Monday, December 28, 2009

How to Convince People That Black is White

For generations, Harvard psychology students were treated to a jaw-dropping classroom experiment. With the aplomb of a magician, Professor S.S. "Smitty" Stevens (1906-1973) would darken the room and reveal a white disk. Then Stevens turned a spotlight on the disk. Instantly, it turned black. Unless you're seen it, the sense of logic turned upside is hard to convey. Perhaps Chico Marx said it best: "Who you gonna believe, me or your own eyes?"
The secret was marvelously simple. The "white" disk was actually gray. Stevens made sure it was the brightest thing in a dark room, and that made it look white. Then Stevens illuminated a ring of (truly) white paper around the gray disk. The white paper was so more reflective that it made the gray look black by contrast.
As Stevens put it in his textbook, Psychophysics, "black is white with a bright ring around it." The Orwellian tone of that must have been intentional. In Orwell's 1984, Big Brother convinces everyone that war is peace, freedom is slavery, and black is white. Stevens managed the same feat (with lighting rather than a cage of rats). His point was that human perception is sensitive to contrasts, not absolute values. Subjectively, it's all relative. (This too is a chilling talking point of Big Brother's minions.)
I write about Stevens (above) in my new book, Priceless. Stevens' studies of perception were an important precedent for behavioral decision theory and the marketing based on it. It turns out that contrasts rule with economic judgments as well as sensory ones. A BMW 3-series may seem expensive until you compare it to a 7-series. Then the 3-series looks, well, reasonably priced. Such contrast effects are a foundation of contemporary marketing. Like it or not, they allow marketers to push our buttons as effectively as Stevens did—to convince us that expensive is cheap, consumption is thrift, and luxury is necessity.
Because Stevens' experiment was so influential, I wanted to find a way to illustrate it within the pages of my book. Obviously, I can't control the lighting of a printed page (though that might be possible with next generation Kindle?). I found the next best thing, an amusing perceptual illusion that works nicely on the page. But this weekend, I came across a strikingly exact counterpart of Stevens' experiment. It's art, not science, specifically a 1966 work, Multiplication Electronique III, by the Argentinian artist Gregorio Vardanega. It's currently at the Museum of Latin American Art, Long Beach, Calif. (through Jan. 24) and is owned by the Cisneros Fontanals Art Foundation, Miami.
The visual trick works perfectly even on my cell phone photos. At top is a typical shot of Vardanega's ever-changing work. You see a four-by-four wooden grid of squares, something like the cardboard grids holding holiday ornaments. Each square cubicle is partitioned (via a 5-by-5 grid) into three concentric smaller squares. Light bulbs switch on and off, illuminating different squares and sub-squares. This produces a sequence of scintillating black-and-white abstractions.
Periodically, all the light bulbs switch off at once. You see the work "in its true light" — that is, in the normal gallery lighting that's been there all along. The whole thing is painted white. The blackness was all in your head.
Stevens' message is that this is not a mere "optical illusion." This is how we all experience the world. It applies to pleasures, pains, and prices — joys and griefs and discounts — and everything.

Sunday, December 27, 2009

Decoding Fast-Food Menus

Fast-food menus are among the most rigorously tested products of our consumer culture. Because the decision of what to order for lunch isn't that important in the grand scheme of things, we don't spend much time or thought on it. Instead, we rely on cues in the environment. If your friend mentioned having a barbecue sandwich yesterday, you're more likely to try it today (assuming you like barbecue, and the friend). Memories are short, so the most powerful source of cues is the menu. The prices are designed to get consumers to order more than they might have otherwise.
• The most common trick of fast-food menus is the "combo meal." As everyone understands, the combo meal offers an incentive to order something extra. The burger plus fries plus soda combination costs just pennies more than burger plus soda à la carte. You might as well get the fries — it seems like you're throwing away money not to order it. For most consumers, this is irresistible.
There's another reason fast-food places offer combo meals. They foster confusion. It’s hard to be sure how much the burger costs, and how much the drink costs—and whether it’s too much. So consumers are a bit less price-sensitive with combos. Of course, eventually repeat customers become familiar with the prices of their favorite combos. For this reason, fast-food menus are an ever-changing caloric kaleidoscope. New entrees are offered, and old ones change or vanish. Combos can be super-sized. Do you want curly fries? You can’t buy exactly the same thing you did last time (neither can you compare prices, exactly).
• The Starbucks menu uses the "rule of three." The menu offers three sizes of coffees, given the enigmatic names of Tall, Grande, and Venti. (They're 12, 16, and 20 ounces respectively; 24 ounces for cold Venti drinks, to allow for ice.) Since Starbucks newbies won't know what they're getting, they tend to order the middle choice, Grande. In the psychology literature, this is known as "extremeness aversion" — people instinctively favor a middle choice, figuring it's safer. Guess what? You've just ordered two cups of expensive coffee. The Grande's sixteen ounces is two regular cups. Here's a secret: Most Starbucks will serve you eight ounces of coffee, but you have to ask for a "Short" coffee (which isn't listed on the menu). You have to remember that password "Short": Company policy says that a customer who asks for a "small" coffee is to be given a "Tall" one.
• Anyone who doubts the power of prices ending in 9 should check out a fast-food menu. The menu above, at a Los Angeles Pollo Loco outlet, has 75 prices, and all but one end in the digit "9."
• The exception: a deal offering 10 buffalo wings for $5. Quick: How much is that per wing? It takes most of us a moment to do the math. And that's the point: not many people bother, not with kids screaming in the back seat. But "10 wings for $5" sounds like a better deal than "50 cents a wing."
• Critics have blasted the nutritional value of fast food, causing both the industry and government to take action. Since 2008 New York City has required fast-food places to post calories—in large fonts—on menus. This may or may not have promoted healthier eating. It probably hasn't hurt chain profits, though. The reason is that consumers now have two sets of numbers to juggle: calories and dollars. As many experiments have shown, the human mind has a finite capacity to deal with numerical information. By encouraging diners to pay more attention to calories, the new menus prompt them to pay less attention to prices. That gives chains scope to charge a little more. (Not only that, the salads are among the most expensive things on McDonald's menus, anyway.)

Poundstone, William. "Menu Mind Games." New York, December 14, 2009.
Poundstone, William. "Menu Psych." YouTube, 2009.

Monday, December 7, 2009

New York Magazine Excerpt

New York magazine is running an excerpt of my upcoming book Priceless. It tells how to decode menus. Patrons of the New York eatery Balthazar should particularly take note.

