Stick or Carrot – Traffic Tickets or Gas Vouchers?

This morning NPR reported on an experiment by French traffic cops

Instead of scanning the road for bad drivers, traffic police in one town south of Paris, are looking for drivers who are obeying the rules of the road. They’re pulling over good drivers at random, and handing them gas vouchers worth more than $60.

People respond to incentives but they respond more to disincentives or negative incentives. According to Prospect Theory the satisfaction from a gain of $60 gas voucher is not as intense as the pain from losing $60 (or more) to traffic tickets. Besides, I am not sure who would enjoy being pulled over even if it is for being presented with a gift for obeying traffic rules.

When it comes to changing behaviors sticks are better nudges than carrots.

Here is another study on the effect of Stick vs. Carrot  reported in today’s WSJ that validates the power of sticks over carrots:

Our main findings are that reemployment bonuses don’t seem to have worked, while benefit sanctions increased the job finding rate significantly,” the economists write.

So if you are trying to change to customer’s behavior, be it getting them to bring their own shopping bags or sign-up for electronic billing over paper billing – Sticks work better than Carrots.

Where To Allocate Your Promotion Dollars?

You have $X dollars to be used as promotional discount to increase your product uptake, i.e., maximize number of subscribers rather than maximize profit. You have two versions of your product, Silver priced at $19 and  Gold priced  at $49. How will you allocate the promotional dollars to drive most uptake? Will you discount your Silver version, Gold version or split between both?

Sidebar: I understand I have  consistently advocated about profit maximization and not using price to drive volume. But let us assume you have a very good reason to do that and it is not permanent price drop but a controlled price promotion. May be you have a freemium model with a Bronze version at $0 and want to move most free customers to paying customers.

Consumer behavior research says, based on Prospect Theory (Kahneman and Tversky 1979), you are better off spending the promotional budget on discounting the lower priced version than the higher priced version. While rational economics states (assumed?)  a $5 discount is the same regardless of the price, consumers look at $5 with reference to the base price. Consumers value $5 discount on $19 version more than then do the discount on the $49 version.  So  discounting your silver version maximizes new customers.

However there is an exception – when customers’ reference price (the price they expect to pay for similar products regardless of their economic value) is lower than the price you charge. Here the effect is reversed so you should discount the Gold version. If you are interested in understanding this case please write to me.

In either case, you are better off allocating the promotional budget to just one version and not dividing between two versions.

Does Presence of Customer Reviews Drive Down Product Returns?

Does presence of customer reviews and the number of reviews drive down returns by customers?

According to Internet Retailer (thanks to Gerardo for the link), that is the case. The article says, reviews has helped Petco considerably

Petco’s approach to gaining more customer reviews has paid off. On average, products with reviews have a 20.4% lower return rate than products without reviews. The return rate continues to decline as a product gains more reviews. Products with more than 50 reviews have a 65% lower return rate than products with no reviews.

Since returns eat into profits, reducing returns goes directly to the bottom line – there is no question here. But can presence of reviews drive down returns? Is there a direct causal relation or is this just incidental correlation.

Commitment and Consistency Bias: If the  case of customers who took the time to write reviews I can see that their return rate will be much lower than the return rates among those who did not write one. This is the Commitment and Consistency bias (the book Influence by Robert Cialdini has very good discussion of these biases). When the customer “commits” by writing how good they feel about the product their internal system compels them to act consistently to their previous commitment. So they keep the product.

Reason doesn’t matter: This does not mater whether or not customers wrote the review because of their LOVE for the product or because they were paid in coupons or raffles. This does not apply to negative reviews, but according to one research, most reviews are positive reviews and there is generally high product ratings. On the other hand we could argue that those who returned the products are more likely to write a negative review.

Conformity Bias: Commitment and consistency bias alone cannot explain the drop in returns because this is still a small number of reviews compared to products sold. But another cognitive bias that could be at play is conformity bias. When customers make the purchase based on many reviews by “customers just like them”, they tend to confirm to those peer reviewers. This will compel them to “like” the product and keep it – all those positive reviews cannot all be wrong, if I do not like the product it must be me.  Again, Cialdini has chapters describing Conformity bias in his book.

Cognitive Dissonance: Intertwined with conformity bias is our need to assuage cognitive dissonance. People who buy a product by doing the research, reading multiple reviews and evaluating options believe they made a rational decision of buying the best possible product. But after buying the product if it turns out that it did not live up to their expectation they  suffer cognitive dissonance – a gulf between how their feelings before and after the purchase. Customers overcome that by convincing themselves that they like the product.

On top of these cognitive biases, it is possible that there exists another common variable that both drives up number of reviews and drive down returns – for example the product experience matches its promise.

