People often make irrational decisions when money is involved. They’ll go out of their way to save 25 cents, say by driving around and around looking for a parking meter with time remaining, yet immediately after blow that much and more without a thought ($4.50 for a latte, anyone?).
Dan Ariely explores such irrational behavior in his book Predictably Irrational. Ariely is a business school professor at MIT, and much of the book describes simple yet ingenious experiments he’s conducted that demonstrate over and over again the consistently illogical behavior of people when making choices. This field of research, known as behavioral economics, stems from the ground-breaking research of Daniel Kahneman and Amos Tversky’s that won Kahneman the Nobel Prize in economics (I’ve been citing Kahneman for years in my talks on cognitive attention and effort, but it seems that every week for the past year I’ve read Kahneman’s name referenced in a different news story, book, or magazine article. Behavioral economics seems to be the hot topic these days). Ariely’s experiments demonstrate the fascinating ways in which people repeatably make decisions that appear to be contrary to common sense.
Ariely details, for example, the powerful allure of something being free. People’s choices change dramatically when items change from being effectively free (costing one cent, for example) to being actually free (costing zero cents). For example, he tells how Amazon’s customers bought more books on average once Amazon started shipping for free on purchases greater than $25—the increase in customer spending far exceeded the amount that they were saving on the free shipping, but they gladly spent more on books to get shipping for free. More puzzlingly, Amazon saw this behavior exhibited worldwide except in France. Was this because the French were more logical in their purchasing behavior? No. The country manager in France decided not to make shipping free but to reduce it to one franc, or 20 cents, which wasn’t a small enough shipping amount to change people’s purchasing behavior. Is 20 cents really a significant amount when buying a $20 book? No. Is a shipping cost of 20 cents effectively the same as 0 cents? For most people,yes. But when the manager in France reduced Amazon’s shipping charge from 20 cents to Free, French customers suddenly increased the amount of books they purchased per order by the same amount as the rest of the world.
The reason that I am writing about Predictably Irrational is to contest an explanation that Ariely gives for his first example, and one of the most interesting, of irrational behavior. In the example, Ariely describes an offer that I’ve seen before but never understood, which made me even more interested in his explanation (and my alternative one).
Ariely noted an ad in the Economist magazine that offered three different types of subscriptions:
- an electronic subscription for $59;
- a print subscription for $125;
- a print and electronic subscription for $125.
That’s right, the price for a print-only subscription was the same as the price for a print&electronic subscription. Why would they bother offering the print-only option when it was clear that no one would select it because they could get both the print&electronic versions for the same price? Being the good researcher that he is, Ariely decided to run some experiments to determine if there was a reason why the Economist made this offer (Ariely’s ability to set up simple experiments to provide insight into unusual behavior is fascinating).
Ariely asked two different groups of students to make a selection among a choice of Economist subscriptions, but each group were given a different list of options. One group was given the same three selections that the Economist offered. The percentage of students who selected each option was as follows:
- electronic: 16%
- print: 0%
- print&electronic: 84%
No one chose the print-only option (not surprisingly). This begs the question of why one would offer that option at all (the same question that motivated this experiment).
For the second group, the unchosen print-only option was removed and only the electronic subscription and print&electronic subscription were offered (still priced at $59 and $125, respectively). One might expect results similar to those from the previous group (16% for electronic and 84% for print&electronic) since there wasn’t any interest in the print-only option that was removed. The results for this second group were as follows:
- electronic: 68%
- print & electronic: 32%
Without print-only as an option, the number of people interested in the print&electronic option dropped from 84% to 32%! In other words, by offering an option that no one wanted, 52% of the people changed their preference from electronic-only to print&electronic at a $66 higher cost. What’s going on here?
Ariely’s explanation was that people need a basis for comparison when evaluating whether a deal is a good one or not, and from this comparison they make their decisions. With a similar item for comparison, they can assess the value of an item and determine whether that item is a good or bad deal. He gives a couple fascinating examples where the choices that people make are biased by the presence of a similar and inferior alternative. If people are choosing between A and B, they will choose A more often if there exists a third alternative similar to but inferior to A, and they will choose B more often if there exists a third alternative similar to but inferior to B. Having that third alternative allows people to say to themselves, “I can’t judge whether A or B is a better choice, but I know that A is better than this similar third alternative, so A must be a good deal.”
Ariely suggests that this is why the selection for print&electronic is high when print-only is offered for the same price—the print-only option gives people an alternative from they determine that print&electronics is a better deal, and that drives their choice.
I believe, however, that there’s another possibility for these results: people are more likely to select the print&electronic option in the presence of a print-only option because of the Free phenomenon. Let me explain.
Ariely’s explanation is partly correct: in the absence of knowing the cost of the print-only subscription, people cannot judge whether the combined subscription is a good deal or not. Maybe print-only was $66, and the cost of print&electronic was simply the sum of the costs of the individual subscriptions ($59+$66=$125). Or maybe print-only was $100 and getting the combined subscription would save $34. Or maybe print-only was also $50 and $125 for print&electronic was a rip-off. No one can tell whether both together is a good deal in the absence of a print-only option—in that, Ariely is correct.
The fact that the print-only and print&electronic options are priced the same, however, suggests another explanation for the large difference in behavior between whether or not the print-only option is offered. Ariely made the convincing case later in his book that getting something for free can have a hypnotizing allure on people’s decisions. Providing a print-only option at less than $125 probably would not be enough to drive such a large percentage of people to change their selection from print-only to the more expensive print&electronic option—the print-only option had to be priced at exactly same same price as print&electronics so that the electronics version was free if they chose both. It was the identification of something free that made such a large percentage of people select the print&electronic option. This is similar to the phenomenon observed by Amazon: 20–cent delivery didn’t change behavior but free delivery did. Given the convincing case that Ariely made for this free effect, one would probably have predicted that people would switch their decision from the electronic-only option to the print&electronic option when they discovered that the latter choice would get them the electronic version for free.
So, now you know why so many ads offer free cheap items if you purchase an expensive product A free month of HBO if I get the Lifetime Triple Gold package of cable—sign me up!