Tuesday, December 1, 2009

The Gender Surcharge

The January 2010 Consumer Reports has an article that's sure to provoke some outrage. "Roam any drugstore and you'll see products that seem to be twins, except for one thing: One is for women, the other for men. We discovered that products directed at women—through packaging, description, or name—might cost up to 50 percent more than similar products for men."
For instance, a can of men's Barbasol shaving cream costs $1.69. A skinnier can of the women's version contains less product yet sells for $2.49. Nivea Body Wash for men is $5.49; the same size container of the women's product is $7.49. A four-pack of Schick Quattro razors is $10.49 for men, $10.99 for women. The biggest difference CU found was for Neutragena eye cream, at $9.99 for the gentlemen and $14.99 for the ladies.
Even when prices seem the same, they're not. Both men's and women's Degree antiperspirant cost $3.59 — but the men's version contains 2.7 ounces, v. 2.6 ounces for the women's. And even when products seem to be different, they may not be. Excedrin Menstrual Complete has the same active ingredients, in the same amounts, as the regular Excedrin. But 20 gel caps of Menstrual Complete runs $6.49, v. $5.99 for 20 gels of the regular pain reliever.
The magazine asked the manufacturers to comment. Their explanations ranged from the half-believable (women shave in the shower, so their shaving cream comes in a more expensive rust-resistant can) to the amusingly ingenious (women's Nivea "has skin-sensation technology.")
Psychologists suspect that gender plays a big role in the prices we pay. It is nonetheless tricky to draw conclusions from the shopping aisle, where there are so many variables. Some of the most compelling experiments have used a simple bargaining game, the "ultimatum game." One person is given $10 to split with another. A split might be "I keep $6 and you get $4." Provided the other person agrees, the money is divided as proposed. But should the other person reject the offer, neither gets anything. Think of a vendor in a bazaar setting a price. He want to keep as much profit as possible for himself by naming a high price. But if he demands too high a price, the customers will walk away.
In a typical ultimatum game, the splitter keeps a little more than half of the $10, and the other person OKs the deal. Psychologist and behavioral economist Sara Solnick, now at the University of Vermont, did a clever version of the game focusing on gender. The players sat on opposite sides of a partition and could not see each other. One group learned the first name of their partner and thus knew the partner's gender. Another group never heard names and had no idea whether they were playing with a man or a woman.
The splitters who didn’t know their partner's gender offered an average of $4.68 out of $10. But for those who knew their partner was a man, the average offer was a more generous $4.89. When they knew they were dealing with a woman, the average was only $4.37.
Solnick also had players state the minimum offer they would accept. This minimum was higher when they knew their partner was female. Women got the short end of the stick, no matter which role they played.
It's possible that similar dynamics apply in the supermarket aisle. Women's products may cost more because women are a little less price-sensitive than men. Is that unfair? Maybe, but Solnick's experiment leaves little scope for anyone to feel morally superior. Her subjects were college kids too young to remember a pre-feminist past. They probably would have loudly rejected a sexual double standard, had they been asked. But they had no idea this experiment was "about" gender. Both women and men unconsciously set higher "prices" for female partners.
That underlying psychology poses some difficult challenges to our would-be egalitarian society. What's to be done when people who aren't sexist unknowingly act as if they were? It's a question we'll probably be wrestling with for years to come.
As usual, Consumer Reports has this sensible advice for shoppers: Ignore the gender marketing and buy whatever is cheaper.

Solnick, Sara (2001). "Gender Differences in the Ultimatum Game," Economic Inquiry, April 2001, 39(2): 189-200.

Tuesday, November 24, 2009

Double Take

Some readers may be wondering why the cover of my new book, Priceless, looks something like that of Chris Anderson's recent book Free. Did my publisher rip off the Free design? Short answer: no.
"It takes as long to make a book as to make a baby." That was the wry industry maxim back when publishers took three-martini lunches and Bennett Cerf was a panelist on What's My Line?. From finished manuscript to physical books took nine months. For reasons mysterious to almost everyone, the digital age hasn't speeded things up one iota. You might think that, now that manuscripts don't have to be rekeyed by typsetters, they could have shaved it to, oh, eight months? Nope. It's still nine. Anyway, the Priceless cover was created a couple of months before Free came out — notwithstanding the fact that Priceless is being published in January, six months after the Anderson book.

We started bouncing around ideas for a cover in April 2009. Publisher Thomas LeBien had the notion of putting a fake price on the jacket and having it "marked down" to the real price. By the end of May, the artist had developed this idea into the cover you see above. Hill and Wang had had success with a trompe l'oeil cover for my Fortune's Formula (left). The fake roulette chips made people want to pick up the book, and maybe that had something to do with the book's success. The Priceless design continued this theme with a very realistic pricetag projecting from a clothbound volume (this is all a printed jacket, of course). I loved the cover, and so did seemingly everyone who saw it. It was quickly approved and went out in the Hill and Wang catalogs.
Then on June 24, I saw a piece in the Los Angeles Times about Anderson's book, with an illustration of the cover. I e-mailed my editor, Joe Wisnovsky, and after due editorial handwringing, it was decided to stick with the cover we all liked. The reasoning was:
• The books are being published six months apart, and that makes it a bit less awkward.
• The two books' subject matter is quite distinct. Priceless is about the hidden psychology of prices, and Free is about giving away free content in the Internet, to promote the sale of something else.
• As mortifying as this might be to us (we thought we were so original!), it's not such a big deal with book buyers. Many won't notice, anyway.
• Some Chris Anderson fans might falsely assume that Priceless is a follow-up or response to Free. It's not, but if they want to buy it, it's a free country.
• Mainly, we just thought the cover worked and there was no point in switching to a less appealing cover to avoid an honest coincidence. The verisimitude is amazing, particularly in the actual object. Joe Wisnovsky showed both covers, side by side, to his brother-in-law, a French architect and talented amateur artist. He pronounced ours far more intriguing and eye-catching. Okay, it's like passing around baby photos — I'm sure that Chris Anderson likes his cover better. But I think it's a cool cover.
Just in case you're wondering, the hardcover version of Free costs $29.99, and Priceless is $26.99. Yes, that's another similarity: both use charm prices (ending in "9").

Tuesday, November 10, 2009

How Much for a Can of Whoop Ass?

How much would you pay for a can of Whoop Ass? Regular Facebook users will recognize the Whoop Ass as a popular "virtual gift" in the networking site's Gift Shop. The price is 10 credits. That's $1 in Earth money. For the same price, you can buy a rose, a slinky, a troll doll, or your favorite team's mascot — all virtual. They're nothing more than icons you can post on a friend's page — pixels with a price tag. The surprising thing is how big the virtual goods industry has become. Merchandise-that-isn't-really-there is one the few bright spots in a dismal economy. By one estimate it brings in a billion dollars a year, just in the U.S. To put it in perspective, that's roughly what Americans spend on lipstick or Mini Coopers.
It wasn't so long ago that virtual goods were limited to "weapons" and "spells" that hardcore gamers bought, to the befuddlement of most everyone female or over 30. That started to change with Second Life, the networked simulation game. The currency of Second Life is called "Linden Dollars," with about L$266 to the U.S. Dollar. By that standard, many prices in Second Life are bargains. A Linden Dollar will buy a new hair style or tattoo for your avatar. That sounds really great, until you try to explain to a nonplayer exactly what it is you bought.

One of the attractions of Second Life is that you can play for free. You quickly discover that this is like saying you can live in Manhattan for free — by sleeping on friends' couches. Your Second Life avatar will be homeless unless you fork over $9.95 a month (real dollars) to get a premium account with 512 square meters of land. That's about enough for a small tract house. Intentionally or not, much of Second Life is a dead-on caricature of our society's obsession with real estate. The point of Second Life is to impress your virtual friends, and that generally means building a virtual McMansion. Larger properties are available for sale or auction and yes, there are Second Life home flippers.
"For outsiders, the selling of virtual goods — items with no actual value in the real world — might seem the very definition of a swindle," wrote Claire Cain Miller and Brad Stone in The New York Times. Actually, the virtual product business says a lot about the real-world price decisions we all make. The products may be imaginary but buyer psychology is pretty much the same.

The virtual merchants use a trick familiar to every world traveler. Confronted with an unfamiliar currency, we all splurge and tip more freely than we would, blinded by a smokescreen of exchange rates and prices strictly for tourists. To Americans overseas, yen or lira just don't seem like "real money." That's the reason for the virtual currencies. We normally feel a conflict between the desire to spend and the obligation to save. Spending is fun, and saving is what we do because we'll feel guilty otherwise. But once you buy Linden dollars, credits, or other virtual currencies, you're committed to spend. What else are they for? It's difficult to convert virtual currencies back to real money, and nobody feels a pang of guilt about not squirreling Linden dollars away in a 401(k). The exchange rates of virtual currencies are often intentionally confusing. To convert Linden dollars to U.S. dollars, you have to divide by 266. Much of the time, that's just too much bother. Instead, Second Lifers think in Linden Dollars, which is to say, they take cues from the prices they see posted in the virtual world. Your friend buys an island, and you want an island. It's only money — and fake money, at that.

