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.

Nudging Customers to Choose the Right Version

[tweetmeme source="pricingright"]My favorite online survey platform is SurveyGizmo. Its pricing page shows five four different versions with special formatting for “Pro” version that tells us it is the most popular version. (Since I last wrote this article, SurveyGizmo has done an amazing job of re-designing their pricing page, presenting just 4 vs. 5 versions.)

Another example is BaseCamp, its pricing page shows four versions and  tells us its Plus version is the most popular. Are these examples of versioning strategy? Why will these marketers draw our attention to one specific version if they are offering us choices that we are supposed to self-select?
Let me start with a few definitions:

  • Versioning strategy is finding different customer segments and delivering different versions designed to appeal to each. For example there are customers who prefer a Acura and those that are happy with Civic.  Strategy means making choices. Since a marketer has only limited resources they have to make a choice which segments they can serve and what versions should they deliver to maximize profit.
  • Versioning tactics is second level of optimization, fine tuning if you will, after the strategy is chosen. For example different trim levels within Civic. This comes from sub-segmentation, recognizing there are still variances in customer types within a segment.  Versioning tactics help extract additional profit  from minor product variations. No significant resource commitments are needed.
  • Self Selection is offering customers multiple versions at different price points so they self select. When marketers cannot clearly tell which customer is which, they simply present they version with the assumption customers pick the right one. Self selection works when customers know (to an extent) the value they get from each version and whether that matches the price they are willing to pay for it. A rational customer will pick the one that leaves them “consumer surplus“.
  • Nudging is sending signals to the customer and applying many of consumer behavior methods to nudge them to choose the one the marketer wants. Nudging is important and effective when the customer does not know the value they get and whether or not the price they pay matches the value they get. When nudging is applied, usually there are three versions but these are not designed based on segmentation (i.e., not versioning strategy). These additional versions have just one role – help sell the real version. Despite multiple versions the marketer expects to sell only one which she highlights to draw customer’s attention to it.

In case of information goods (and sometimes for experience goods like Wine) customers do not know the value and do not know what price to pay. Customers must first understand what they are buying before they can tell what value they get (DeLong).  In such cases, when the customer is presented with just one version they do not know whether or not to buy it because there is no value information. Customers decide value  and price to pay by comparing  options so it helps to present them with more than one version.  How many versions? In his 1997 paper on versioning, Hal Varian, tells us  presenting three versions are better than two versions. The reason – extremeness aversion.  Varian labels three versions as Goldilocks pricing.

Unlike the tall, grande, venti (where customer can see value) it is not enough to depend on extremeness aversion to let the customers pick the “Pro” or the “Plus” version. Customers need to be nudged. The nudge could be either highlighting a version or  using conformity principle to tell a prospective customer that most customers bought a certain version. Sometime all such influence methods are applied.

What we are seeing with SurveyGizmo, BaseCamp  and many other similar services telling us the “Most Popular” version is Nudging!

Don’t  their Enterprise Edition and Dedicated version count as versioning strategy since they are targeting high end large enterprises?  It is correct that these are products that is designed for a different segment but I am not certain whether the enterprise segment makes its buying decisions through a website form like small businesses and individual customers do. I bet they have account managers to target the Enterprise segment.

Does your business practice Strategic versioining or  Nudging with Goldilocks Pricing?

The Power Of The Middle Option

Behavioral economists like Dan Ariely and Cass Sunstein are in one way or another have been associated with President Obama’s campaign or administration. It appears people who pitch the President are also taking lessons from the behavioral economists.

One of the concepts of behavioral economics is the power of the middle option – given three options at three different price points most people aggregate towards the middle option. The same principle now seem to be applied in troop requests to the President. General Stanley McChrystal sent three options to the President for his Afghanistan troop request:

  1. 60,000
  2. 40,000
  3. far fewer than 40,000 but with consequences

The general recommends 40,000 troops.

I bet this will be the option he will end up getting, except that the President understands behavioral economics as well and may look beyond this versioning.

Fox Tale Soup

There is a children’s book called “Fox Tale Soup“. This is the old story of Stone Soup retold with Fox and farm animals. If you have not read the original I recommend reading this version.

