Priceless: The Myth of Fair Value (and How to Take Advantage of It) (25 page)

With complex billing plans, it is difficult to comparison shop (every plan is different) and nearly impossible to predict what a plan will cost. Choosing a phone plan becomes a judgment under uncertainty, mediated by loss aversion and heuristics.

One of the most powerful tools of psychological pricing is the flat-rate bias. Consumers like flat rates, even when they cost more. A 2009 study by the Utility Consumers’ Action Network claimed that cell phone users in the San Diego area paid an average of $3.02 a minute for calls. That’s the price when you divide the aggregate amount paid by the number of minutes used. The per-minute tab is surprisingly large because many customers who don’t talk much nevertheless choose flat-rate plans.

Richard Thaler has explained this as a consequence of prospect theory. Just as infomercials slice and dice the product into many little bonuses, an opposite rule says that you should sweep losses into one big pile. A $90 parking ticket is not three times as bad as a $30 ticket. It is better to get one $90 ticket than three $30 tickets on three separate days.

Since the cost of any product is a loss, costs are less painful as flat rates. You pay once (per billing cycle) and don’t have to worry about it. “Free” food is an unaccountably big draw for cruise ships. Vacationers know they paid for the food with their fare, and that it wasn’t exactly cheap . . . but it
feels
free. You don’t have to count the cost of every rumaki. The flat-rate bias helps define the American middle class. Americans love owning their homes and cars and hate renting or taking public transportation. It isn’t that owning is cheaper than renting, necessarily. It’s just that with renting the cost is more apparent. (“All you’ll end up with is a pile of rent receipts!”) Many urbanites would find it cheaper to sell their SUVs and take taxis everywhere. But the thought of paying $15 in cab fare to go to the supermarket is unconscionable. No one likes to hear the taxi meter running.

Many believe that the success of the video rental service Netflix is largely the result of pricing. It offers DVD rentals by mail, with an assortment of plans currently ranging from $4.99 to $47.99 a month. All but the cheapest plan have unlimited rentals. Had Netflix charged per rental, it would have been competing on price with the video stores. A reasonable customer contemplating a Netflix subscription must estimate how many movies he or she will watch a month. Academic studies have shown that consumers have a tendency to grossly overestimate their
usage of various services. At that, the Netflix customer normally expects her household’s viewing habits to change. With “free” DVDs and easy return in a postage-paid mailer, everyone watches more movies, or thinks they will. The movie lover is likely to conclude that Netflix is reasonably priced almost regardless of what that price is. With willingness to pay so vaguely defined, Netflix has scope to price aggressively, as the video store does not.

Another of Simon’s favorite examples is a movie chain that gave customers free loyalty cards. The cards recorded the number of visits. The chain charged one price for the first visit each month, a lower price for the second visit within the month, a still lower price for the third visit. These prices subtly encouraged customers to “save” money—by attending more movies. But the customers didn’t save money. The number of tickets sold increased 22 percent under this scheme,
and
the average ticket price paid went up 11 percent. The chain’s profits were up 37 percent. “Such improvements are not possible through one-dimensional price increases or decreases,” Simon wrote, “but only through new price structures that have been carefully researched.”

To hear today’s price consultants tell it, the goal is to devise price structures that extract the maximum willingness to pay from each consumer. Capitalism takes on a weirdly Marxist twist: every customer pays according to his ability. This is a discomfiting idea, like the Firesign Theatre bit advertising the bicycle seat that fits you like a glove. In the digital age, this is where we’re heading—to price plans morphing to the soft contours of consumer desire.

Rebates make no sense. Instead of buying something and getting a rebate, why not just pay a lower price in the first place? Practical-minded consumers have been asking this question for years. Businesses and most everyone else have paid little attention. Rebates are more pervasive than ever. About a third of all computer gear comes with rebates, and over 20 percent of LCD TVs and digital cameras do. Fly your favorite airline and get frequent flyer miles for free trips and first-class upgrades. Use a credit card and get cash back, or more of those airline miles. Cars have “dealer incentives,” and some real estate developments offer free cars to buyers. You do not need the savvy of a coupon queen to cop a rebate trifecta at any checkout line: use a manufacturer’s coupon, swipe your loyalty card for another discount, and then pay with a credit card that gives back a few percent vigorish.

Rebates have been big business at least since the early twentieth century. In 1896 Thomas Sperry and Shelly Hutchinson founded a company issuing S&H Green Stamps. Sperry and Hutchinson sold the stamps to markets and gas stations, who gave them away free with purchases. Consumers were supposed to save the stamps, paste them in free “books,” and redeem the books for merchandise. This created what was euphemistically called loyalty. Customers didn’t want to switch markets because they needed more stamps to get a toaster or a bathroom scale. Green Stamps peaked in popularity in the 1960s, when Sperry and Hutchinson was printing three times as many stamps as the U.S. Postal Service, worth some $825 million. The company operated a
chain of “redemption centers,” mini–department stores that didn’t accept money—only Green Stamps. The business took a downturn in the 1970s and was supplanted by the rise of modern rebate programs like frequent flyer miles and supermarket loyalty cards in the 1980s. Sperry and Hutchinson still runs a “GreenPoints” program for Internet purchases, a rather insignificant part of today’s rebate picture.

One thing Sperry and Hutchinson bequeathed to today’s rebaters is the “Green Stamps Syndrome.” It was a lot of
work
to paste stamps into books. Americans had drawers full of stamps and never got around to redeeming them. The unredeemed stamps were pure profit for Sperry and Hutchinson.