Thursday, October 29, 2009

“Artisanal”: A Word That’ll Cost You

How much is a word worth? If the word is "artisanal," a lot. Try pricing artisanal chocolates or artisanal jeans. Studio D'Artisan jeans run $350, while some R by 45RPM models can still top $1000, even in these chastened times. The word "artisanal" also works its magic on menus and in markets. Foodies will insist that "artisanal" is a meaningful distinction in danger of being overused. That ship has sailed. The "artisanal" bread on some of Jack in the Box's sandwiches has "become a huge hit with the burgers-and-fries crowd," crowed a 2004 press release. Diet conscious? Weight Watchers has "Artisan" pizza. You'll find it in your grocer's frozen-food aisle.

What does "artisanal" mean, anyway? For one thing, it means the seller can charge more money. Psychological studies have refuted the longtime economic notion of a "reserve price," a fixed maximum one is willing to pay for something. Is $8 reasonable price for a box of chocolates, or is $80? The answer will depend on the context: how nice a box it's in, what we see other people buying, and so on. Above all, we rely on memory. In deciding whether $80 is too much to pay for chocolates, I remember the prices I've seen advertised and what I paid the last time. Remembered prices allow us to impose a veneer of rationality and consistency on our money decisions. Inside, we're more like kids in a candy store. We want what we want, and we haven't a clue what it should cost.
That's where a word like "artisanal" comes in. Its sends the message, remembered prices don't count. "Artisanal" jeans are different from plain old jeans. Therefore, the old prices don't apply. The consumer is left guessing at what a fair price might be. Influenced by context (stores are all about context) many choose to pay a price that has little to do with the cost of materials and labor. Eric Wilson, in The New York Times, wrote

During the modern gilded age, the spiraling prices of designer clothes had more to do with driving profits than the actual design or construction of a garment. Designers found they could charge a lot for the perception of prestige. Dresses and suits and handbags were priced like cars, and consumers didn’t blink. But with jeans, it just felt more obvious that some kind of game was being played; the basic elements, after all, had not changed substantially in decades: five pockets, cotton, some rivets.

Don't get me wrong: Many "artisanal" products are truly superior. The term's adoption by frozen and fast-food producers suggests it's also smart marketing. Jack in the Box charges more for its artisanal-bread sandwiches than for more meat-intensive burgers.
Why has "artisanal" been so widely adopted? Probably because it's one of those poetic terms (like "creamery" butter and "heirloom" tomatoes) that sounds great without making much of a factual claim. An artisan is someone who makes something, so "artisanal" can basically apply to anything made by humans. It's therefore become the all-purpose excuse for charging a premium.

Sunday, October 11, 2009

“10 for $10”

Price labels like this have become a sign of the Great Recession. You're invited to buy ten of something for $10. Small print says "$1.00 each." Huh? That's right, there's no discount for buying ten items. So what's the point?
Rest assured that supermarkets must have reason to believe that these labels boost sales. The question is, how? I'm not aware of any academic papers directly addressing 10/$10 pricing. Two ideas come to mind.
One is that it's a twist on the old "economy size" tactic. Many shoppers instinctively reach for the bigger package — or shop at the big box store — in the belief that they're getting a better deal. Sometimes they are, and sometimes they aren't. In this case, shoppers might lob ten cans into their cart and never read the fine print.
I doubt too many people do that, though. It seems that 10-for-$10 pricing is mostly applied when you wouldn't normally buy ten of an item. I don't think I've ever bought ten cans of anything, save soft drinks. My impulse would be to scrutinize the label to see whether you can buy less than ten at the special price — which you can.
An alternate explanation for 10/$10 prices is anchoring, the cognitive phenomenon described by Amos Tversky and Daniel Kahneman in the 1970s. Anchoring occurs when we guesstimate numerical quantities. Shoppers do that a lot. The shopper must decide, how much should I pay? and how many should I buy? Strict logic cannot answer such questions. The answer is necessarily intuitive (and often, must be made while wrestling kids or yakking on the cellphone). It's been shown that when people have to come up with a numerical estimate on intuitive grounds, they are easily swayed by any numbers provided as cues (or "anchors.") With 10/$10 pricing, the suggested ten items becomes an anchor. It sends the subtle message, of course you need ten cans of salsa this week! On the face of it, that sounds ridiculous. But anchoring exerts an effect even when we know the cue is absurd.
One of the most amusing anchoring experiments, by Karen Jacowitz and Daniel Kahneman, asked a group of subjects this two-part question:

(a) Does the average American eat more or less than 50 pounds of meat a year?
(b) How much meat does the average American eat in a year?

The group's median answer was 100 pounds of meat. The researchers asked a separate group a similar question, except that this time, part (a) asked whether the average American ate more or less than 1000 pounds of meat. For this group, the median estimate was 500 pounds. Just hearing a different cue — 1000 rather than 50 pounds — boosted the group's estimate five-fold. Furthermore, anyone who thought about it could have calculated that 1000 pounds was a ridiculous answer. It would be the equivalent of ten McDonald's Quarter-Pounders a day! The ridiculous anchor value still had a huge statistical effect on answers.
In the experiment, the subjects were simply guessing the answer to a trivia question. Shoppers guess too in estimating how many cans of salsa their family will eat. It's possible that 10-for-$10 pricing has an effect similar to the cues in Jacowitz and Kahneman's experiment. It makes shoppers buy more items than they would have.

Jacowitz, Karen E., and Daniel Kahneman (1995). “Measuring of anchoring in estimation tasks.” Personality and Social Psychology Bulletin 21, 1161-1166.

Tuesday, September 15, 2009

Living Next to the Obamas: Worth $500,000?

The home next to Barack Obama's in Hyde Park, Chicago, has just gone on the market. Reports The New York Times,

The price? Hard to know, real estate agents say, because not since Richard M. Nixon lived in a New York City apartment has the market tried to assess the value of immediate proximity to the president in a dense urban neighborhood. (The Greenwood Avenue neighbors are separated by about 20 feet, a line of thin trees and an iron fence that is more decorative than forbidding.) The Grimshaws paid $35,000 in 1973; other homes in the area have sold for $1 million to $2.5 million.
“We think there’s a premium,” said Matt Garrison, the listing agent with Coldwell Banker, who does not intend to put an asking price on the house. “We don’t know what the Obama effect is.”
Mr. Garrison said he had tried to scout similar parcels of residential property, but pointed out that there was no family living next door to the White House.
“I tried to look at 12 Downing Street, but that’s all offices,” Mr. Garrison said, referring to the building next door to the British prime minister’s residence in London.

Needless to say, the Obamas aren't spending much time in Chicago these days. Thus the value of living next-door to "Barry" and Michelle amounts to a rather vague bragging right. This can't be called an "entertainer's house" as the Secret Service bars the street to non-residents. (Yes, that's even with the Obamas in Washington.) Sellers Bill and Jackie Grimshaw were urban pioneers who bought a down-at-heel mansion in a gritty neighborhood. Now the area has gentrified, and like most people in that position, the Grimshaws live a bit more modestly than the pool of likely buyers. (“I didn’t lavish attention on the house,” Professor Grimshaw admits. Mocking an outraged, imaginary potential buyer, he said: “Where’s the granite? How can people live like this?”) By current Hyde Park standards, it's a fixer-upper.
Evidently the listing agent chose not to have an asking price out of fear it would be too low (cheating the seller) or too high (scaring off buyers). There is considerable evidence that it would be wiser to set a high price and be willing to come down. The list price is an "anchor" that exerts a powerful influence on estimations of value. In a 1987 paper, Gregory Northcraft and Margaret Neale, then at the University of Arizona, studied the effect of listing prices on perceptions of real estate values in Tucson. The effect was huge: even practicing real estate agents could be swayed 14 percent in their estimations of fair market value. For regular folks, the effect was twice that. That's an advantage no home seller should ever willingly cede.

