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