Two independent companies, Young America and Parago, handle much of the nation’s rebate paying. In consumer circles, their reputation is little better than the average dogfight promoter’s. “Breakage” is the industry term for rebates that never get sent in, and “slippage” refers to checks that are sent out but somehow never get cashed. Both are big drivers of profit. “The game is obviously that anything less than 100 percent redemption is free money,” the consultant Paula Rosenblum told
BusinessWeek
.

In theory, rebate processors do not profit from unredeemed rebates. Their clients do. But one processor, TCA Fulfillment Services, bragged about the low, low percentage of rebate checks it cut and that got cashed—as little as 10 percent for a $10 rebate. “If you are using another fulfillment company, add 20% to these redemption rates,” said a TCA promotional brochure. (TCA sold its customer list to Parago, which has disavowed this claim.)

By industry convention, rebates require a store receipt with the price circled; a UPC code cut from the box (making the item unreturnable); and a completely and correctly filled out form. Minor omissions mandate “further research,” requests for more paperwork, and transferring the case to a “special team.” This is defended as necessary to prevent fraud, but it also has the effect of causing many a consumer to give up. One of the industry’s tricks for increasing slippage is to mail the check in an unmarked envelope that looks and feels like junk mail. Guess where the checks end up?

Comical as this may sound, rebates are a big business. By one recent estimate, about 400 million rebates are offered per year, with a face value
of $6 billion. Anything that shaves a few percent off that is worth nine figures. About 40 percent of all rebates are believed to go uncollected.

This says something about why rebate programs appeal to the companies that offer them. The tougher question is, Why are rebates so entrancing to consumers? Both experiments and practice confirm that rebates cast a magic spell. People are more inclined to buy a $200 printer with a $25 rebate than a similar printer for $175.

Richard Thaler explains rebates as psychophysical arbitrage. The $200 does not seem that much higher than $175, first of all. But there’s a big psychological difference between getting a rebate and not getting a rebate. Most prefer the rebate. Thaler calls this the “silver lining” principle. He demonstrated it with this survey question:

Mr. A’s car was damaged in a parking lot. He had to spend $200 to repair the damage. The same day the car was damaged, he won $25 in the office football pool.

Mr. B’s car was damaged in a parking lot. He had to spend $175 to repair the damage. Who was more upset?

A large majority of Cornell students felt that Mr. B was more upset. Though no worse off financially than Mr. A, he missed out on the $25 windfall.

The commonsense dismissal of rebates is right about one thing: there’s no free lunch. Every product that offers a rebate has to be more expensive because of it. This need not dampen sales. Since consumer price sense is vague at best, shoppers take a cue from the posted price. A $200 printer is assumed to be better than a $175 printer, no matter that the only extra “feature” is the rebate.

For about $2,400, any gas station operator can buy a machine that pulls two of the most audacious grifts ever conceived. One side of the machine sells
air
. The other side sells
vacuum
.

The air-vacuum machines are “long life and low maintenance” to “send more dollars to your bottom line,” according to one manufacturer’s website. The price of air and vacuum apparently has little to do with the amortized cost of the machine and everything to do with psychology. We pay for air because we’ve come to accept that you have to pay for it. The price is whatever is. That kind of uncontemplative consumption is a marketer’s nirvana.

In many ways, we all end up paying for air. Take batteries. What you’re buying is battery life: how many pictures you can take in a camera, how often you have to replace the smoke detector battery, how long a flashlight lasts in an outage. But battery life isn’t disclosed anywhere on the label. Instead, batteries are labeled by voltage, a measure of limited relevance to the consumer. It’s as if you had to buy gasoline from pumps that told you the octane rating and not how many gallons you were getting.

This would be okay if battery life was the same across brands. It’s not. A 2008
Consumer Reports
piece tested the life of 13 brands of single-use AA batteries in digital cameras. The best battery was good for 637 photos, the worst for 95. Some batteries pack a lot more juice than others, and consumers are left to guess which ones they are.

The chart on page 180 shows how 12 tested batteries compare. (I’ve excluded the single lithium battery that
Consumer Reports
tested. It was
much more expensive and offered about four times the life of regular batteries). The price for two batteries is on the bottom, and the number of photos a pair of batteries is good for is on the left axis. If you got exactly what you paid for, the dots would form a diagonal line from lower left to upper right. Instead, the dots are a formless cloud better fitting a horizontal line. All the tested batteries were good for somewhere around 150 photos, and price didn’t matter. The cheapest battery (Kirkland Signature, a house brand sold by Costco) performed the longest.

Okay: There’s a rack of batteries in front of you, and you haven’t memorized
Consumer Reports
. How do you choose one? Well, I tell myself I can’t judge battery life but I can judge price. I tend to choose the cheapest battery. But I’m also a sucker for discounts. I’ll see a Duracell or Energizer marked down
almost
to my usual bargain-basement level. I’ll buy it, just to feel like a regular American buying a real brand advertised on TV. I justify this by telling myself that there must be a grain of truth to those Energizer bunny commercials, so I’m not really paying any more than with my no-name brands. That’s exactly how the Energizer and Duracell people want me to think.

Batteries aren’t the only product where it’s hard to judge what you’re getting. Liquid laundry detergent is, by definition, “watered down” to greater or lesser degree. You know how much
water
you’re buying, not how much soap. Lately, manufacturers have started claiming that their liquid detergent is twice as concentrated. They don’t say relative to what.