Deflation is in the minds of customers, just like Inflation

The New York Times story on Black Friday sales has this quote from a non-shopper,

At Westfield Century City Shopping Center in California, Harper Mance, 31, said: “I’m looking around, thinking, ‘If there are discounts on everything now, what’s it going to be like after Christmas?’ You know it’s going to go down further.”

Influencing Consumer Decision With Deliberate Versioning

Thanks to my friend Helen I learned about a lever for nudging consumer behavior  called  Asymmetric Dominance Effect also known as the Decoy Effect.

Joel Huber, a marketing professor at Duke, explanined this effect in a Washington Post article (via Wikipedia entry):

What the decoy effect basically shows is that when people cannot decide between two front-runners, they use the third candidate as a sort of measuring stick. If one front-runner looks much better than the third candidate, people gravitate toward that front-runner. Third candidates, in other words, can make a complicated decision feel simple.

In fact if you release two versions, 1 and 2,  of a product, it would help you to position these two in such a way that you capture market share in respective segments. In addition to these two versions, a marketer should introduce two more versions, 3 and 4,  each one unattractive by themselves but will make both version 1 and 2 attractive to the respective segments.

NYTimes Reports Increase in Online Shopping

Greg Manikw, the author of my favorite Macroeconomics book, writes in his blog a series on Cross-Price Elasticity of Demand.

The New York Times reports that shoppers are doing more online shopping than driving to the stores. While the demand for the products has not shifted to their substitutions, the channels through which people buy has.

Online shopping is gaining at a time when simply filling up a gas tank to head to the mall can seem like a spending spree.

A number of retailers — including Gap, Victoria’s Secret and J. C. Penney — are experiencing double-digit sales growth at their shopping Web sites, creating a surprising bright spot during an otherwise gloomy time for sales in brick-and-mortar stores.

Down the line this means drop in incentives to the employees who work in the shops and it is bound to cause shift in their consuming patterns.

If I can make predictions about other economic and consumer behavior changes we should expect in the future, these are in my short list:

1. People brown-bagging lunch
2. Product unbundling in restaurants. No more free bread, chips-salsa or worse no more free napkins or water.
3. 4 day work week, with 10 hours a day
4. US Mail stopping Saturday delivery
5. Newspapers adding a higher delivery surcharge, causing a shift to their online version.

Will you feel unhappy about picking up the whole tab?

Last week a big group of us went to eat at a Dim Sum place in the City. The group was so big that they had to sit us in two round tables, 10 in each. I did not understand how the Dim Sum pricing works. I admit, I consider price before ordering. But we never got to see a menu, there were Dim Sum carts coming by and they kept serving.  When it came time to pay, it was  $230 for the table.

The ritual of how to spit the check began awkwardly as people trying to figure out what they ate. But in a Dim Sum restaurant when everything was shared, and some of us were vegetarians and did not get to eat much, how would you decide who ate what? The easy decision was to split it. One of us suggested playing credit card roulette. Everyone drops their credit card in the middle and the waitress picks one and charges the full check to that card. We ended up splitting $23 per head. I bet everyone felt equally unhappy.

Dan Ariely, author of the must read book Predictably Irrational, had a piece on exactly this in MarketPlace. Dan's book Predictably Irrational is about consumer behavior and our personal decision making.  Dan recommends,

Findings from behavioral economics tell us that one person should pay the entire bill and that the person paying should alternate over time. When we pay any amount of money, we feel some psychological pain. We call this the pain of paying. This is the unpleasantness that is associated with forking over our hard earned cash. But it also turns out that this pain does not increase linearly with the cost of the meal.

 

 

 The extension of the non-linearity argument is, even when one pays in full they don't feel 10 times as bad as splitting the tab and the rest of the group are all happy. However this leads to a few questions on generality:

1. Is the "pain of paying", in this model, uniform for everybody when it is their turn to pay? 
2. Did the person who kick starts this feels more pain than the one who comes last?
3. Does she feel "more happy" than the rest of the cycle? 
4. Do people who already paid feel the pain when they see the next person's total tab is less than that during their period?
5. Do people whose turn is coming up start feeling the pain before it is their turn?

I am interested in finding answers to these questions. Generalizing from personal perspective, I would answer YES to all the above questions.

Early in my career, our office had the tradition of  having bagels on Fridays. There was a "Bagel Wheel" with employee names written on it. The wheel is passed around and the holder of the wheel is responsibile for buying all the bagels and cream cheese. Then he passed it to next one in random. It was my fourth week and I got the wheel. In a sixty member office I felt the "pain of paying". I sure did felt pain that was directly associated with the perceived unfairness of paying for 60 people when I had only 4 bagels. I did not look ahead to the future (to make matters worse, the very next week the Organization decided to pick up the weekly bagel tab).

 

Which scheme do I prefer? I recommend splitting the tab evenly. If you see everyone order a glass of wine, salad, or dessert go ahead and order it.  Your marginal cost is much less due to your extra and you end up enjoying the experience more.

Will the Oil Shock Lead to Unbundled Services?

When I was visiting Sweden I found it shocking that they charged me 4 Kroner for a 8oz glass of tap water. As I traveled a bit more in Europe I found this common practice of restaurants charging extra for things that in US we take for granted. Sitting at a table has a surcharge, bread has a surcharge, water too. I compare this to a sign that I saw outside a Hot Dog stand near UC Berkeley, "All toppings always free", this captures the characteristic of US restaurants.

