Priceless: The Myth of Fair Value (and How to Take Advantage of It) (24 page)

In a more formal poll of fans who had paid face value for their tickets (then $325), Krueger asked whether they would have sold their ticket for $3,000. Ninety-three percent said no. The ticket was apparently worth more than that. Given a choice between the $3,000 and the ticket, they’d choose the ticket. Krueger also asked the fans to imagine that they had lost their face-value ticket: Would they have paid $3,000 to replace it? The fans overwhelmingly said no. Put this way, the ticket
wasn’t
worth the market price. A Super Bowl ticket is in some strong sense priceless: no single, one-dimensional dollar valuation can account for the fans’ responses to Krueger’s questions.

The NFL has experience in distributing too-scarce tickets to too-enthusiastic fans. Compare that to the free-for-all accompanying the 2007 Hannah Montana tour. A feeding frenzy of tweener parents snatched and clawed for every possible Hannah Montana ticket throughout the show’s 55-stop tour. In every city, tickets, priced at about $25 to $65, sold out in minutes through official channels. A large fraction went to scalpers, amateur or professional. Tenfold markups weren’t uncommon. Members of the Miley Cyrus Fan Club filed a lawsuit, claiming they had been told their $29.95 annual memberships would give them
access to tickets, but they couldn’t get them. An online poster had this take on the lawsuit: “Mommy get me tickets or I’ll hold my breath forever!” Radio stations offered tickets as contest prizes. One woman won an essay contest for tickets by claiming her daughter’s father had been killed by a roadside bomb in Iraq. (He hadn’t.) Given the markups, the scalpers must have collectively made more from the tour than Cyrus and Disney did. But what was a ticket worth? Nowhere near the eBay prices (according to parents who didn’t have tickets). Priceless (felt lucky families who did).

Ticket sellers break the rules of fairness at their peril. During Bruce Springsteen’s 2009 tour, the Ticketmaster website began redirecting fans to TicketsNow, a resale site that just happened to be a wholly owned subsidiary of Ticketmaster. The “sold out” Springsteen tickets were readily available on TicketsNow—for as much as $1,600. One fan, Diane La Rue, said she signed on to the Ticketmaster site from two computers the instant the tickets went on sale and was immediately directed to the scalper site. Springsteen was furious, forcing a weaselly apology from a Ticketmaster spokesman and a promise never, ever to do it again. The New Jersey attorney general promised an investigation. It was odd, though—fans were more worked up about the high prices (that they had no intention of paying) than about missing the show.

This paradox is not unique to entertainment tickets. Think of the hotel minibar. It’s stocked to overflowing with yummy treats
at prices you’d have to be insane to pay
. Were prices one-dimensional, you’d just ignore the minibar. (“It’s too expensive and that’s that.”) The thing is, sometimes you end the day tired and hungry in a strange city, and there’s nothing you’d like better than a big chocolate chip cookie. The one in the mini-bar will set you back $8 plus tax. You are likely to experience conflicting gut reactions. One, you want that cookie, no matter the cost, and, two, there should be a law against charging $8 for one cookie.

A wise friend would say,
Buy the damn cookie already
. Thrift becomes stinginess when it prevents you from having something you want and can easily afford. Even erstwhile spendthrifts find it hard to follow this advice.
It’s the principle of the thing
. . .

Richard Thaler explains this with the concept of “transaction utility.”
When the consumer believes an item’s true value is more than its selling price, the purchase has positive transaction utility. In plain language, it’s a bargain, and everybody loves a bargain. When the perceived value is less than the price, it’s a rip-off, and the transaction utility is negative. Thaler’s point is that buying decisions depend on transaction utility as well as on the traditional trade-off of price versus desire.

Transaction utility has two consequences, both familiar. Sometimes the perception of a sweet deal causes consumers to buy completely useless junk. Infomercials, factory outlets, riot racks, going-out-of-business sales, and duty-free shops thrive on this psychology. The flip side of the coin is the dilemma of minibars and Super Bowl tickets. Sometimes consumers deprive themselves of things they want and can afford because of an inner voice telling them it’s a rip-off. Either that, or they complain about prices they’re not going to pay anyway. You can say all you want about free markets—that’s hollow logic, and this is emotion.

