Post No.: 0418
Here comes another selection of irrational or illogical behaviours when it comes to people and money (the last lot was presented in Post No.: 0389)…
People are less willing to give something up once they have it in their possession than to obtain that exact same thing if they didn’t yet have it – this is the ‘endowment effect’. We get easily attached to things in our possession. We start to amplify the love we have for the things we own, and amplify the dislike or indifference we have for the things we don’t. This endowment effect can happen really quickly once something is in our possession. For instance, if we’re in a class in school and everyone gets given a pen each – quite soon the particular pen we’ve been given becomes ‘my pen’ and we won’t want to swap it for another person’s, even if it’s essentially identical! We’ll need to be offered something extra on top.
Retailers offer ‘30-day guarantees’ and ‘buy now, pay later’ deals to exploit this effect – customers seldom return things as often as they should once they’re in their possession (unless they’re naughtily implementing a ‘wear and return’ strategy). Once a person has something, they’ll likely get used to having it and will find it more difficult to let it go – so get the product physically in their hands. They’ll then ascribe more value to it and so will tend to keep it once they’ve bought and owned the product.
We tend to prefer the things we’ve personally invested in or know work successfully for us, even though we don’t really know exactly how much better or worse those other options might’ve been. Overall, the endowment effect can be good for us because it makes us more content about the things we cannot change, but in some contexts the effect can be exploited.
Related is the ‘IKEA effect’, which is when people tend to place a higher value on things that they’ve had at least some hand in creating, regardless of the quality of the end result, as long as they successfully complete the task. There’s a sense of pride in knowing we assembled something, and we would irrationally care too much if it were swapped with an exactly identical object that someone else had assembled. This is one reason why it’s hard to dispassionately analyse our own ideas or creations (or children!) and may need the input of independent, external opinions if we intend to share or sell them (not the children!) It’s linked to if you’ve struggled hard to get something then you’ll tend to like that thing even more than if it came easily, even if that thing isn’t actually that impressive; or if you’ve invested a lot into something then you’ll find it harder to divest from it or give it up, even if it might not be worth it going forwards (the ‘sunk cost fallacy’).
The other side is that things handed to us on a plate tend to become undervalued and easier to take for granted (unless/until we lose them), and unconditional offers feel easier to ditch or leave.
When things are complex or hidden, we use mental shortcuts or heuristics to help us make decisions, which can sometimes result in errors. One such shortcut is that we’re more willing to compensate someone for doing something that seemed to require conspicuous effort compared to if they completed the job expertly, effortlessly and efficiently. For instance, if you witness a repairperson just tap a machine a couple of times then suddenly it’s fixed, you’d hope that the bill they charge will be small – but the expertise is in knowing exactly where to tap and exactly how many times and how hard, and that might deserve a larger invoice than you’d expect.
Of course, what typically happens instead is that tradespeople try to exaggerate how difficult and long a job is going to take to give the impression that the work deserves what they’re going to charge you(!) Efficiency can therefore get punished, while loafing gets rewarded.
Seeing cocktails get made in front of us therefore increases our appreciation of them, and makes us savour those drinks more. Cheers!
Because people can mix up cause and effect or make other logical fallacies, people can believe that something expensive must be good because something good is usually expensive (e.g. with wine). But this ‘if it’s good or rare then it’s expensive, therefore if it’s expensive then it’s good or rare’ mental shortcut is as logically fallacious as ‘all dogs are mammals, therefore all mammals are dogs’. Woof!
Our ideas of fairness are based more on the perceived marginal costs rather than on the actual costs of something, hence why a lot of people don’t see enough wrong with downloading music or movies for free – why pay anything if it isn’t costing the artists or filmmakers anything more? Therefore when selling things, it can be useful to make the costs more visually explicit.
Money is also viewed differently to in-kind goods/services – people generally find it less fair if money were equally distributed between everyone in society, yet find it fairer if non-monetary in-kind goods/services were equally distributed (even if the rich don’t need them).
Although tremendously unethical and illegal – since people tend to follow the herd, fake reviews and artificially pumped-up sales figures can make a product seem popular and attract more customers to trust in or desire the product. So be wary of these practices in the market. (Real customers can also muddy ratings by writing reviews such as ‘I haven’t tried the product yet but I’ll give it 5-stars’(!)) Popular books, songs, etc. tend to become even more popular (the ‘bandwagon effect’), and popular networks tend to become even more desirable to join, such as social networks (the ‘network effect’). Therefore if something is genuinely popular then show that it is (e.g. use a download counter for a highly downloaded app).