These are not really free, restaurants here use bundled pricing. The problem with this bundling is some of the added items are valued below cost by the customers and hence the restaurants do not reap the advantages of bundling.

Now in US, as the food and fuel prices keep increasing, restaurants are finding it hard to keep their margins. All these free toppings and additions that are "always free" add to the cost with no relief through higher pricing. Until now they have not passed on much of the supplies cost increases to their customers in the form of higher prices. It is not that it is difficult to keep changing prices (economists call this the menu costs).

Restaurant owners are wary of customer reaction and competitor moves. There may also be lingering doubts on whether we are experiencing a temporary price shock or the higher prices are here to stay. If the businesses and the public are convinced that is is the latter, then the cost increases will flow into prices.

However, an acceptance of increased prices does not mean the demand will stay the same. There are substitutes, eating at home and packing lunch from home. So restaurants may still be reluctant to increase prices. That leads us to unbundled pricing. Should the US restaurants do costing right (do not price items below their cost)? Should they price the food items at its current levels and start charging for service, water, bread, toppings, paper napkins, plastic ware etc?

It is not clear to me.

Customers may not value some of the items included in the bundle but will consider these essential to support the main product they are buying. If customers do not value something by itself, they also will not be willing to pay it. So charging a quarter for toppings may find fewer takers. While the costs will go down, I am not certain if the demand for the main product will remain steady.

It is definitely worth experimenting at a smaller scale before unbundling the whole burrito.

Sizing up the Customer

Coke and Pepsi bottlers make the most margin from their sales at vending machines and convenience stores. These channels target the customers who are willing to trade in high price for convenience and immediacy in satisfying their want. The most common packaging option sold at convenience stores is the 20 Oz bottle sold at $1.29, more expensive that the 2 liter bottle pricing for the same brand in supermarkets.

WSJ reports that the bottlers are seeing a fall in sales in the convenience stores. The cited reasons include health concerns and softening economy. To stem falling sales, the bottlers have introduced multiple packaging, 12, 16 and 24 Oz bottles. The 16 oz Coke sells for $0.99 and 24 oz sells for $1.49.

The marginal cost per bottle is fairly independent of the size since the bigger cost component is packing and distribution. So the 30 cent pricing difference between 20 oz and 16 oz bottles is a bigger drop in margin to the bottler. Yet they chose to introduce new sizes instead of dropping the pricing on 20 oz bottles.

This indicates their understanding of consumer behavior and their reactions to economic weakness and health concerns. By replacing one size bottle with two new sizes and a large price differential ($0.99 vs $1.49), the Coca Cola bottlers are nudging the consumers to prefer the lower prices and smaller sized bottle. The price per oz for the consumer is the same on these two sizes and hence there is no rent to the consumer to pick the bigger size. They do not expect to sell many 24 oz bottle. The onl role of 24 oz bottle is to sell the 16 oz bottle.

Pepsi's tactic is slightly different from Coke's. Pepsi retained the 20 oz bottle and introduced 12 and 16 oz bottles. Between these two they cover the entire spectrum of packaging for studying market reaction. The two sure will be watching each other's sales results and will soon converge on the winning combination.

Branding and Pricing effects on Consumer Behavior

I regret not doing the Consumer Behavior course this semester. I see a whole bunch of experiments being conducted by my classmates for their final projects. I served as a willing subject for many such experiments, from tasting organic vs. non-organic vegetables and wines to deciding whether or not I will bet on an outcome with same expected payout but different entry costs. There was one study that promised a gift card raffle for participants deciding on Tulley's pricing market entry strategy, now I wonder if the study was really about consumer behavior with respect to raffles.

The New York Times talks about recession diets, people cutting down on brand name goods for cheaper alternatives.

Holly Levitsky, a 56-year-old supermarket cashier in Cleveland, buys a brand of steak sauce called Briargate for 85 cents and surreptitiously pours it into an A1 steak sauce bottle she keeps at home.

“My husband can’t even tell the difference,” she said.

The packaging and the marketing has obviously trained her husband to associate the taste and the experience to the brand name A1 even if there is no clear link (as Ms. Levitsky's experiment demonstrates).

On a more scientific level, Business Week reports a study done by Stanford and CalTech researchers on the same consumer behavior on wine pricing.

"The marketing industry has done a good job convincing people about their free will and that they are making logical, well-thought-out decisions about the things that they buy," Linn said. "Studies like this suggest that, in fact, there are lots of things that influence our responses to marketing and our choices of products that are completely irrational that we might not be aware of."

Changing Consumer Behavior: Heinz in India

Indians are used to ketchup that flows easily from the bottle. No tapping on the sides or the bottom of the bottle. The well known Indian ketchup brand is Maggi (owned by Nestle). Its viscosity is very low and it almost pours out. Heinz ketchup is much thicker viscous than anything Indians are used to. Heinz could have changed their product to match the expectations, instead they decided to train the consumer, change their behavior to accept Heinz for what it is. Instead of masking the difference they showcase it, trying to get the consumer accept it. See the following Ads. (You may want to lower the volume)




The punch line is, "takes a while to come out".

I wonder how they decided that reducing product variability in different markets is more important than meeting the consumer taste.