In Thaler’s model, the consumer is of two minds. Lately there’s been evidence that this is almost literally true. It involves some ingenious brain-scanning studies of the ultimatum game. A responder faced with a low offer experiences the Super Bowl–minibar dilemma. Let the offer be $1 out of $10. On the one hand, that $1 is found money. We’ve all been trained from birth to grab on to any money pushed our way. On the other hand, one lousy dollar out of ten is a raw deal. For most Westerners, the raw deal trumps the found-money argument, and they’ll veto.

In a 2003 experiment by Alan Sanfey and colleagues, plucky volunteers played the game while their heads were immobilized within an MRI scanner. This revealed that fair offers ($5 or $4 out of $10) activated different parts of the brain than grossly unfair offers ($1 or $2). The unfair offers activated the insula cortex, which is otherwise triggered by pain and foul odors, and the dorsolateral prefrontal cortex, a region involved in planning and decision making. This appears to represent an inner conflict between a visceral rejection of a low offer and a desire to keep free money. As one survey article said of this study, “The fact that unfair offers activate [the] insula means that a verbal statement like ‘I am so disgusted about being treated this way’ is literal, not metaphorical—they really
do
feel disgusted.”

In 1978 adman Arthur Schiff took on the unpromising assignment of devising a commercial for a cheap knife made in Fremont, Ohio. Schiff concocted the faux-Asian name “Ginsu” and wrote a two-minute TV spot that set the template for future infomercials. Schiff’s leap of imagination was that you don’t just sell the product, you sell a bunch of extra stuff for “free.” “How much would you pay for a knife like this?” the announcer of the Ginsu commercial asked. “Before you answer, listen: it even comes with a matching fork to make carving a pleasure. Wait, there’s much, much more . . .” Soon the announcer was throwing in a “six-in-one kitchen tool,” a set of steak knives, and a “unique spiral slicer.” “At the end of the offer,” said one of the Ginsu partners, Ed Valenti, “you don’t know what you’re getting, but you know it doesn’t cost a lot.”

At the original price of $9.95 for the Ginsu—plus all that other stuff for free—the commercial had pared away the uncertainties of buying from a TV ad to a bare nub. Valenti even claims the Ginsu commercial coined the term “toll-free” for its order lines. His company posted $50 million in sales before it was bought by Warren Buffett’s Berkshire Hathaway in 1984.

Infomercials are as stylized as a Kabuki drama. There is a reason for that. The infomercials that succeed are those best at pushing consumers’ buttons. However different the products, human nature is pretty much the same. Central to the infomercial industry is a principle that Richard Thaler calls “Don’t wrap all the Christmas presents in one box.” In a 1985 paper in the journal
Marketing Science
, “Mental Accounting and
Consumer Choice,” Thaler presented an original view of how consumers decide what’s worth buying and at what price.

Thaler applied prospect theory to typical transactions, in which one side surrenders a price (a loss) to acquire something of value (a gain). There are diminishing returns to both gains and losses. A $30,000 bonus is nice, but it’s not three times as nice as a $10,000 bonus. There is thus more pleasure in receiving three separate $10,000 bonuses (all unanticipated, and spread out a little in time) than in receiving one lump sum of $30,000. With three bonuses, you’d get to rejoice three times. The actual dollar amount of those windfalls isn’t so important, or so additive, as you might think.

Thaler tested this principle with Cornell students. He asked them who was happier, a Mr. A who won $50 and $25 in two lotteries, or a Mr. B who won $75. Most felt that Mr. A was happier. He won twice.

From this Thaler deduced that marketers should devote less energy to promoting how absolutely wonderful their product is, and more to breaking it down, feature by feature, or selling several products in one bundle. Infomercials were already doing this in the 1980s, and they still do. The one thing you can’t buy in an infomercial is
one thing
(of anything).

“Buy one Snuggie with FREE Book Light for $19.95 + $7.95 P&H and receive a second set free” runs the pitch for Snuggie, the “blanket with sleeves.” What if you want just one Snuggie? Sorry, it doesn’t work that way. One Snuggie is like the sound of one hand clapping (in a cheap fleece sleeve).

For one seen-on-TV adhesive, the minimum is about three and a half bottles: “Normally 1 Bottle of Mighty Mendit is only $19.99 and just $8.95 S&H, but order today and we’ll triple your order to 3 Large bottles of Mighty Mendit. And as a special bonus, you’ll receive a travel size bottle of Mighty Mendit, 1 bottle of Mighty Gemit, and a money saving idea guide for FREE!”

