that the case? “A large array of options may discourage consumers because it forces an increase in the effort that goes into making a decision. Or if they do, the effort that the decision requires detracts from the enjoyment derived from the results,” writes Scwartz.
In fact, less choice is more beneficial for companies as well. As Iyengar and Lepper point out in their study “Several major manufacturers of a variety of consumer products have have been streamlining the number of options they provide customers. Proctor & Gamble, for example, reduced the number of versions of its popular Head and Shoulders shampoo from 26 to 15, and they, in turn, experienced a 10% increase in sales.”
This does not mean that choice should be done away with completely. The lesson here is that beyond a point choice confuses rather than helping people. When people are given a limited choice they are more likely to make a choice. As Iyengar writes in
The Art of Choosing “Since the publication of the jam study, I and other researchers have conducted more experiments on the effects of assortment size. These studies, many of which were designed to replicate real-world choosing contexts, have found fairly consistently that when people are given a moderate number of options (4 to 6) rather than a large number (20 to 30), they are more likely to make a choice, are more confident in their decisions, and are happier with what they choose.”
Interestingly, the rise of the internet was helped to make choosing easier. But it hasn’t. It has introduced one more level of choice. As Schwartz explains “The Internet can give us information that is absolutely up-to-the-minute, but as a resource, it is democratic to a fault—everyone with a computer and an Internet hookup can express their opinion, whether they know anything or not. The avalanche of electronic information we now face is such that in order to solve the problem of choosing from among 200 brands of cereal or 5000 mutual funds, we must first solve the problem of choosing from 10,000 websites offering to make us informed consumers.”
The article originally appeared on www.FirstBiz.com on February 12, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek)

## Retail discount ‘sales’: Why high prices and big discounts go hand in hand

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)