Generally, people will follow something if they see others doing so, and not follow something if they see others not doing so. Sometimes the result is that many people unfortunately trust in things they shouldn’t trust, and distrust in things they should trust. So people will more often look at how many other people follow a social media account or video channel as a heuristic of what’s trustworthy or interesting, rather than what someone or something is actually saying. This is related to FOMO and ‘social proofs’ too.
The rational model of valuation would be that value is proportional to price i.e. more pleasure demands more money, and vice-versa. But not only do people herd with a (especially peer) crowd, they self-herd and tend to follow the same decisions they’ve made in the past. Future decisions are influenced by previous decisions; and we remember our actions better than our transient emotional states too, thus we can sometimes stick with something we don’t like. Due to ‘coherent arbitrariness’, when a particular, possibly arbitrary, number (anchor) is introduced, it not only influences what we think the present price of something should be but becomes the reference point from which all subsequent prices are judged too; although the ranking order of ‘cheapest to dearest’ will be preserved.
If there are two prices for the same item but at different times (e.g. because there are on-peak and off-peak times), it can be better for a seller to label them as ‘standard’ and ‘discount’ rather than ‘premium’ and ‘standard’. Most customers are attracted to the word and notion of a ‘discount’. It’s mentally better to lose €20 and find €10 than to just lose €10, or to find that a €20 item has been discounted to €10 rather than just be originally priced at €10.
But if you’re placing products on a temporary price-reduced sale, then make sure that your customers know that the sale price is only temporary and don’t constantly provide that product around that sale price. If not, then people will start to anchor on that discounted price and use it as the new reference price for any future price changes, rather than anchor on the full retail price – thus they’ll start to expect the lower price every single subsequent time. Discounting prices too often makes customers expect these discounts, and more than feeling happy to pay the discounted price, they’ll feel averse to paying the full price ever again. So if a price goes up again, even back to the old price, it’ll feel worse than the equivalent amount discounted feels good, due to ‘loss aversion’.
Or if you’re the fluffy customer, the key is to not look at what money you’re supposedly ‘saving’ – for list prices can be arbitrary or previous prices could’ve been temporarily over-inflated – but to look at how much you’re absolutely spending compared to what you’re absolutely getting when compared to the alternatives and opportunity costs (e.g. what substitute goods you could get for that price from elsewhere).
You’ve also got to calculate whether the cost of working for and earning the money to pay for something is worth it compared to doing that something yourself? For example, if the redecorating costs a week’s wages but you could do it yourself in 4 days then would it be better to just take 4 days off to do it yourself? Do you need it, can you afford it, will you use it, and is it worth having anyway?
Because of opportunity costs – is stocking up on ‘shopping bargains’ a savvy practice (e.g. collecting 20 shampoo bottles for future personal consumption because they were each found on sale)? It depends on the calculations and factors like how often those discounts occur. In business, stock or inventory isn’t something you want to keep hanging around, even if they’re durable goods, because if it’s not shifting then that money could’ve been, say, held in a bank account and accruing interest instead. The warehouses to store inventory cost money too. The more efficient practice is ‘just-in-time’ (JIT) where possible. Bulk-buying can result in a discounted price per unit, and supply chain problems can arise, hence such factors need to be weighed out though.
Offering apps for free reduces the number that will be sold for a profit – better to charge the smallest amount possible for the ‘lite’ version because when people compare ‘free’ to, say, €4.99, it’s mentally infinitely miles apart compared to, say, €0.99 compared to €4.99. Plus in the latter case, they’ll have already gotten their wallets out anyway so might plump for the ‘full’ version while they’re there. (There are many different monetisation strategies though, such as collecting advertising revenues, which might make offering an app for free better overall.)
In a sealed-bid auction where there’s only one round of bidding, it’s best to set a high reserve price as the seller. But if the bidding is open and there are many rounds of bidding, it’s best to set a low reserve price to attract many bidders in, which will hopefully create greater competition between them and therefore larger resultant bids. However, in most auction scenarios if you’re a bidder, just bid to your price – the highest price you’re happy to pay for the item but no more. This is because if it’s a price you’re happy to pay for the item then you should be happy with it, regardless of whether you could’ve paid less with the benefit of hindsight. And the risk if you don’t bid that price is that you’ll miss out on getting that item altogether. (And there’s obviously no point in bidding a price that’s greater than what you think the item is worth to you because then you wouldn’t be happy even if you got it.) Well that would be the rational thing to do anyway – but the competition to ‘beat a rival bidder’ can lead some people astray.
People behaving irrationally? Sounds about right.