Predictably Irrational

February 17th, 2015

Predictably Irrational by Dan Ariely front cover

Humans don't make choices in absolute terms. Everything is relative. We know something is cheap because its price is lower relative to that of something similar. But what sets the initial price that’s the basis for the comparison? According to Dan Ariely, Professor of Psychology and Behavioral Economics at Duke University and author of this book, that’s entirely arbitrary, but once a price has been established, it will act as a baseline for what we are willing to pay, both for that item and for related products.

Using prices of existing products as anchors when introducing new products, marketers make it easier for us to compare their products, but also make us easier to manipulate. One such manipulation is decoys, which we're not supposed to select but which are there to steer us towards another alternative. Ariely uses the example of a real estate agent taking a buyer to see three houses: one contemporary and two colonials, one of which is in fine condition and one with a bad roof. Had the buyer been shown only the contemporary and the colonial in fine condition, they may have been torn because it’s a difficult comparison between two contrasting styles. By introducing the colonial with the bad roof, a home that is similar to one of the others but in an obviously inferior condition, the buyer believes that the colonial home in fine condition is not only a better choice than the one with a bad roof, but also superior to the contemporary home.

Companies will sometimes frame their relationship with us as a social one. Ariely mentions Home Depot’s then-slogan "You Can Do It. We Can Help," presumably chosen to instill in customers the notion that their relationship with the company is one of social norms. This illusion of a familial relationship between a company and its customer is shattered when the customer fails to pay a bill on time. The company immediately reverts to market norms, slapping on late fees and sky-high interest rates instead of giving the customer the courtesy of a friendly reminder over the phone.

And once the social norms under which the relationship was ostensibly established have been broken, it’s very hard to reestablish.

The difference between social and market norms also apply to personal relationships. When a friend offers you money to help move their couch, the task switches from the social norm (doing it for the pleasure of helping out) to market norms. It’s interesting that we’ll work our asses off for free, but as soon as money is introduced to the equation, we expect to be compensated appropriately and won’t settle for scraps.

There's a huge difference between free and nearly free. Ariely’s experiment with cheap Hershey’s Kisses vs. more expensive Lindt truffle chocolates shows that, given the choice between two competing non-free products, we apply a rational cost-benefit analysis to determine which of the two we prefer. But lower the price of both products by the price of the cheapest product, and all rationality goes out the window. Now, even though we’ve effectively maintained the price difference between the products, the fact that one is now free makes the vast majority of us gravitate towards that product. As a game geveloper, I see a similar phenomenon that applies to the Apple App Store, where customers’ appetite for free software has put at a disadvantage any developer not willing to give his app away for free.

Ariely argues that when opting for a free item, there's no visible possibility of loss, but I think the possibility need not be literally visible to be noticeable. Sure, the product could just be a loss leader designed to get customers through the door to buy other stuff, but I grow suspicious of free items, wondering why the company would give something away when they could be making money off it. Ariely himself later points out how we will instinctively assume a discounted item to be of lesser quality than a full-price item. He also contemplates whether the allure of zero applies to other things than price, such as zero-calorie soft drinks. In these cases I certainly contemplate what nefarious substances the company replaced sugar with to be able to boast such a claim.

Ariely proposes more regulation to protect consumers from their irrationalities, eg. in the form of a $100 deposit when making a doctor’s appointment, to be repaid only if the patient shows up on time, or a self-control credit card that sets hard limits on the amount we can spend on different types of goods and sends emails to our friends when we go over.

The dangers of putting a regulated ceiling on consumer spending is that it gives consumers the notion that it’s OK to keep brushing up against that ceiling, leaving no margin of error. Ariely does touch upon this later on when discussing the difference between what we should borrow and what we can borrow with regard to a mortgage:

...How people figure out their mortgage offers a general lesson in human decision making. When we can’t figure out the right answer to the question facing us, we often figure out the answer to a slightly different question, and apply this answer to the original problem. This is how a question about the optimal amount to borrow transforms itself into one about the largest amount that a bank is willing to lend. But these are not equivalent questions at all.

Imposing hard limits isn’t the way to go. Properly educating consumers is.