Zillow estimates the value of the Grimshaw house (5040 S. Greenwood Avenue, centered in the aerial view above) at $1,837,000. It also appears to confirm a substantial Obama premium. This Zillow chart traces the house's estimated value over the last year, compared to average values for the 60615 zip code and Chicago. Not surprisingly, Chicago values are down 10 percent over the past year. But Hyde Park's zip code is flat, and the Grimshaw house is up a hefty 38 percent.

Zillow's pricing formula doesn't factor in an Obama premium, not directly. And the estimates for the Grimshaw house actually dipped after the election. That may reflect the time lag for nearby houses to go on the market and close escrow at prices reflecting the Obama premium. If accurate, the Zillow figures imply the Grimshaws are up about half a million, thanks to the neighbors.

Northcraft, Gregory B., and Margaret A. Neale (1987). “Experts, Amateurs, and Real Estate: An Anchoring-and-Adjustment Perspective on Property Pricing Decisions.” Organizational Behavior and Human Decision Processes 84, 87-93.

Sunday, August 30, 2009

Scalping in the Age of Craigslist

Writing in The New York Times, Ben Sisario has an eye-opening piece on online ticket scalping. Among the revelations:
• Miley Cyrus' upcoming tour will use paperless ticketing and require photo ID, moves intended to prevent the reselling of tickets. Scalper Don Vaccaro called it "a career-ending situation" -- for Miley Cyrus, that is.
• One recent report claims that 40 percent of tickets sold on online resell sites go for face value or less.
• Many online sites exaggerate their inventory. They advertise tickets owned by other online sites; in the event of a sale, both sites share in the profit. The consumer never knows who he's buying from.
• When popular shows sell out within minutes, it "educates" buyers to bypass official channels:

David Kronstat, a 43-year-old music fan in New Jersey, said he hasn’t placed a Ticketmaster order in years “because of how convoluted the whole ticket-buying process has come.” Instead he scours Craigslist, trying to avoid brokers by looking for telltale signs of ordinary Joes motivated to sell. “There’s always some guy who bought four tickets and can only use two, or can’t get a baby sitter,” he said. (When told about those lines, one broker said, “That’s all stuff that I write on Craigslist.”)

Friday, August 28, 2009

Answer: Who Paid for the Beers?

Most people reason that, since the man is getting something for a net cost of nothing, it is the bars that are being cheated out of beer. Another answer shifts the cost onto the banks or exchange companies. But the banks are not offering these exchange rates as an act of charity to border-town alcoholics. (Very little that banks do is an act of charity, actually.) They presumably have a reason for offering these rates. The best answer to the puzzle is that the man earns his beers by returning currency to its issuing nation.
Look at it this way. An alien walks into a bar and tries to buy a drink with an Alpha Centauri zlorqat. “Whoa, buddy!” says the bartender. “Pay up in American money or vamoose!” The bartender has a point. He will not be able to spend an Alpha Centauri zlorqat on earth. It is not general knowledge on this planet that there is intelligent life on Alpha Centauri, much less that they have an economic system based on a currency answering the description of what the alien has offered. The “culture of belief” in the value of the Alpha Centaurian zlorqat does not reach this far. To spend a zlorqat, the bartender would either have to travel to Alpha Centauri or find an exchange company or currency trader willing to make the trip for him. Both alternatives will be expensive, if not impossible.
The value of the U.S. dollar also diminishes beyond the U.S. border. It does not diminish much, given that it is a benchmark currency of a global economy. Still, it is sometimes difficult to find somebody willing to accept a U.S. dollar outside the U.S. There are situations where a U.S. dollar will not be accepted at all. This diminished spendability is reflected in the lower rate offered for U.S. dollars outside of the country. The Canadian bartender in the story is effectively saying, “We know this U.S. dollar is worth as much as a Canadian dollar, but it’s occasionally a hassle to spend it here. We’ll pay you ten cents to take it back to the U.S., where it will regain its full value.” This is how the man earns his beers.
Conceptually, the situation isn't so odd. Every country overvalues its own currency, compared to how it’s valued elsewhere. This near-universal fact is simply more apparent here because (a) the U.S. and Canada both happen to call their currency dollars and (b) the two are worth approximately the same. The puzzle is unrealistic, however, in that order towns with open borders rarely observe the official exchange rates. In a community where both U.S. and Canadian dollars commonly circulate, and where you can walk across the border without passing customs, it’s likely that everyone would value the two currencies at parity.

Tuesday, August 18, 2009

Who Paid for the Beers?

There was a time when U.S. banks valued the Canadian dollar at $0.90 American, and Canadian banks returned the favor by valuing the U.S. dollar at $0.90 Canadian. This inspired the following puzzle. I’ll give my answer next week.
A man walked into a bar in International Falls, Minn., U.S., and ordered a 10-cent beer (such was the price at the time.) He paid the bartender a U.S. dollar and a got a Canadian dollar in change (for of course both currencies freely circulate in the cosmopolitan community of International Falls.) The man then walked across the border into Canada, ducked into another bar, and ordered a beer. It too cost 10 cents (Canadian). The man paid by giving the bartender the Canadian dollar he’d been given, and got a U.S. dollar in change.
You get the picture. The man then went back to the U.S. side, bought another beer the same way, then returned to the Canadian bar. By the end of the day, he was falling-down drunk, with $1 American in his pocket.
Who really paid for the man’s beers?

Wednesday, July 29, 2009

Why Stand in Line for Cheap Broadway Tickets?

The New York Times has an interview with Victoria Bailey, executive director of the organization that operates the TKTS Booth. The Booth's long lines (for discount Broadway tickets) have always been an anomaly. If tourists are willing to stand in line hours in sauna-like heat, why not charge a higher price for tickets (and have shorter lines)? One answer: Fairness research has shown that most people regard lines as "fair" and higher market prices less so. The New York Times' Erik Piepenberg asked Bailey about the lines and got this:

Our mission is in large part to promote conversations about theater. You do that in person. The booth is kind of a town square. About 30 to 35 percent of people there are first-time Broadway attendees. There is anxiety about what to see. You hear those conversations within a few minutes of getting there.

It’s hard to believe because the lines are moving so quickly but almost every transaction involves a series of questions: “I’m interested in ABC show, but which show has the best seats or the steepest discounts?” There is an urban fellowship about that experience.

Tuesday, July 28, 2009

Fourth Circle of Hell (Home Edition)

In George Loewenstein's classification, people can be divided into "tightwads" and "spendthrifts." Tightwads feel an excess of pain when spending money and thus spend less. Spendthrifts don't feel enough pain and overspend. In both cases, the gut reaction to spending money biases, and sometimes trumps, rational budgeting. A new study by Scott Rick, Deborah Small, and Eli Finkel finds that spendthrifts tend to marry tightwads, and vice-versa. That may not be a good thing — "In spite of this initial attraction," the authors write, "spendthrift/tightwad differences within a marriage predict disagreements over finances, which in turn predict diminished marital well-being." The article begins with this quote from Dante's description of the Fourth Circle of Hell:

I saw a nation of lost souls…they strained their chests against enormous weights, and with mad howls rolled them at one another. Then in haste they rolled them back, one party shouting out: “Why do you hoard?” and the other: “Why do you waste?”

