Free to Fee – Kraft Charging For Its Magazine

Kraft Foods has a magazine called  Food & Family that is basically a recipe book that pushes brands owned by Kraft in all its recipes. The print version of the magazine, published quarterly, used to be free to its subscribers. Not anymore.Kraft decided to charge its subscribers $13.98 for an year. Not all customers are amused. The reader comments in discussion boards hosted at KraftFoods.com ask why Kraft is charging for what is a book of advertisements for its brands. Here is one example:

How can you charge for what is nothing more than an advertisement for Kraft products? As a free magazine, I liked looking at the ideas for using your products in the recipes, but upon receipt of my issue today including the invoice, I promptly tore the invoice in half and threw it in the trash. I don’t know how the idea of paying for a bound advertisement for Kraft came to be, but I will not be doing so.

I have written about Kraft’s effective price management before. I like their current decision to charge for their magazine. I believe they would not have decided to charge for this without the required analysis. I can think there is data that shows pricing for this magazine delivers them incremental profit over the free offering. Here are my reasons:

  1. Cost: Kraft wants to move to move their customers from print version to digital version. This is clear in their messaging and from the bulletin board discussions. Moving customers to digital version does result in savings. While one way is to incent customers to switch to digital version charging for print has its advantages. They are applying prospect theory (like some mobile phone providers did for paperless statements) to nudge customers to move to digital version.
  2. Analytics:  With print magazine it is difficult to track to the impact of Ads and promotions on sales unless they use coupons. There is better traceability and ability to run targeted Ads with digital version. This improves their model of customer margins and make better predictions about profitability.
  3. Sharing in value: If the print magazine adds value to customers and if there exists customer segments that only wants to receive the print version then Kraft should get their fair share of the value added. For example, here is one customer comment:

    This is such a beautiful, and well done magazine. I just love it, and this time was almost better than ever, if possible, with the wonderful calendar included. I was as thrilled as a kid in a toy shop. Thank you Kraft!!! :) We all just pour over it reading and rereading it and looking at the lovely presentations, each of us deciding on what to make first, and there are so many good recipes in it.

The net is I think Kraft’s decision to charge for their magazine makes very good business sense.

Prospect Theory in Paperless Billing

Businesses want their customers to switch to paperless statement for multiple reasons. The chief among them is that it costs them tp print and mail the bill and there are green reasons. They tried incentives to get their customers to switch to online billing. Some sent coupons or cash discounts. Yet none of these worked as well as T-Mobile’s plan to charge its customers $1.50 to receive paper statements. The New York Times reports,

The new fee immediately produced an explosive increase in the rate at which customers converted to paperless billing. Before the August bills were mailed out, T-Mobile had an average of a little more than 1,000 customers sign up for paperless billing each day.

When the $1.50 fee was added to the bills that went out in August, the number jumped to 33,000 a day, according to a spokesman. This was even before the charge really bit: for August, T-Mobile also added a matching $1.50 credit to every bill for the initial month, to give customers more time to decide whether to opt for paperless.

Why did the customers who willingly give up gains in the first case? Why did they switch when hit with a fee? This is because we all perceive gains and losses differently. According to   Kahneman and Tversky, the intensity of positive feeling from the gain is not as high as that from losing $1.50. Hence the big jump in the number of customer who switched to paperless billing.

Is there a fairness issue here? If receiving paper statements adds value to customers then it is appropriate for T-Mobile to get a fair share of that value. One more thing, USPS should increase its charges for these paper statements as well, after all if businesses get value from mailing these paper statements, USPS should get its fair share for providing this service.

Relative Price

I was at Best Buy stores the other day and was looking at their cables. I was surprised to see HDMI cables being sold for $40-$80. Even a simple DVI to HDMI converter, which is useless without a cable, was priced at $30.  The same cables  from non-name brands are priced at fraction of the price online. In fact a quick search in the Internet shows stories since 2006 taking about  alleged “price gouging.

