Cost of Fungibility – Price of Target Gift Cards

I came across $100 Target gift card for sale on eBay for $90 (thanks to Zach). It is a deal for selling you $100 Target gift card for $90. Let us assume here everything is legitimate and not add other external factors.

Can you think of why anyone would take less than face value of the gift card?

On the other hand, can you think of a scenario when someone would refuse to a fair trade of $100 cash for $100 Target gift card?
100-target-card

Looking at the seller and number of deals sold, this is a case a wholesaler who likely struck a deal with Target to get $100 gift cards for less than $90 and trying to make a profit.  For Target such a deal would make sense because of assured $100 sale (it is as if they are giving, say, 20% discount) and there is always breakage (people not using full value of gift cards).

Seems like rational automatons making spreadsheet driven decisions.

Now how about refusing to trade even for fair value?

A while back I wrote about a case of Target gift card. It was an offer for you to trade a $20 Target gift card for cash that is lot more fungible than a gift card.

I offer to take that gift card from your hand for cold hard cash – cash that is lot more flexible than the Target gift card which has the limitation that it can only be spent at Target.

As a Homo Economicus you should be willing to accept any reasonable offer that is just about less than $20

There exists a scenario where the gift card guarantees more hedonistic pleasure than fungibility of cash that creates conflicts. Applying Prospect Theory, a gift card represents money that is already spent. So there is less or no additional pain from buying things with it. When you trade it in as cash it becomes “unspent” and creates more pain (Prospect Theory) when you buy things with it.

Furthermore, if it is a gift card you know you have to spend and there is no mental conflict. When it is cash, the very fungibility creates choices – could you be paying rent or saving that money instead of spending it?

That is where some will refuse to trade in their gift card for cash.

What will you do?

 

 

How to offer free version – Google Fiber Pricing

 

Google is getting into ISP business with its Google fiber offering. There are several relevant questions about this attempt by a business whose core competence is in organizing world’s information.  There are questions about the pricing strategy, cost structure and whether they have the operational wherewithal to pull this off against others whose core competence is in running a network.

Here let us look at one specific topic – their Free version. Some will see this as significant evidence supporting freemium model. It is anything but a case for freemium. Let us take a closer look at this free version.

The service is available in one city that is likely not the one with hunger for high-speed internet. This in essence is a test market and what they offer here has nothing to do with what they will eventually offer in other markets.

The Free internet is technically not free. Customers either pay $300 upfront or pay $25 a month.

The $300 price is labeled as construction fee which is waived for other premium versions. That is a clever presentation for two reasons. First, the $300 is a high upfront cost for any customer and even more so for someone attracted to free. Right there it limits the most price sensitive customers from opting for this. Second, by explicitly waiving this cost for other two versions, those who choose Free are made to think they are losing out on this value.  Pain from this foregone value will push most to opt for the higher priced versions.

Free is also not free forever, customers who pay the upfront fee will get free service for 7 years. This limits the liability for Google and sets clear expectation among customers. It is likely that most customers who would choose this option do not stay in the same house for 7 years.  If they did stay, they are less likely to switch to another ISP because of sunk cost bias. In essence Google captured upfront value and locked away these customers for up to 7 years, making them unavailable to others.

There is indeed an option to pay-off the $300 fee over twelve months which will help reduce the barrier for some. Prospect theory suggests that paying $25 a month for twelve months will cause more pain than single payment of $300. So even fewer customers are likely to chose the installment option.

Netting it out, this free is not the run of the mill Chris Anderson school of free. There is a well defined segmentation strategy with  carefully crafted free used as a tactic to support it.

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.

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.

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.

Subscription Pricing For Unbundled Offerings

The problem with unbundled pricing (pricing separately for each component of a monolith) is the multiple purchase decisions the customer has to make. Every time the customer opens the wallet and pays for an extra, they feel increasing pain (Prospect Theory). Customers will see each transaction as a loss and according to Prospect Theory the pain from multiple small losses can be more than the pain from a single loss of same magnitude.  The pain from losses do not increase linearly with amount paid but the pain is felt every time customers have to pay.

Take the case of airline unbundled pricing, specifically the baggage fees. Profit from baggage fee is nothing to be sneezed at. For someone who travels a few times a year and checks-in bags, it is painful each time they pay for bags and leads to brand erosion. United has come up with an innovative way to reduce this pain by reducing number of payments – they now offer an yearly subscription for baggage check-ins for $249.

Forget about first and second bag fees for an entire year. With Premier Baggage, you and up to eight companions can check up to two standard bags each without fees, where applicable, every time you travel in the United States

Premier Baggage also makes a great gift for a frequent traveler.

This is a great pricing plan in many ways:

  1. It addresses the multiple pain instances by reducing payments.
  2. It captures value upfront.
  3. Someone buying this subscription is going to prefer the same airline for the entire year even though they should not (because after they paid the fee it is sunk and they should compare the cost of available options for each trip).
  4. The best possible case for United is people buying it not using it.
  5. The worst possible case is a group of eight companions checking in two bags even once. But in that case they are generating so much revenue from the tickets that it more than makes up for lost baggage fees.
  6. They have a good chance of getting businesses to buy it for their employees or gifting to their clients/customers.
  7. To United there is really no cost, all of this is profit. The only cost is the opportunity cost of lost baggage fee from high volume and or frequent users but that is made up and more from ticket sales.

Now if only they can turn profit from the rest of the operations.