Tuesday, June 30, 2009

Why We Don't Always Order the Gnocci

Take a look at the menu above (click for a larger version). It's a prix fixe meal recently offered at a Tel Aviv restaurant. The prices are quoted in New Israel Shekels (NIS), worth about as much as an American quarter. The three-course meal costs 115 NIS, or around $30. You've got a choice of five entrees. Which would you choose?
The menu is from an experiment by behavioral economists Ori Heffetz and Moses Shayo, of Cornell and Hebrew University, Jerusalem. They got a fancy Tel Aviv restaurant to play along as they manipulated the menu prices, specifically the little prices in parentheses telling how much the entrees would have cost a la carte. They wanted to test whether more people would pick an item just because it was more expensive. (Did you choose the shrimp gnocchi?) Those who pick up many checks on dates might swear it works that way, but Heffetz and Shayo showed it didn't. The a la carte reference prices did not affect diners' choices.
“Maybe, sometimes, old-fashioned economics is just about right,” Shayo told The New York Times' John Tierney. “Maybe when it comes to food, people do have reasonably stable preferences. Some people like shrimp and some don’t, even if it’s worth a lot of money.” The Times article picks up on that thought, offering the research as a corrective to the current wave of Homo economicus-bashing.
Well, kind of. Nobody disputes that taste can trump money, especially when money isn't truly at stake. More generally, it's long been known that reference prices affect estimations of prices — but choices are a whole different matter. In the late 1960s, Sarah Lichtenstein and Paul Slovic demonstrated this in some classic experiments. Volunteers were required to assign prices to wagers and, separately, to choose between pairs of wagers. Their choices and prices were often contradictory. That is, the volunteers would insist that wager A was worth more than wager B… but when given a free choice of the two, they would consistently chose wager B. This was especially paradoxical because the volunteers were simply trying to maximize money (not balance a taste for stuffed artichokes against a desire to get the best "deal").
Obviously, both choices and prices are important in the real world. There is now a applied science of menu design, based at least loosely on psychological principles. The practical restaurateur is mainly concerned with nudging diners to select high-profit items. One trick is this: If a restaurant wants to push a $30 steak, it will put it on the menu next to a $80 Kobe steak. The latter, even if no one orders it, makes the $30 steak seem reasonable in comparison. And it causes more diners to choose the $30 steak rather than something else, or so menu consultants believe. The Heffetz-Shayo menu was unusual in that it gave prices that don't apply (you're going to pay the prix fixe no matter what you choose). Conceivably, some diners might have picked the most expensive item, to get maximum value (the hypothesis Heffetz and Shayo were testing), while others might have momentarily forgotten about the prix fixe and picked something inexpensive, to get a bargain (as the menu design trick supposes). It's even possible that the two effects canceled out, contributing to the null result. It might be interesting to see more rigorous testing of the tricks used by menu designers.
News to me: that shrimp, pork, and sausages are popular entrees in Tel Aviv.

Friday, June 19, 2009

Frank Lloyd Wright Money Pit, $15 Million

In the hard-to-price real estate department, a foundation has listed Frank Lloyd Wright's iconic Ennis House, in the Los Feliz district of Los Angeles, for $15 million. Completed 1924, it's the grandest of Wright's "textile block" houses, constructed from molded concrete blocks. Wright had the utopian notion that these concrete blocks would be the lost-cost housing material of the future. It didn't work out that way. Only four textile block houses were built, all for rich people in Southern California. Wright wrote: "The concrete block? The cheapest (and ugliest) thing in the building world.… Why not see what could be done with that gutter-rat?… It might be permanent, noble, beautiful."
Well, two out of three isn't bad. The textile blocks began crumbling at the first drop of rain. Earthquakes didn't help, either. Exasperated owners tried well-meaning conservation treatments, like sealing the concrete, that did more harm than good. The Ennis House, severely damaged by the 1994 Northridge earthquake and some monsoon-like rainy seasons, was red-tagged by city inspectors in 2005.
How much would you pay for a Frank Lloyd Wright masterpiece needing perpetual TLC?
Pluses: The architecture, of course, and unparalleled views of the city and Hollywood Hills. The foundation invested $6.5 million on repairs. The home has been in numerous movies, including Blade Runner. It was in a Ricky Martin video.
Negatives: It's estimated the new owner will need to spend $5 to $7 million in further repairs. Zillow's "Zestimate" for the place is only $2,131,500, presumably reflecting what it would be worth without the Wright name or the upkeep issues. The last price paid for the house, in 1968, was $119,000.

Listed by Hilton & Hyland and Dilbeck Realtors with international marketing by Christie's Great Estates.

Wednesday, June 3, 2009

The Price Machine of Irving Fisher

There's a great piece on the "Phillips machine" in today's New York Times. It's a hydraulic computer that uses water to predicts the ebb and flow of the economy. A New Zealander named Bill Phillips built it in 1949, and copies were sold to Harvard, Cambridge, Ford Motor Company, and the Central Bank of Guatemala(!) The Times site has video of a restored Phillips machine gurgling away.
Not mentioned is a remarkable predecessor, the 1892 price machine of Irving Fisher. (I write about Fisher and his machine in my upcoming book, Priceless.) Fisher was probably the most famous American economist of the Gilded Age. The public first knew him as the author of a best-selling self-help book with the earnest title, How to Live. A successful inventor, Fisher devised an index card system, a precursor of the Rolodex, and made a fortune off of it. From his perch at Yale, Fisher pontificated on the issues of the day. He was for vegetarianism, prohibition, eugenics, and just about every nutty health regimen under the sun.
Like Phillips' machine, Fisher's was based on a simple principle: water seeks its level. The device consisted of a tank of water with a flotilla of half-flooded wooden “cisterns” connected by a system of levers. Adjustments to “stoppers” and levers fed in data on incomes, marginal utilities, and supplies; then prices could be read off scales. The device prefigured, if not parodied, the direction of twentieth-century economics. “Press stopper I and raise III,” read part of Fisher’s instructions for the thing. “I, II, III now represent a wealthy, middle class, and poor man respectively…”
Fisher’s career came screeching to a halt in 1929. Days before Black Monday, Fisher waved aside the volatility that was worrying investors. “Stock prices have reached what looks like a permanently high plateau,” he announced. They hadn’t, and that statement — now perhaps Fisher’s most quoted pronouncement — inevitably turns up in humorous compendiums of Famous Last Words.

Sunday, May 31, 2009

Are Two Prices Better Than One?

In Australia, it's been the custom for home sellers to list two prices, a minimum and a maximum. The practice has turned up in suburban Long Island, reports Marcelle S. Fischler in The New York Times.

…Ms. Karekinian has joined a small group of pricing pioneers on Long Island: Rather than settling on one number for her five-bedroom colonial, she opted for a “value range price” of $999,000 to $1,194,876. She decided to adopt the tactic in listing the property last fall with Carol Poetsch of Prudential Douglas Elliman’s East Meadow office.
“I am not just going to say I want $1.3 and that’s final,” Ms. Karekinian said, signaling her flexibility but vowing that she won’t sell below the range. “Now I’m flexible — not stupid flexible, but flexible.”