The Magic Bullet—a blender shaped like live ammo—has one of the most fulsome applications of Thaler’s rule. “What You Get . . . High Torque Power Base . . . Cross Blade and Flat Blade . . . Tall and Short Bullet Cups . . .” They go on to list 21 parts and attachments, as if each one is a separate and worthwhile product. For good measure they throw in “Four Party Mugs with Comfort Lip Rings [to] turn your Magic Bullet into the Ultimate Party Machine . . . The Magic Bullet ‘10 Second Recipe’ Book” and—“Bonus Items!”—the “Magic Bullet Blender and Lid . . . Magic Bullet Juicer . . .” Then, just when you think it’s possible that they’re selling a singleton: “Get two complete 21 piece MAGIC BULLET systems for the price of 1! . . . 30 DAY SUPPLY FAT BURNING BOOST FREE WITH YOUR ORDER!”

Clearly, it’s not about the value so much as it is about the staccato rhythm of the pitch. Every feature, freebie, or three-for-one offer is another hedonic rush. Willingness to pay surges with every bullet point until the price—whatever the price—seems just about right.

Prices are more annoying than ever. When the Apple iPhone came out in 2007, customers were astonished at the size of their bills—the
physical
size of their bills. Pittsburgh blogger Justine Ezarik’s August bill came in a box. It was three hundred pages, and she made a viral YouTube video about it. Ezarik was being billed for data usage every single time her iPhone connected to the Internet. The data usage was free. The bill had thousands of items saying data usage $0.00.

In the past generation, most of us have come to accept that we will never fully understand our phone bills, cable bills, Internet bills (or bundles of all three); airline fares, car rental rates, hotel rates; premiums for health insurance, car insurance, life insurance; dues for health clubs and country clubs; credit card bills and adjustable mortgages. Prices have been replaced with algorithms. If you can get a simple price at all, it’ll cost you.

Simon-Kucher & Partners deserves at least some of the credit, or blame, for the complexity of phone bills. They have advised T-Mobile, Vodafone, Deutsche Telekom, Swisscom, and others on pricing. The complexity of today’s phone bills is part of an elaborate philosophy grounded in the precepts of prospect theory. In the usual business school thinking, a price is just a number. Sales go up as prices go down, and there is a certain price X at which profits are at a maximum. Solve for X

. . . SKP’s consultants are trained to think in terms of price structures. Instead of one price, there’s a formula telling what each act of consumption costs.

The customer usually gets to choose the formula (“billing plan”). Taken at face value, price structures are generous. “If you’re paying too much for phone minutes, here’s a plan with unlimited minutes.” More options means freedom of choice, and common sense tells us that’s a good thing. Actually, the consumer is both hammer and anvil. Given that preferences are constructed from the choices presented, extra options can be manipulative. Offering an additional billing plan may cause the consumer to be willing to pay a higher price—or buy more—or both—than he would without the option.

“Optimizing” pricing generally means making it more complicated. Hermann Simon tells of a successful promotion used by Deutsche Bahn, the German railroad. They introduced the BahnCard, a discount card costing 400 euros. This BahnCard entitles customers to a 50 percent reduction on all rail tickets in the course of a year. Otherwise, it’s worthless. You can’t redeem the BahnCard itself for travel.

Is the card worth 400 euros? It all depends. The only thing that’s certain is that frequent travelers can save a lot of money. “With more than 3 million customers every year, the BahnCard has been a huge success,” Simon wrote. “But only a few customers know where the break-even point compared to the normal fare is.”

Not knowing the break-even point is becoming the postmodern condition. An SKP publication says that the key to pricing lies in managing the consumer’s limited attention:

Companies need to answer several questions: What pricing elements matter most in the perception of the customer? Where will the customer’s eye be drawn when he or she examines the offer? Would they pay more attention to one-off charges, a monthly fee, or a price per download, a hardware subsidy, or some other element?

Those elements which are in the customer’s focus will require attractive prices to draw them in, while those outside the customer’s main focus can be maintained at higher, less attractive levels. The colorful mix of pricing elements in mobile telephony—which range from one-off installation charges to monthly fees to per minute charges (peak, off-peak, weekend) to billing intervals (full minutes, 10 seconds), etc.—shows how many degrees of freedom such a complex pricing challenge can present.