I do not believe price gouging exists in a free market where customers have options and are allowed to make their own choice.  But what explains the high price of these cables? It is the price  flat screen TVs.

The first reason is the relative price that is rooted in behavioral economics. To a consumer buying this TV (or having bought one), compared to the price the pay or TVs, the price of cables look cheap. Consumers tend to think of price they pay in terms of percentages and not absolutes. This is the relative price. For a crisper description see this.  $40 is a small percentage of $1000.

The second reason is the increase in reference price, which is the price a customer expects to pay based on their past experience. Having just paid $1000, customers are anchored to this price and are willing to pay $40-$80 on cables for these TVs.

Conveniently,  Best Buy only stocks cables $40 or more taking advantage of these factors at work. However, Amazon.com stocks cables of every possible price. In fact for the TVs Amazon says, “customers also bought $6 HDMI cables”. Here even though customers might be willing to pay high price for cables, the presence of cheaper options decreases  their reference price.

If you are a marketer, it is obvious what you should do with pricing. Price your complements as a percentage of the price of the primary component. Due to relative price and reference price effects, your customers will not mind paying high price for the complements.

If you are a buyer, be aware of relative price effects. The price you pay for accessories and complements should be looked at in isolation and not relative to the price of the primary component. In a consumer setup this can be handled by separating the two purchases in time. In a B2B set up, it can handled by having separate purchasing managers responsible for the primary component and secondary parts purchases.

Slow decline of Home Prices

Shiller (of Case -Shiller index) wrote in The New York Times about why home prices fall slowly instead of crashing and why the prices may continue to fall. This is a great explanation of the averages and the reasons for slow decline. Two questions occur to me:

  1. Why does a homeowner start with a very high list price even though the market price (based on comparable homes) is lower?
  2. Why are homeowners willing to let go an offer only to settle later for the same or lower price?

The reason for the high list price can be attributed to endowment effect. People tend to value things they own more than the things they do not. This is nicely demonstrated in a video by Dan Ariely. There is considerable emotional connections that get translated into higher utility and hence a higher valuation. In addition to this people do not consider opportunity cost of carrying the home for longer time. This results in initial high priced listing despite the fact that comparable houses in the neighborhood have been in the market for a much longer time and are currently priced lower than this house. Unfortunately buyers do not share the same emotional value hence houses end up sitting in the market longer.

The reason for rejecting reasonable offers during the initial days only to settle for same or lower price later is due to mental accounting that ignores the opportunity cost of carrying the home longer. Opportunity cost here includes additional mortgage payments, carrying costs and most importantly lost revenue from capital tied up in the house. Even if they considered opportunity costs, homeowners overestimate the chances of getting better offer and underestimate the time they need to wait for such an offer. Due to  high initial price, a low offer will also look substantially lower.

The net result is prices not reflecting what the market is willing to pay. Hence the slow decline of home prices.

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.

Do you pick free shipping or pay for it at Amazon.com?

In his book Predictably Irrational, Dan Ariely talks about how we treat money as percentages instead of absolutes. For example,

You can buy a nice pen for $25 at a store you are in. Then you remember (or are told) the exact same pen can be had for $18 at another store that is a 15-minute walk away. Most people will take the walk. But if someone is about to buy a suit for $455 and finds out he can get the exact same thing for $448 by walking to another store 15 minutes distant, he will not, if he is like most people, bother to walk there.

The explanation for this comes from Prospect Theory, the decision context (and framing)  our decision making, even though  the absolute result is the same and context and framing are irrelevant according to rational expected utility theory.

The same goes when picking shipping option for Amazon.  The claim is that all thing being equal,  those who generally prefer the free shipping option for small purchases ($25-$70) will pick the paid option for larger purchases (>$80).  I do not have statistically significant data to verify but from the few informal queries I did with my colleagues it appears to be the case.

Next time you order something big from Amazon.com, (all things being equal and you are not in hurry to get your hands on the item) see what shipping option you check. When buying something for $100, the $4 additional shipping does not look much, whereas it  does when you order for $25.