Prudential Douglas Elliman is said to have begun using the strategy in 1996. The Times says that 180 homes in Nassau County and 360 in Suffolk County are currently listed by a range.
One advantage is obvious: Buyers scanning listings online usually set a minimum and maximum price, and these are round numbers (often chosen from a menu on the listing site). In the example above, a buyer whose maximum price was $1 million would presumably see a house listed at "$999,000 to $1,194,876," but not a house listed at a single price higher than a million. (Of course, this depends on listing sites being able to handle price ranges.)
I can think of a couple of other reasons why this may work. The range probably acts like an advertised reference price. Discount stores will have price tags saying something like "$14.99 COMPARABLE VALUE OF $25.00." Empirical studies and retail practice confirm that customers, even those who know better, are more likely to buy at $14.99 when reminded that they could be paying more elsewhere. In the case of a house, buyers will figure that if they can get it near the low end of the listing range, it's a bargain.
I suspect the biggest advantage of this trick may be simple confusion. Just about everyone knows that a listing price of $X typically signals that the seller is willing to accept a good deal less than $X. In this market, few sane buyers are going to offer list price. Having two prices upsets this comfortable strategy. Do you offer the low price of the range? Less than the low price? Or do you make an offer somewhere in the range? Maybe you really, really want the house and want to make a preemptive offer. Do you offer the high price?
All of the above make a certain amount of sense. Range pricing is likely to spread out the bell curve of offers. Since sellers choose an offer from the high end of the bell curve (or did, back when there were buyers) that ought to result in higher transacted prices.
Prudential apparently has some weird algorithm for devising its range prices. Another example given in the Times article is a Cape Cod listed at $399,000 to $458,876. The $399,000 is easy to understand. But where did they get $458,876, with six significant figures?

Tuesday, May 19, 2009

Do Credit Card “Deadbeats” Get a Free Ride?

In credit card industry parlance, a "deadbeat" is a customer who pays his bill in full each month, incurring no finance charges. Since most cards have no annual fee, deadbeats pay nothing for use of the cards. In recent days, there's been much speculation that the "free ride" is over. Congress' credit card reform bill is due to be on Obama's desk by Memorial Day. The purpose of the bill is to limit the fees and penalties imposed on those who don't pay their monthly minimums (the folks the rest of us might actually call "deadbeats"). Understandably, banks aren't crazy about the bill. They've been hinting that they'll take it out on the other deadbeats. This might involve discontinuing rebate programs or grace periods and introducing annual fees.
I'm a hard-core deadbeat. I don't pay fees or interest, and I get free credit between the time I make a purchase and pay for it. That adds up. Assuming a 6 percent cost of funds, one month's free interest amounts to a 0.5 percent "rebate" on everything I buy. That's not all. My main card (get this: a "Platinum Rewards Visa Card" issued by State Farm Bank) gives me an additional 1 percent rebate on purchases, good for paying my home insurance premiums. Since I'm going to pay my insurance anyway, that's as good as cash.
Am I getting a free ride? Not really. I am paying for that 1.5 percent total "rebate," just not in ways easy to see. Merchants pay credit card companies a service fee for all credit card purchases. The fee usually ranges from 2 to 4 percent. When gas stations first starting taking credit cards, they offered a "cash discount" rather than a "credit surcharge." The credit card companies knew enough behavioral economics to demand that. Increasingly, transactions are electronic, and that means there's always a third party getting a cut. Today, to do business with Amazon, iTunes, or car rental places, you basically have to pay by credit card. Ergo, these businesses build the 2 to 4 percent fee into their prices. That means I pay 2 to 4 percent more than I would otherwise, in order to give the credit card issuer its cut. The issuer than refunds 1.5 percent to me. It's still made a profit of 0.5-2.5 percent (less its expenses) on the transaction. As long as the expenses are less than 0.5-2.5 percent, the issuer is making money off deadbeats.
Banks may well use the new credit card regulations as an pretext to test how price-sensitive their customers are. Would you really give up your credit card if you had to pay a $35 annual fee? (My answer: no, not for the one card I really use. I would cancel a bunch of rarely-used cards in my wallet.) Issuers are unlikely to do anything that causes too many customers to cut up their cards. The business—even the deadbeat business—is too profitable.

Wednesday, May 13, 2009

Priceless Painting Marked Down to $6 Million

How much is a Michelangelo painting worth? Until recently, that question was academic. The Sistine Chapel frescoes aren't going anywhere, and only three portable Michelangelo paintings were known: a masterpiece in Florence's Uffizi Gallery and two unfinished works in London's National Gallery. Today Fort Worth's small and scrappy Kimbell Art Museum announced it had bought Michelangelo's earliest known painting, The Torment of St. Anthony.
Or did it? The New York Times write-up places a question mark in the headline ("By the Hand of a Very Young Master?") and brims with qualifications. It notes that one prominent Michelangelo expert, Michael Hirst, was a doubter. But Metropolitan Museum curator Keith Christiansen examined the work in the Met lab and believes it's authentic. The Met will be showing the work this summer, before it goes to Fort Worth.
You will find no reservations about authenticity in the Kimbell's press release, nor in the Texas media. The Dallas Morning News reports,

The Kimbell refuses to reveal what it paid, and no one in art circles is willing to put a price on a Michelangelo painting. Sotheby's won't guess what the Kimbell paid. It offers up its 2002 sale of a Peter Paul Rubens work, The Massacre of the Innocents, for $69 million as comparable, although rarity wasn't a factor as eight Rubens paintings sold at auction in 2002.
What most experts say is there's no Michelangelo precedent. "Priceless" is the consensus. But apparently there is a price for priceless. "We were able to afford it," says Lee, whose institution estimated that it had an endowment of $350 million in February.

The New York Times is (slightly) more forthcoming: "Although no one will disclose the price, experts in the field say they believe the figure was more than $6 million."
"Priceless" marked down to $6 million plus? That's not so surprising, really. Nobody knows what an authentic Michelangelo painting should be worth—and this isn't a positively indisputable Michelangelo. When you look at the history of ambitious reattributions, the odds aren't so good. Lately, pocketable Michelangelos have been crawling out of the woodwork. Last year, the Italian government spent over $4 million on a wooden crucifix purportedly by Michelangelo. Experts aren't so sure. One, Francesco Caglioti, felt that "The attribution wrongs Michelangelo, as well as the history of 15th-century Florence." He said that "every time something beautiful emerges, they attribute it to a famous name. It would seem like everything done in Renaissance Florence can be attributed to 10 people with a thousand hands."
In 1996 a scholar decided that a marble cupid in the French Embassy, New York, was by Michelangelo. It got a lot of press at the time and also a lot of negative verdicts from experts. After a while, the excitement died down.
For the sake of argument, suppose there was a magic machine that was able to determine the accuracy of any attribution. Scan the object (objet), type in the supposed creator, and it gives you a yes-or-no verdict. We try it on the Kimbell painting, and it says it's by Michelangelo. How much would it be worth then?
Well, it's not a great time to be selling nonessentials. Even so, an authentic Michelangelo would almost have to fetch 9 figures. Middling Picassos topped $100M pre-recession, and so did Gustave Klimt's greatest painting. Wonderful as Klimt is, he wouldn't necessarily make a list of the 100 greatest artists, or Western artists even.
The Kimbell painting would not be Michelangelo's greatest by a long shot. He would have been only 12 or 13 when he painted it, and it's a mere copy (in paint) of a famous print by Schongauer. It would still be in the ballpark of 100M, easy.
And if it was shopped around and sold for just over $6 million, that would count as a vote of no confidence. According to The New York Times,

Asked why the Metropolitan didn’t try to buy the painting, Mr. Christiansen replied: “The timing wasn’t right. We had other acquisitions on the dock.”