There is one way to answer many of these questions and to find out whether or not number of reviews drive down returns. It requires doing two sample test, showing some of the customers the review,  suppressing it for others and tracking the respective return rates. If the return rates are statistically significant then we can declare presence of reviews drives down product returns.

Next step, if we do the experiments by showing different number of reviews we can even find the linear causal relation between number of reviews and returns.

Pay What You Can Is Not Price Discrimination

This has been my favorite pricing case study for the past ten months or so – Sensorielle spa in the city I love, Boulder, went to a Pay-what-you-can pricing model. The spa’s owner, Ms. Petteway made it clear that this is not “pay what you want” but a scheme to allow those loyal customers who were hurt by down economy to come back and pay only what they could afford.

A few months back I wrote about the partial results published by:

Ms.Petteway published results from her experience in the Boulder Net LinkedIn discussion board. She talks about how  few customers interpret the pricing plan as “pay what I want” and ask for high-end services even though they pay less than the posted prices. For any rational customer (Homo Economicus) whose goal is to maximize their utility, it makes sense to pay the minimum they can get away with.

I said then Pay-what-you-can  scheme despite its close resemblance to first order price discrimination is not really price discrimination. It does not stand on solid data ground or analysis and leaves the future profit uncertain. Better results could be achieved with segmentation and targeting.

Will this pricing scheme help the spa identify willingness to pay of different customers? No, because the reference price is set by the list price and is pushed down by the option for “pay-what-you-can”. There are other ways to get customers to reveal their true willingess to pay (see my article on Pricing for garage sale).

I do not have access to any sales data nor have I had this conversation with Ms.Petteway but I hypothesize that they found this pricing scheme yielded lower profit than previous years.  The spa is not standing still and is making  more pricing changes  for the coming year:

1. The Pay-what-you-can is limited to just two days of the week. This is something they should have done to start with and that would have been a great way to sort customers based on their WTP.  This would also help reduce cost of operations for those days by staffing with junior staff and not offering their high margin services. I also would recommend offering no reservations or charge for reservation separately (unbundled pricing) for these pay-what-you-can days.
2. They are increasing prices of some and decreasing prices of some. If they based it on customer survey then it makes perfect sense. When re-pricing  two version of the same service I would have recommended that they don’t reduce the price for both.
3. Note how the text reads for price decrease and price increase. They say “price reduced” and “price changed” respectively. That is not a strategy but the right messaging – do not ever say price increase.

Small businesses can blame the economy and be swept by the recessionary wave or they can take control on their marketing strategy to drive higher profits. Lack of specific marketing skills is not an excuse anymore. Kudos to Ms.Petteway for experimenting with pricing and her willingness to adapt as she gained more data about consumer behavior.

Not Leaving It To Chance

Yesterday I was at a Borders bookstore. The checkout line was long and growing. At one of the counters a grandmother and her granddaughter were in the process of completing their transaction. The grandmother had allowed her granddaughter to buy one of the trinkets (glowing ball, etc.) that Borders stacks plentiful along the check out area. But the little girl had two items in her hand and was indecisive. The checkout clerk, not wanting to spend idle cycles on girl’s indecision, took a coin out of his pocket and  flipped stating heads this and tails that.

Then magic happened. Before even the clerk revealed the outcome of coin toss, the little girl said, “I will pick this one” and returned the other item.

Behavioral economists say it is our  natural tendency to pick options that seem certain over options that are associated with uncertain outcome. When the clerk flipped the coin it became clear to the girl that she might end up with an item that she preferred less and hence was forced to make a choice. Next time you are with an indecisive partner, try flipping a coin.

Kudos to the clerk for understanding consumer behavior,  and keeping the line moving. I am not sure if Borders trains their clerks or the clerk read the many books on behavioral economics in the store.

Home Prices – Value Gap

Sometime back I wrote about why homeowners list their prices at higher prices than the comparable sales prices in their localized market.  I theorized it is due to endowment effect and ignoring opportunity costs. It appears now the list prices are starting to reflect the market rather than what the homeowners value. Here is a report on MarketPlace:

Chris Mayer tracks real estate at Columbia’s business school. He says reality is finally sinking in for home sellers.

CHRIS MAYER: There’s an initial loss and people are looking at this and saying, but God, I paid $400,000 for the house. I’m just not going to sell it at $300,000. And over time, people realize that $400,000 isn’t coming back and they adjust their expectations.

According to the report. quarter of all homes that are for sale have dropped in prices at least once.   Behavioral economists say, homeowners are going to feel pain every time  they drop prices that is comparable in magnitude to the pain felt with the first price drop.

What does it mean for those who have their house on the market? Emotionally,  it is better for them to calculate more accurately the required price drop and do it once rather than do it in steps.