Mental Accounting

Consumer Behavior
Dan Bartels

Reluctance to Close
Accounts at a Loss: Your Data
As the president of an airline company, you have invested $120
million of the companys money into a research project. The
purpose was to build a plane that would not be detected by
conventional radar. When the project is 97% completed, another
firm begins marketing a plane that cannot be detected by
radar. Also, it is apparent that their plane is much faster and more
economical than the plane your company is building. The
question is: Should you invest the last 3 percent of research funds
to finish your plane?

NoIt makes no sense to continue spending money on the

project
YesAs long as the $120 million is already invested, I
might as well finish the project

Your data: The Breakeven Effect

Choose between:
A. A sure loss of $20
B. A 33% chance of losing nothing and a
67% chance of losing $30

You have just lost $30. Choose between:

A. A sure gain of $10
B. A 33% chance to win $30 and a 67%
chance to win nothing

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 Your data: The House Money Effect
Choose between:
A. A sure gain of $30
B. A 50% chance to win $21 and a 50%
chance to win $39

You have just won $30. Choose between:

A. No gamble; no further gain or loss
B. A 50% chance to gain $9 and a 50%
chance to lose $9

Opening and Closing

Mental Accounts
History matters
Previous losses can lead to:
Throwing good money after bad (sunk costs)
People taking on risks they otherwise wouldnt
(breakeven effect)

Previous gains can lead to:

Increased risk-taking (house money effect)
Increased spending/decreased saving (windfalls, funny
money)

Pricing: Whats your cable bill?

How do you think about it?
How often do you pay?
How much do you pay?
How about movies?
How about music?

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 Choosing a price structure
Decisions:
Should prices be bundled or separate?
Timing: Frequency, before or after usage
Relationship to Usage: flat fee or metered
Issues to consider
Cost structure (Fixed vs. Variable)
Payment risk (Collectibles)
Demand balancing
Consumer psychology

Transactions across types of spending

Homo economicus big, fat utility vat
All income streams and costs, current and future, are
integrated into one unified whole
Allocation, at the margin, is optimal

Homo sapiens consideration of situations in

isolation
Accounts are myopic and narrow,
Include things that are similar and/or related

How does mental accounting relate to normal

accounting?

Hedonic Editing:
What do People Want?
Value Function:
If x > 0 then V(x) = x
If x < 0 then V(x) = x

What is seen as a better deal?

Ten $9.59 payments, made
weekly
A one-time $100 payment

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 Hedonic Editing:
Four Combination Rules
Integrate Losses
Loss function is convex

Segregate Gains
Gains are concave

Integrate smaller losses with

larger gains
Segregate small gains from
larger losses

Tactic 1: The Silver Lining Principle

Generate, mix in a small positive outcome

Even if you have to raise the price to do it

Insurance:
Deductibles vs. Rebates
You have just bought a $32,000 car and need insurance...

The policy has a deductible of $600 which will be

subtracted from the total claims against the policy during
the year... Would you pay $1000 for one year of
coverage?

With this policy, a rebate of $600 minus any claims paid

will be given to you at the end of the year...Would you
pay $1600 for one year of this coverage?

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 Why might this work?
The concreteness principle
People tend to represent the transaction in the
way it is presented

People have difficulty spontaneously reframing,

but when they do, they lump similar things
together.

Tactic 2: Integrate Losses

Dont present a price in its parts

Particularly if the price is to buy an added

feature

Tactic 3: Decoupling Payment

from Consumption
Make it hard to connect payment with
consumption, e.g., Club Med
Most things are price inclusive (all-you-can-eat)
Introduce another currency (beads for drinks)

Flat rates
Imagine a health club where one had to pay per
step on a Stairmaster!

Credit Cards: The great decoupler

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 Tactic 4: Pennies a Day Framing
Why do so many charities and marketers
frame payments this way?
What are some reasons why people dont do
lasik?
Small transactions are not booked
We dont pay as much attention to our purchases of
contact lens fluid

Small amounts bring about comparisons to small

purchases
Why does $0.27 a day for NPR seem so good?
Compare it to $100 a year

Instant CaseOnline Music

iTunes Napster
$.99 a song All you can eat, while
Lifetime ownership on net.
(transfer to 3 devices) $12.95 month.

Cost Structure (WSJ: 3/23/04) .55 for licensing, .15 for infrastructure,
and something for credit card charges.

Tactic 5: Price Partitioning

Adding small surcharges can raise profitability
Ticketmaster surcharge
Buyers premium in auctions
Shipping and handling
Tips for large parties
Baggage fees

Note:
This goes against straight hedonic editing
Works best when seen as a cost of doing business:
energy surcharge vs. excess demand charge

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 Tactic 6: Shrouded Payments
Not just mental
accounting, but making
some costs hidden

Example: Free Checking,

but
$30 for bounced check
$15 for a checkbook
$2 penalty for each check
>5

Other Examples
Hotels:
Taxes, long distance phone fees, parking, minibar,
aspirin from gift shop, room service
Rental car companies:
Insurance and gas refill charges
Mutual funds:
Management fees (most do not know them)
Printers:
Operating costs (only 3% of consumers know
them)

Why does all of this work?

Two kinds of consumers:
Nave: Dont know it or care
Sophisticated: Do know it and care
Intuition: Sophisticated firms offer these
packages
Sophisticated consumers may exploit the firms
Nave consumers are exploited by the firms (and by
sophisticated consumers)
Implication:
It does not pay for firms to educate consumers.

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 Wrap-up
Principles of hedonic editing
Concreteness: People take the transaction as
given
Several applications:
Silver Lining, Integrate Losses, Decoupling,
Pennies a day, Price Partitioning, Price Shrouding

Notice all have limits: Boundaries

Things to remember
History of investment of effort, money matters
People want to break even, honor sunk costs, and
blow funny money

And so does the way in which benefits, and

especially costs, are framed for the consumer
Mixing in a little gain can make a big loss seem better
Decoupling and subjectively shrinking costs (in
various ways) can soothe the sting