I doubt they're buying anything as important as an original oil and tempera painting by Michelangelo. The subtext is that Christiansen couldn't convince the Met's powers that be that it was authentic.
The Kimbell purchase illustrates two classic determinants of prices. One is risk-aversion. Nobody wants to buy something unless they're sure it's all they hope it is.
Dealers are in business to make money. They don't automatically ship masterpieces off to Fort Worth. Most of the world's great museums don't have a Michelangelo. The Louvre doesn't. The Getty doesn't, nor the U.S. National Gallery. Presumably the dealer, Adam Williams (who bought the painting for $2 million) made sure these and other institutions and collectors were informed of the painting. An easy-credit deal could have been arranged. That it wasn't implies that no other well-heeled buyers were sufficiently interested.
Why? Because the deciders-in-chief fretted that the painting wasn't by Michelangelo. Whoever approved the purchase would look like a fool, if and when it was shown to be a fake.
From a strict risk-neutral stance, the Kimbell purchase may make sense. Let's say that the chance it's authentic is 10 percent (hugely pessimistic, going by the press release). Then the expected value is 10 percent of 9 figures, or 8 figures. The presumptive 7 figure price looks great.
That's not the way museums (or most collectors) think, of course. They may be crass but not in that way. They demand 100 percent certainty and pay a premium for it.
The purchase also illustrates the "winner's curse." In an archeotypic, Ayn Rand free market, the highest bidder is whoever wants the commodity most. All well and fine. Introduce a note of uncertainty. The commodity may be what it seems to be and may not. In that case, the high bidder is whoever has the most optimistic estimate of the odds. This too could be fine, assuming that high bidder knows more than everyone else does. But suppose the high bidder is simply more unrealistic (not an unrealistic assumption).
I imagine that all museums and collectors concur in the pre-eminent importance of Michelangelo in the grand narrative of European art history. It appears, however, that there are great differences of opinion about the probability that this particular painting is by Michelangelo. This makes it likely that the high bidder will be an outlier on the attribution controversy.

Thursday, May 7, 2009

The Why of "Free" WiFi

WiFi is free at midprice hotels, and costs as much as $19.95 a day (plus tax) at expensive ones. A New York Times piece investigates the mystery and blames "branding agreements." In a 2008 survey, 49 percent of luxury or upscale hotels charge for WiFi, versus 16 percent for economy and budget properties. WiFi is most likely to be free at midprice chains, where all but 5 percent offer it free.

Monday, April 20, 2009

Secret of the 99 Cents Only Store

How much does stuff cost at the 99 Cents Only Store? It sounds like asking who's buried in Grant's Tomb. Oh, sure, inflation is constantly assailing the business model. The 99 Cents Only chain dates to 1982. What was 99 cents then would be worth over $2 now. In 2008 the company it bit the bullet and raised its top price to $99.99. For President Jeff Gold, it was almost like a death in the family. "The number 99 is a magic number — deviating from that is something we absolutely are not taking lightly," Gold was quoted. "I find significant discomfort emotionally about considering making the change."
Nevertheless, the vast majority of items the store sells still do cost under a dollar — but perhaps not so much under a dollar as you might think. This recent sales receipt shows that the items are priced, not at 99 cents but at $0.9999. That's four significant digits to the right of the decimal point. (Picture the meeting where this was floated. "Jeff, I thought it was crazy, too, then I asked myself: why leave money on the table?" Was there a debate over how many 9's were seemly? Would $0.99999999 be pushing it?)

As far as I can tell, those two extra 9s are an unadvertised special. The store has not changed its signage to read 99.99 Cents Only. (I guess it's like Motel 6, which originally charged $6 for a room but retains the original name.) It's not clear from the above how the store accomplishes the rounding. In this case, the buyer paid a de facto price of $1.00 for the $0.9999 items. Suppose someone bought a hundred such items. Would she be charged $99.99 plus tax? Or does the register immediately round every $0.9999 to $1.00?

Pricing the Cable TV Banquet

When McDonald's raises the price of hamburgers, it can usually point to increased costs for beef, buns, and ketchup. Cable TV companies are different: Though their rates have gone up (more than hamburgers have), their costs have mostly gone down. In Saul Hansel's New York Times piece on this topic, the metaphor du jour is food:

“When you go to lunch with a friend, do you split the bill in half if he gets the steak and you have a salad?” Landel C. Hobbs, the chief operating officer of Time Warner Cable, asked recently in a blog post…

Still, critics say the image of Internet providers as restaurants about to go broke serving an endless line of gluttons simply does not match the financial or technological realities of the industry.… Cable or telephone networks have little in common with a restaurant, the critics say, because there is no electronic equivalent of food to buy. If all Time Warner customers decided one day not to check their e-mail or download a single movie, the company’s costs would be no different than on a day when every customer was glued to the screen watching one YouTube video after another.

Monday, April 6, 2009

Information Wants to Be Free (or Reasonable?)

At the New York Times, Matt Richtel and Bob Tedeschi take on the puzzle, how come phone companies can charge for digital content and no one else can?

At its annual trade show in Las Vegas last week, the phone industry pushed new software stores, video players, games and content. Their efforts are based on a digital twist on Pavlov: The phone rings and we pay.

“There’s been no expectation that anything would be free,” said David Chamberlain, an analyst with In-Stat, a market research firm. “The telcos have been very careful not to give stuff away.”

By contrast, he said, “a lot of people on the Internet are wondering — why did we let all this stuff go for free?”

Friday, April 3, 2009

Mr. Whipple Was Wrong

The worst marketing pitch of all time? It might be "Please don't squeeze the Charmin!" suggests Time magazine's Sean Gregory. He's writing about an upcoming study of the instant endowment effect, to be published in the Journal of Consumer Research. In the endowment effect (a term coined by Richard Thaler in the 1980s), people place a higher value on things they own than on things they don't own. A familiar example is the elderly couple selling the family home, "full of memories." They place an unrealistically high price on it and can't understand why no buyer is interested. There is at least an emotional logic to that. Much stranger is the "instant endowment effect" in which merely touching something raises people's stated prices. Most economics students experience the classroom demonstration of this effect: Coffee mugs from the campus store are distributed randomly to half the students. The people with mugs are encouraged to bargain with the have-nots and sell their mug at a mutually agreeable price. You might expect (and economic theory predicts) that half the mugs would be sold. That is, half the owners would find a buyer who happened to value the mug more than they did. After all, the mugs were passed out randomly, without any regard to who actually wanted a mug and who could have used some easy cash. But the experiment's usual result is that few mugs sell. The people who have the mugs find that no buyer is willing to pay what they think they're worth.
The instant endowment effect has always had an air of mystery. Day after day, a bag of beef jerky sits at the elbow of the guy at the 7-11. He’s spent more time in proximity to that dried meat snack than he has with his latest girlfriend. Does the instant endowment effect cast its spell on that checker, causing him to demand an inflated price to part with a humble sodium-laden treat? Surely not. Daniel Kahneman proposed that, when you're in the business of selling something, you become immune to endowment effects. Beef jerky does not register as "mine" when it's part of a stock in trade. This plausible hypothesis raises as many questions as it answers. There has been much debate over how, and whether, instant endowment effects apply in marketing.
In the new study, by the University of Wisconsin's Joann Peck and UCLA's Suzanne Shu, coffee mugs and Slinkys were set in front of 241 Wisconsin undergraduates. Half the students were allowed to touch the items; the other half could only look at them (as window shoppers, more or less). The students who touched the products were willing to pay more for them than the window-shoppers. This augments the growing case that instant endowment effects are robust and would apply in the real world. Indeed, Peck and Shu cite the Apple Store as a good application. For fanboy looky-loos, touching is buying.
(Time's Sean Gregory may be a little hard on Mr. Whipple. I imagine Procter & Gamble was counting on reverse psychology. Telling shoppers not to fondle the toilet paper made them do so — in the commercials, and probably in real life).

