If One Coupon is good, are Three Better?

Consider this scenario – You are at a casual dining chain restaurant like Chilis, Applebee etc. You are done with your meal, paid your check and finishing off your last drop of coffee. Then the manager walks by, asks you about your experience and voila gives you  not one, not two, but three $10 coupons good for your future visits. The coupons require a minimum of $20 purchase, can be used one per visit and have a three month time period. Coupons are valid at all locations.

Are you more likely to visit the restaurant in the future because you received three coupons  than if you had received just one coupon?

The case of single coupon has been studied at length in the marketing literature and yes it does work in generating repeat visits. Whether the coupon driven visits are profitable or not is a different question and it depends on percentage of customers who would not have visited without the coupons. Coupon driven visits are profitable when

(ave tab per visit less coupon ) * % who visited only because of coupon

>

(coupon amount) * % who would have visited anyway

Suppose one coupon is good for business in generating incremental revenue, are three coupons better?

The answer comes from Prospect Theory and Mental accounting. When presented with one $10 coupon with strict expiration date, letting the coupon expire will create a sense of loss in the minds of customers. When presented with three such coupons, even though the coupons are not additive, customers will see the value as additive. Not using any of them will cause a greater sense of loss (loss curve is convex – prospect theory). A customer who lets all three coupons expire will have greater sense of loss than the one who lets the single coupon expire. So those who receive three coupons are more likely to revisit at least once than those who received just one coupon.

Since this increases percentage of customers who visit because of coupons, the restaurant stands to gain from giving more than one coupon to the customer who is less likely to visit otherwise.

Finally, what if the customer decides to use all three coupons? At an average restaurant tab of $50, that is $120 incremental revenue (since all restaurant costs are sunk, this goes straight to bottom line).

If one coupon is good, three are indeed better!

You do not have to settle for the theoretical explanation – this is easy to experiment. Do  A/B tesst and see if this works for your business.

Whether this trains the customer to expect coupons and reduces their reference price is a topic for different post.

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.

Business Built On Endowment Effect

Endowment Effect,  introduced by Thaler, states that people tend to value things they own more than they are valued by the market. Hence people are reluctant to let go of things they own at the market price and end up accumulating them. The New York Times magazine profiles  the business that is build on this, Self-storage. People are not rational automatons, they are not aware of sunk costs nor are they capable of doing net present value calculations of multiple options. They cannot tell the monetary difference between storing their wares in self-storage vs. selling them now in garage sales at the prices the market is willing to pay.

Clem Tang, a spokesman for Public Storage, explains: “You say, ‘I paid $1,000 for this table a couple of years ago. I’m not getting rid of it, or selling it for 10 bucks at a garage sale. That’s like throwing away $1,000.’ ”

People end up paying $100-$200 per month for storing things that will not even cover the rent if they were to be sold off. The result is a thriving business – self-storage  that adds negative value to most of its customers. The question is will we see a return to rationality due to current economic conditions?

Other related articles:

  1. Endowment Affect in Wendy’s commercial
  2. Theory Behind Home Staging
  3. Pricing Garage Sale

Theory Behind Home Staging

In the down economy and slow housing market, most homeowners are staging their house for the sale. To a homeowner the value from staging comes from

  1. Higher price than they would have received otherwise
  2. Shorter time on the market and hence savings on carrying costs

Does staging work? Does it improve sale prices and days on market? What could be the consumer behavior theories behind it?

I hypothesize that there are reasons to  believe that staging works. Sometime back I wrote a piece titled “You touch it! You own it!“.  That article was based on new consumer behavior research that found that touching products increased customer willingness to pay for them. This was because touching increased ownership and as endowment effect theory show, we value things we own more than twhat the market is willing to pay for it.

The hypothesis for why Home Staging works is the reverse of this ownership effect. If we think someone else owns it then we tend to value it lower than if we owned it. A staged home reduces the footprint of the  owner and helps the potential buyer better imagine this as their own and hence helps to increase their willingness to pay for the home.

There is one statistic I saw from StagedHomes website that states, higher sale price and fewer days on the market for staged homes. This is not based on a controlled experiment but based on a survey they did. I cannot rely on these numbers to validate my hypothesis.

