Priceless

The Hidden Psychology of Value

William Poundstone

• Publisher: Oneworld Publications
• Year: 2011
• ISBN:
  9781780740331
• Topic: Commerce
• Subtopic: Comportement du consommateur

The first book to reveal how everday pricing strategies manipulate us Why do text messages cost money while emails are free? Why do cereal packets keep getting smaller? Why do department stores have a few extortionate goods that no one will buy? Why do so many prices end in 9? In Priceless, bestselling author William Poundstone reveals the hidden psychology of value and explores how we react to the most pervasive persuader of all: price. Charting the burgeoning growth of price-consultants who advise retailers from Nike to Nokia, Poundstone shows how behavioural decision theory has revolutionised the pricing strategies of major corporations.
Informed by fascinating behavioural experiments and packed with real-life examples, Priceless explains why prices are so important, and the tricks that companies use to sell their goods. It will prove indispensable to
anyone who buys, sells, or negotiates.

Part One

“The more you ask for, the more you get”

One

The $2.9 Million Cup of Coffee

In 1994 a jury in Albuquerque in the U.S.A. awarded Stella Liebeck $2.9 million in damages after she spilled a piping-hot cup of McDonald’s coffee on herself. This resulted in third-degree burns and precious little sympathy from the American public. Late-night comedians and drive-time DJs turned Liebeck into a punch line. Talk radio pundits saw the lawsuit as Exhibit A to What’s Wrong with Our Legal System. A Seinfeld episode had Kramer suing over spilled coffee, and a website inaugurated the “Stella Awards”—booby prizes for the wackiest perversions of the justice system.

Liebeck’s injuries were no joke. Her grandson had driven her to the McDonald’s drive-through window. They bought the coffee, then pulled over and stopped the car so that Mrs. Liebeck could add milk and sugar. She steadied the cup between her legs as she pried off the lid. That’s when it spilled. Liebeck racked up $11,000 in medical bills for skin grafts on her groin, buttocks, and thighs. The tricky question was, how do you put a price on Liebeck’s suffering and McDonald’s culpability?

Liebeck initially asked the fast-food chain for $20,000. McDonald’s dismissed that figure and countered with a buzz-off offer of $800.

Liebeck’s lawyer, New Orleans–born S. Reed Morgan, had been down this road before. In 1986 he sued McDonald’s on behalf of a woman from Houston, Texas, who also had third-degree burns from spilt coffee. In his most mesmerizing Deep South baritone, Morgan advanced the legally ingenious theory that McDonald’s coffee was ‘defective’ because it was too hot. McDonald’s quality control people said the coffee should be served at 180 to 190 degrees Fahrenheit, and this was shown to be hotter than some other chains’ coffee. The Houston case was settled for $27,500.

Morgan monitored subsequent coffee lawsuits closely. He knew that in 1990 a California woman had suffered third-degree burns from McDonald’s coffee and settled, with no great fanfare, for $230,000. There was one big difference. In the California case, it was a McDonald’s employee who had spilled coffee on the woman.

Since Liebeck had spilled the coffee on herself, logic would say that her case was worth a lot less than $230,000. Morgan ignored that precedent and used a controversial psychological technique on the jury. I will describe that in a moment. For the time being, I will represent it with a row of dollar signs:

$ $ $ $ $ $ $ $ $ $ $ $

The technique worked. As if hypnotized, the jury awarded Liebeck just under $2.9 million. That was $160,000 in compensatory damages plus $2.7 million in punitive damages. It took the jury four hours to decide. Reportedly, some jurors wanted to award as much as $9.6 million, and the others had to talk them down.

Judge Robert Scott apparently thought the jury award was as outlandish as almost the entire general public did. He slashed the punitive damages to $480,000.

Even with the reduced award, an appeal from McDonald’s was inevitable. The eighty-one-year-old Liebeck wasn’t getting any younger. She soon settled with McDonald’s for an undisclosed amount said to be less than $600,000. She must have recognised that she had hit a home run and wasn’t likely to repeat it.

Skippy peanut butter recently redesigned its plastic jar. “The jar used to have a smooth bottom,” explained Frank Luby, a price consultant with Simon-Kucher & Partners in Cambridge, Massachusetts. ‘It now has an indentation, which takes a couple of ounces of peanut butter out of the product.’ The old jar contained 18 ounces; the new one has 16.3. The reason, of course, is so that Skippy can charge the same price.

That dimple at the bottom of the peanut butter jar has much to do with a new theory of pricing, one known in the psychology literature as coherent arbitrariness. This says that consumers really don’t know what anything should cost. They wander the supermarket aisles in a half-conscious daze, judging prices from cues, helpful and otherwise. Coherent arbitrariness is above all a theory of relativity. Buyers are mainly sensitive to relative differences, not absolute prices. The new Skippy jar essentially amounts to a 10 per cent increase in the price of peanut butter. Had they just raised the price 10 per cent (to $3.39, say), shoppers would have noticed and some would have changed brands. According to the theory, the same shopper would be perfectly happy to pay $3.39 for Skippy, just as long as she doesn’t know there’s been an increase.