Saturday, March 21, 2009

Bonus Rage

The New York Times' Charles M. Blow has an amusingly minimal graphic, comparing the size of the A.I.G. bailout to the that of the bonuses driving everyone nuts. If the A.I.G. bailout is the sun, the bonuses are Jupiter, or something like that. The question is, why are we more worked up about the bonus millions than the bailout billions? A recent Gallup poll said 59 percent of Americans were outraged over the bonuses. A.I.G. execs have hired security, apparently with reason. ("All the executives and their families should be executed with piano wire — my greatest hope" ran one e-mail note to A.I.G.)
There is something about that word "bonus." A.I.G. execs are, to be sure, drawing large salaries, and large salaries are also supposed to be a reward for the kind of superior performance that generally makes it unnecessary for the government to bail out a company. But big salaries haven't inspired the same level of emotion.
Consider a telephone survey conduced by Daniel Kahneman, Jack Knetsch, and Richard Thaler in the mid 1980s. They asked a nationwide sample of Canadians to rate the fairness of this scenario:

A small company employs several people. The workers have been receiving a 10 percent annual bonus each year and their total incomes have been about average for the community. In recent months, business for the company has not increased as it had before. The owners eliminate the workers' bonus for the year.

An overwhelming majority (80 percent) found this an acceptable business practice. Only 20 percent thought it "unfair." The researchers also tested this alternate scenario on a different random group:

A small company employs several people. The workers' incomes have been about average for the community. In recent months, business for the company has not increased as it had before. The owners reduce the workers' wages by 10 percent for the next year.

This time, most people (61 percent) judged this unfair. But of course all that's really changed is words. In both scenarios, the workers are essentially getting a ten percent pay cut. Those surveyed thought that was acceptable if and only if the foregone pay was labelled a "bonus."
The financial services industry had long used this trick. Profits are volatile. Rather than cut "salaries" in bad years, they cut "bonuses" (which account for much or most of the compensation overall). This makes pay cuts easier to swallow. The verbal legerdemain has now come back to haunt A.I.G. They are finding that the public is far more upset at a multi-million-dollar "bonus" than a multi-million-dollar "salary." Words matter, even for people who ought to know better.

Wednesday, March 11, 2009

How Many Significant Digits to Prices?

There is something funny about gas prices, and that's how exact they are. Gasoline seems to be the only common consumer commodity whose price is quoted in tenths of a cent. Of course, the last figure is invariably 9—on many signs, the little 9/10 figures don't even come off. The cent digit is usually 9, too, creating a charm price (e.g., $2.299 a gallon). A charm price is one a little below a psychologically significant round figure. For many types of products, charm prices do seem to motivate buyers. So the little 9s make sense, and a price like $2.299 basically means $2.30, a number with two significant digits.
I mention this because a theme of my upcoming book is how fuzzy prices are. Many experiments have demonstrated that subjective valuations are much more fluid than we think. In bargaining experiments, "irrelevant" factors such as the genders of the participants or the number of offers on the table can change agreed-on prices by 10 percent or more. This might suggest that there is little point in quoting prices to more than 2 significant figures.
The imprecision of prices is recognized by the custom of rounding retail and asking prices. Imagine you're selling your home. You use a spreadsheet to compute the appropriate list price. Based on comps, square footage, taxes, and the plummeting market, you compute that the optimal asking price is $562,118.83. You aren't likely to list it at that. You either round down to $560,000, or round up to $570,000, or opt for a charm price like $569,000.
My point is, sellers mostly round to two significant digits (and then sometimes impose a charm price). A look at the prices in real estate listings, eBay, and Amazon confirms this. Prices like $47.30 or $274,200 are rarely encountered.

There are exceptions. One is cars. The 2009 Hyundai Elantra SE (pictured) has an MSRP of $17,020 and an invoice price of $16,334. That's four or five significant figures, and neither uses the old 9-ending trick. Is Hyundai so sure its customers will buy at $17,020 and walk away at $17,030?
No because Hyundai knows that list prices don't mean anything. Options, fees, and sales tax must be added; the total is negotiated; and then the salesman tries his darndest to sell you rust-proofing. There may not be much point in going psychological with a base list price because no one ever pays it and everyone knows they won't pay it.

I recently came across another case of weirdly exact pricing at Louis Vuitton's Beverly Hills store. Like most luxury retailers, LV uses contrast anchoring. They display a few items so outrageously priced that they rarely sell, and that's okay. These prices make everything else look reasonable in comparison. The most expensive item I saw was a diamond watch, priced at $149,000 (in the midst of the grimmest recession since the 1930s). That's a charm price! Like they were worried it wouldn't sell at $150,000.
LV has a lot of three-significant-digit prices that do not end in 9. I didn't note them, but I found these watch prices on the Louis Vuitton website: $2,680.00, $4,010.00, $18,100.0, $14,700.00. Pictured: the Emprise Paved Watch, large size, designed by Marc Jacobs, and retailing for $134,000.
To the best of my knowledge, haggling is not part of the culture of Rodeo Drive, even in this economy. Does LV assume its customers have very exact reserve prices? Is it run by bean-counters who can't bear to round down?
I'd welcome from hearing from anyone who has encountered retail or list prices with four or more digit precision.

Sunday, March 8, 2009

Negotiation 101 with Professor Gagosian

From David Segal's piece on art dealer Larry Gagosian in The New York Times:
Harvey S. Shipley Miller [trying to buy a Cy Twombly drawing for a non-profit foundation that would donate it to the Museum of Modern Art—other dealers had offered a discount]: “So I said, ‘How about $100,000 off?’”
No, Mr. Gagosian replied.
“How about $25,000 off?”
“Nope, I can’t do it.”
“O.K., Larry,” Mr. Miller said, exasperated. “How about $1? Can you give us a dollar off?”
Well, no.
“I tell you what, though,” Mr. Gagosian answered. “I’ll buy you lunch.”

Tuesday, March 3, 2009

$81 Billion at the Gas Pump

Spokane man Juan Zamora charged a tank of gas on a PayPal debit card, then returned home to hear an automated voice message saying the purchase had been approved for $$81,400,836,908. PayPal spokesperson Sara Gorman blamed a "misunderstanding."

Sunday, March 1, 2009

Boom (or Bust)

"If we went into shops only when we needed to buy something, and if once in there we bought only what we needed, the economy would collapse, boom." — Paco Underhill, environmental marketing consultant

Saturday, February 14, 2009

$21,025 Kiton Suit at Saks

Saks has interesting timing for the opening of its Kiton boutique, reports the New York Times. They will be offering men's suits running $7000 (off the rack) to $21,025 (bespoke). Said Saks president Ronald L. Frasch, “These are decisions that are made with significant advance planning.”
The article claims that a Kiton suit can be balled into the crevice of an airline seat and come out fresh enough to wear (I know, sounds like an infomercial). Incidentally, a pair of Kiton Jeans are $700.

Wednesday, February 11, 2009

John Thain's $35,000 Commode

Of all John Thain's pricey indulgences, none has gotten more press than than the $35,000 commode he bought for his Merrill Lynch office. I am pretty sure the reason is that word commode. Half of America is picturing a $35,000 toilet, and the other half knows it's furniture but can't help picturing a toilet. This isn't the first time someone's gotten in trouble this way. In the 1980s, the U.S. Navy took flak for paying $600 for so-called toilet seats. The Navy was refurbishing old fighter planes (to save taxpayer money) and had to pay that to refabricate some fiberglas pieces, long out of production, that reduced vibration in the toilets. The $600 parts weren't toilet seats, but some governmental document called them that. Someone else found out, and soon the $600 toilet seats were being given a "Golden Fleece Award" as outrageous government waste. There's something about expensive toilets. The populist impulse can't resist it.
Moral: If you're going to spend a lot of someone's else's money, don't spend it on anything that sounds like it could be a toilet.