To test my hypothesis I should conduct a controlled experiment (controlled for time, location, listing price, size etc), randomly assign houses to be staged or not staged and measure the average sale price and mean time spent in the market for the two groups. Only if the  difference between the means of the two groups are statistically significant  can I claim that staging played a role.

I do not have the wherewithal to do this experiment so if you are considering whether or not to stage your house for sale consider writing a conditional contract with your stager. If they truly believe staging increases your home price and reduced days on market then they should agree to a structured incentive scheme that goes down in value every time you decrease your listing price and more days the house spends in the market.

Endowment Effect – When a bird in hand is more than two in the tree

Here is an Ad for Wendy’s double stack burger that shows very neatly Endowment Effect. (wait for 7 seconds into the video for the Wendy’s Ad, as the beginning of the video has another Ad for Religulous)

The Adman says, “your burger has increased in value”. This is only partly true as the value is in the minds of the customer who is holding it and it is the perceived value. Endowment Effect is a theory introduced by Thaler  (of Nudge) and it states that people who own things  tend to value these more than others. Since their perceived value goes up, they are less reluctant to part with the goods at prices they bought or at the current market price.

This is the same reason home prices are not falling as fast as economic  theories suggest – people own their homes more than the market is willing to pay.

As a corollary, if the customer feels ownership of the object then their   willingness to pay goes up as well. An example of this was discussed in my last post  You touch it! You own it!

Unlike an Economist

An economist is trained to assign value (in measurable units too) to every action we undertake and everything we buy. There are always trade-offs and costs including opportunity cost of not picking the next best option. If an option does not offer positive expected net present value it is not worth undertaking. If there are multiple options, then you pick the one that offers the maximum expected net present value.

We do not run our lives like an economist. Our decision making is flawed and is based on emotions than rational thinking. When looking at the decisions made by others, with the advantage of hindsight and emotional detachment, we make commentaries about the qualities of those decisions. The New York Times has an article by DAVID STREITFELD on the unfortunate homeowners who used storage to stash their belongings after foreclosure on their homes. David says,

“… some people cannot keep up with their storage bills any better than they could handle their mortgage payments and the storage companies are auctioning of their property for a pittance”

An economist would ask, have these people considered all options before choosing storage as the best option? David asks,

This is the eternal mystery of self-storage. If the material was worth
money, it was foolish to let it go to default. If it was not worth
much, why spend at least $50 a month to store it?

The problem is most people, and we can safely say all of these people who used storage only to lose the contents, do not have a formal decision process. One could argue that if they did, they would not have reached this stage in the first place. But if we give people the benefit of doubt, unexpected events and bad luck could easily be the reasons that drove them to foreclosure. Kirchler and Rodler of University of Vienna say in one of their cases on Consumer behavior,

“People in private households make decisions when they are still groggy in the morning or tired again in the evening after a day’s work. Economics decision making is imbedded (sic) in the daily routine of a relationship, which is faced with a multitude of different decision topics which often do not present themselves one after the other but rather demand simultaneous solutions”.

At the time of foreclosure they are already stressed and are trying to make a living and/or support their families. Their already sub-optimal decision making process is further weakened by their current state. They cannot make economic decisions on whether to sell the stuff right away or pay the rental charges to the self storage.

People tend to look at their property as a representation of their past, a life they once had and want to have back in the future. While it might make economic sense to sell these off rather than spend $600 a year to store them, only to lose them later, their emotional attachment makes them choose the option of storing instead of selling.

Unlike an economist people are not rational. Unlike a economist people are emotional. Unfortunately, this emotional decision process destroys private and public wealth.

This brings us to the questions,

  1. Should people be making their own decisions?
  2. Should there be professional decision makers, trained economists, who can take on the multitude of decision problems that require simultaneous solutions?
  3. Just like people are not qualified to treat their own medical conditions, should they leave their economic decision making to professionals?

Addendum: People may very well be making a valid decision if they think they value their possessions to be more than the cost to replace them. This could easily be the case as explained by Endowment effect that states we value things that we own more than what the market is willing to pay to buy from us.