Luby holds a physics degree from the University of Chicago, U.S.A. In his job as price consultant, he more often thinks like a magician. Like a skillful conjurer, he is asked to manage what buyers notice and remember. Skippy peanut butter’s customers often have small children and purchase it so regularly that they remember the last price they paid. For such products, consultants recommend creative ways of ‘invisibly’ shrinking packages. In summer 2008 Kellogg’s phased in thinner boxes of Cocoa Krispies, Froot Loops, Corn Pops, Apple Jacks, and Honey Smacks cereals. No one noticed. Shoppers just see the box’s width and height on the shelf; by the time they reach for the box, the decision has been made and they’re thinking of something else.

Dial and Zest recently changed the sculptural contours of their bars, shaving half an ounce off the weight. The boxes stayed about the same. Quilted Northern made its Ultra Plush toilet paper half an inch narrower. The makers of Puffs tissues shrank the length of their product from 8.6 to 8.4 inches. As the Puffs box remained the same (9.5 inches wide), there is presently over an inch of air hidden inside. You can’t see it because the opening is in the middle. In any case, a shopper wouldn’t notice the shrinkage unless she archived old Puffs tissues and measured them.

This ruse can go on only so long. Cereal boxes would collapse to cardboard envelopes; jars would become plastic voids. Eventually there arrives a point at which the manufacturer must make a bold move everyone will notice. It introduces a new, economy-size package. In size, shape, or other design features, the new package (and its price) is difficult to compare to the old. The consumer is flummoxed, unable to tell whether the new package is a good deal or not. So she tosses it into the cart. The cycle of shrinking packages repeats, ad infinitum.

If you find this a silly charade, you’re not alone. Just about everyone does, when they think about it. Many grumble they’d rather pay an inflation-adjusted price for the quantities they’ve known. Others swear they look at the market’s comparison labels, giving price per gram, and wouldn’t be fooled. One of the things that price consultants have learned is that what consumers say and what they do are not the same thing. For the most part, memories of prices are short, and memories of boxes and packages shorter.

It wasn’t so long ago that companies priced their products with no strategy beyond the demand curves of Economics 101. In the past generation, firms such as Boston Consulting, Roland Berger, Revionics, and Atenga have prospered by advising businesses on the surprisingly complex psychology of price. No firm has spearheaded the professionalisation of pricing more than Simon-Kucher & Partners (SKP). German business professor Hermann Simon and two of his doctoral students founded the firm in Bonn in 1985. SKP is now nearing five hundred employees stationed all over the globe, with US offices in Cambridge, New York, and San Francisco. With sixty PhDs among its employees, quite a few in physics, SKP has a reputation as the rocket scientists of pricing. The firm exudes a Star Trek cosmopolitanism. Employees from India, Korea, Germany, Switzerland, and Spain mingle in the Cambridge office, and it’s the practice to rotate promising consultants among nations. Each year SKP assembles its far-flung employees for a party at a castle on the Rhine.

The influence of SKP on the prices we pay for just about everything is as little recognised as it is staggering. Rules that apply to other types of consultancies don’t apply to pricing. An ad agency would not have Coca-Cola and Pepsi as clients—but SKP does. In many industries, SKP advises half a dozen of the leading firms. Its current roster of clients includes Procter & Gamble, Nestlé, Microsoft, Intel, Texas Instruments, T-Mobile, Vodaphone, Nokia, Sony Ericsson, Honeywell, Thyssen-Krupp, Warner Music, Bertelsmann, Merck, Bayer, Johnson & Johnson, UBS, Barclays, HSBC, Goldman Sachs, Dow Jones, Hilton, British Airways, Lufthansa, Emirates Airlines, BMW, Mercedes, Volkswagen, Toyota, General Motors, Volvo, Caterpillar, Adidas, and the Toronto Blue Jays. The same psychological tricks apply whether you’re setting a price for text messages or toilet paper or plane tickets. To SKP’s consultants, prices are the most pervasive of hidden persuaders.

Though a price is just a number, it can evoke a complex set of emotions—something now visible in brain scans. Depending on the context, the same price may be perceived as a bargain or a rip-off; or it may not matter at all. A few of the tricks are timeless, like shrinking packages and prices ending in the magic number 9. But price consultancy is more than the latest chapter in flat-world peddling. It draws on some of the most important and innovative recent work in psychology. In the mundane act of naming a price, we translate the desires of our hearts into the public language of numbers. That turns out to be a surprisingly tricky process.

Two

Price Cluelessness

Imagine you are asked to lift a suitcase and guess its weight. How accurate would your guess be? Not very, most would admit. The arm muscles and brain and eye just aren’t wired to gauge pounds or kilograms. That’s why supermarkets have scales and carnival weight-guessers draw slackjawed crowds.

