The value of a discount
What is the last item you bought? Maybe a coffee, a pack of bin bags during your weekly shop, or a vacuum cleaner. What was it worth to you?
That is a question which is hard, if not impossible to answer. But one thing we can fairly safely assume is that its value in your eyes was at least the amount you paid for it. Otherwise you would simply not have bought it, would you?
When traders buy goods for a certain price, they are not interested in keeping these items. To them, the so-called surplus is entirely represented by the margin they expect to make when they come to resell the items. But end users like you and me are not intending to sell on our coffee, our bin bags or our vacuum cleaner at a profit. To us it is not the direct economic value, but other aspects of what we buy that represent our surplus.
What the price tells us
If — as is sometimes the case — we don’t buy the cheapest item in a particular category, there has to be some extra utility about the item we acquire that justifies the higher price. The enhanced enjoyment of a shot of flavoured syrup in your latte might outweigh the extra cost, for example. Maybe we’ve had a bad experience with a bin bag tearing, and the more expensive, branded variant has turned out to be a bit more robust. And perhaps the vacuum cleaner carried a best buy label from the consumer organization, which gives us some confidence that a higher price means that it performs better or will not break down one day after the warranty expires.
The economic term utility, however, suggests a utilitarian approach that is not always accurate. Perhaps we just believe that the branded bin bags are better, because they are more expensive (this is known as the price-quality heuristic). The economist Oswald Knauth, in an article published as long ago as 1949, describes a retailer who, after a few weeks of lacklustre sales of stockings priced at $1.00 per pair, decided to raise the price by 14% — to an “enormous response”. The explanation was that a higher price was strongly suggestive of better quality
This is an approach that is associated with, in particular, German brands of cars and white goods (I am sure you can think of the brand names). But none of them have used this heuristic as blatantly as the Belgian lager, Stella Artois. In its home country, this beer is as ordinary as it gets. In the UK, however, it was advertised, for 25 years until 2007, as “reassuringly expensive” (for example in this TV spot).
If we buy highly-priced goods because they are more expensive (and we think this makes them qualitatively superior), is there a similar phenomenon with discounted goods?
Some people are attracted by bargains, but perhaps they are being misled. Merle van den Akker is a PhD student in behavioural science at Warwick university, who writes fine posts about money on her blog. She tweeted something interesting recently: “If something cost $1,000, and it is on sale for $750, and then you decide to buy it, you did not save $250. You spent $750.”
At first sight it’s hard to argue with her conclusion. It exposes the popular advertising invitation “The more you spend, the more you save”, about which Randall Munroe (author of the popular XKCD comic) once wrote that it would be difficult to be more wrong. If you check your bank balance after the transaction that is described, you will easily verify that it contains $750 less than before, and not $250 more.
And yet… This depends on your point of reference. You do indeed have less money in your bank account, but you also possess an item that, before, cost $1,000. Provided it is, to you, worth more than $750, it is undeniably a good deal. If it is worth more than $1,000 to you, you are $250 better off having bought it at a discount, and even if you would have paid no more than say $900, you’re still $150 up.
There is nothing particularly mysterious about it: if you are willing to pay X for something, and it is on offer with a discount of Y, then your advantage is Y. Merle’s warning seems of little relevance here. But as so often, the story is not quite over yet.
Perhaps there exists such a thing as the mirror image of the price-quality heuristic, let’s call it the discount-bargain heuristic. Do people buy something simply because it is cheaper, in the same way that they prefer something precisely because it is more expensive? The answer appears to be yes. A paper by Mark Armstrong and Yongmin Chen, economists at respectively the universities of Oxford and Colorado at Boulder, proposes two reasons why a rational consumer may be more willing to buy an item at a price when that is presented as a discount, than when it is simply offered at the (same) low price. One is that the higher (now discounted) price is, as we saw before, strongly suggestive of better quality. The other is that the discount suggests that the price is unusually low, so that there is no point looking for lower prices still.
There is a third reason that could be considered, though. Some people derive specific enjoyment from the purchase of a bargain. I can say this with certainty, because I am such a person.
The rational me does of course verify that I would have bought this jacket at its current price in any case — sale or not. As long I do that, and I am careful not to focus exclusively on the discounted price, buying something because it is a bargain is a perfectly rational thing to do. The knowledge that it cost me 40% less than the ticket price in the sale gives me pleasure every time I wear the jacket. That enjoyment is higher, much higher than that of the actual money I ‘saved’.
That can be the real value of a discount.
Originally published at koenfucius.wordpress.com on October 19, 2018.
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