The clever Fox is a great influencer. He starts out by asking for food but was denied any help by the farm animals. After being rejected for his initial request the fox starts with a trivial request,

“just some water please, after all I got the stone to make stone soup”

One of the animals yield and bring water. Of course, if only there was some seasoning, some potato, some rutabaga, …

The fox slowly builds on his seemingly trivial request for water to get to all the ingredients for the soup. The farm animals one after the other ends up bringing salt, potato, rutabaga etc. There are multiple influence principles at play here.

The fox started with an outrageous request, asking for food. Since he was a total stranger the animals so the animals were right in rejecting his request.

Then he followed up with a trivial request, water, which is available in plenty. This is  anchoring.

Once the animal agreed and brought water, there eas no turning back. They ended up giving the rest of the ingredients because of the power of commitment and the inherent need in us to act consistent to our past actions (consistency principle).

There was also consensus effect. Since other animals were helping the fox, any animal that had any misgivings about not helping the fox were nudged by the actions of others and were convinced to help.

That is the power of persuasion.

If you want the psychology behind this you should also read, Influence: The Psychology of Persuasion by Robert Cialdini.

Other book I recommend is Nudge by Sunstein and Thaler.

Multi Version Pricing – Print and Online Newspaper

I came across the pricing list for print and online versions of The  Newport Daily News through Consumerology blog. The most interesting aspect of their pricing is how they priced the online only version (highest) vs. online plus print combo (lower). Why would they give away the version that includes print newspaper at lower price than online only version? The reasons could be:

  1. Their online Ad revenue may not be significant and advertisers do not think the readers respond to the Ads. Hence they want to compensate for lost revenue opportunities.
  2. There are additional revenue opportunities from print version, for example different types of Ads, inserts etc
  3. More people read the print version, either within households or it is bought by local businesses for their customers. In addition readers may spend more time reading the newspaper. Together these two factors increase the Ad reach and hence the price Newport Daily News can charge their advertisers.

But this pricing is unsustainable due to following reasons:

  1. Since the combo price is lower, those who prefer online version will buy this version and may simply throw away the print version. While the newspaper may claim higher “print impressions” with their advertisers, there is no net increase in reach for the advertisers.
  2. The pricing also goes against customer expectations and assumptions – customers believe online only version should cost lower than print version because of cost difference. To a marketer cost has nothing to do with pricing which is purely based on value, but customer perceptions set a low reference price for online only version. This low reference price prevents the marketer from capturing all the value.

The Newport Daily News may now be employing behavioral economics to nudge customers to pick the print only or the print + online combo over the online only version, but sooner or later they are going to find resistance or backlash to their high priced online only version.

Why we still buy incandescent bulbs?

CFL (Compact Flourescent Light) delivers savings in two forms

  1. Longer life and hence savings from replacement costs
  2. Energy efficient leading to savings on operational costs

The lowest grade  CFL lasts  five times as long as a high quality, “long life” incandescent bulb and saves $36 over its lifetime in energy costs.  The  said CFL costs $5.22 and the long life incandescent costs $0.42 each. Even excluding opportunity costs of buying and changing light bulbs, that is a total savings of  $33 over five years. (Source WSJ)

This does not even address the environmental costs savings from using less energy.

So why do we still keep buying incandescent bulbs when the economics of a CFL are clearly better?  I think the answer lies in our we discount future benefits. If we are rational decision makers then  the present value of $33 will guide us to simply choose the CFL option.

We are not. We have the tendency to underestimate future benefits and hence value it lower than the value of an option with near term benefits. We read news stories, we understand the benefits of CFL but when it comes to the moment of choice our value curves switch and we pick the incandescent bulb which is priced at $0.42 compared to $5.22 for a CFL. George Ainslie called this the hyperbolic discounting, the same concept that is used to explain addiction and temptation. In some sense we give in to the temptation of the present and forgo future benefits because of our ways of discounting the future.

The EU and the US Governments have announced plans to phase out the incandescent bulb in the coming years. I wonder why wait a few years? Is it not time to put some Nudge to work? Why not take away the temptation that stems from higher near term benefit? The Governments should charge a very high tax on these bulbs, to bring their price close to that of a CFL. Anyone buying incandescent bulb even after  these highly taxed prices do really have a need for them and should be charged another price premium.