Now imagine that the suitcase is lost luggage being auctioned. The lock is picked, and the suitcase is shown to contain some holiday clothes, a high-end camera, and other lightly used merchandise. Your task now is to guess the winning bid—the market value of the suitcase and its contents. How accurate do you think this guess would be? Would it be any better than your guess about weight?

Auctions can be unpredictable. Okay, I’ll make it easy for you. Pretend you’re a bidder in the auction. All you have to do is decide your top bid. You’re not guessing what other people will do; you’re just expressing how much the suitcase is worth to you, in pounds and pence. How exact would that valuation be? It’s not the easiest thing to attach a price to something with no clear market value. You may end up wondering whether your top price is any more sharply defined than the other two guesses.

One of the running themes of price psychology is that judgements of monetary value have much in common with sensory judgements like weight—or brightness, loudness, warmth, coldness, or intensity of odours. The study of sensory perceptions is known as psychophysics. Back in the 1800s, psychophysicists determined that people are acutely sensitive to differences and not so sensitive to absolute values. Given two identical-looking suitcases, one weighing 15 kilos and one 18 kilos, it’s a cinch to tell which is the heavier by lifting. But without a scale, it’s hard to be certain whether either suitcase would meet an airline’s 27-kilo limit.

People display a similar cluelessness about prices. This all-important fact goes largely unrecognised. That’s because we live our lives in a media cloud of advertised prices and market values. Because we remember what things are ‘supposed to’ cost, we can adopt the pretense of having an unerring sense of value. Consumers are like a sight-impaired person who can navigate familiar surroundings because he has memorised where the furniture is. This is compensation, not keenness of vision.

Every now and then we get a hint of how myopic the price sense is. Anyone who’s held a car boot sale knows how difficult it can be to put meaningful prices on household castoffs. ‘This old Tribe Called Quest CD should be worth twice as much as that Alanis Morissette—I’m sure of that. I’m not so sure whether Tribe should be selling for £10 or 10 pence.’

In a 2003 paper, economists Dan Ariely, George Loewenstein, and Drazen Prelec termed this curious mix of conviction and uncertainty coherent arbitrariness. Relative valuations are stable and coherent, while actual currency amounts can be wildly arbitrary. Car boot sales reveal a truth we might not care to admit in a business deal: prices are made-up numbers that don’t always carry much conviction.

This book tells the story of a simple finding with far-reaching consequences. The numbers that make our world go around are not so solid, immutable, and logically grounded as they appear. In the new psychology of price, values are slippery and contingent, as fluid as the reflections in a fun-house mirror.

This challenges the credo that ‘everyone has a price,’ something ingrained in business sense and common sense alike. Terry Southern’s 1959 novel, The Magic Christian, expands on that bit of folk wisdom. Billionaire antihero Guy Grand is a prankster who devotes his life to proving that every man and woman has a price. In a typical caper, Grand buys an office building in Chicago just to tear it down and replace it with a boiling vat of manure, blood, and urine from the stockyards. Simmering in the hellish muck is $1 million in hundred-dollar bills. A sign on the vat announces FREE $ HERE. Grand’s doctrine is that there is nothing so degrading that someone won’t do it for a sufficiently large pile of cash. The Magic Christian permits the reader no scope for feeling superior. We may not all be money-grubbing materialists, but it is difficult for anyone in our society not to believe in the weirdly transcendent power of money.

The ‘everyone has a price’ theory holds that valuations are stable and can be revealed by a little wheeling and dealing. When offered a bargain (Faustian or otherwise), I compare it with an internal price and decide whether to accept it. It is not too much of an exaggeration to say that all of traditional economic theory is founded on this simple Guy Grand premise: everyone’s got a price, and those prices determine actions.

There’s now overwhelming evidence that this idea is wrong, at least as a model of how real people act. As far back as the late 1960s, psychologists Sarah Lichtenstein and Paul Slovic demonstrated the deep ambiguity of prices. In their experiments, subjects were unable to set prices consistent with what they wanted or the choices they made. Psychologists have been working out the consequences ever since. In the new view, internal prices are ‘constructed’ as needed from hints in the environment. One demonstration of how that works is the ‘United Nations’ experiment of Amos Tversky and Daniel Kahneman.

Tversky and Kahneman are a legendary team of Israeli American psychologists. Kahneman, now in his mid-seventies, is a very active senior scholar at the Woodrow Wilson School at Princeton University, U.S.A. Tversky, the younger man by three years, died of melanoma in 1996, at the age of fifty-nine. In 2002, Kahneman shared the Nobel Prize in Economic Sciences with American economist Vernon Smith. Tversky was cheated of that honor only by his early death.

Kahneman and Tversky’s primary field was a still-young branch of psychology called behavioral decision theory. This is the study of how people make decisions. At first encounter, that topic may sound worthy and slightly dull. In fact, it spans the human comedy and tragedy. Life is all about deciding.

The word ‘behavioral’ emphasises that this is an empirical science, studying how flesh-and-blood people act rather than prescribing how they ought to act. Behavioral decision theory is still a small field, much like an extended family. In interviewing some of its most distinguished fi...