This evening, I re-read a chapter from a book I have called Predictably
Irrationality, The Hidden Forces That Shape Our Decisions, by Dan Ariely. In
truth, I tried writing this before but never got around to finishing it. I
started sometime last year but in the spirit of New Years’, I decided why not
try it again? The book attempts to challenge the reader’s assumption about
rational thought. Ariely stated goal is “to fundamentally rethink what makes you
and the people around you tick” and for me — I think he certainly achieved this
goal.
In the chapter, The Truth About Relativity, Ariel argues humans don’t have an
internal measure of how much a product or service is worth. Instead, we try to
estimate the value by comparing the relative advantage one might have over the
other. (For Instance, one might not know how much a 16oz jar of Terrance’s
Old-fashion Peanut Butter may cost but it’s easy to assume it’s more expensive
than an 8oz jar).
## Decoy Effect
So let’s do a thought exercise. Imagine you’re a university student shopping
online for textbooks. You come across the following example:
1. Digital edition for $10
2. Print edition for $18
3. Print and digital edition for $18
Which one do you choose? With the print and print/digital edition being the same
price, many consumers would choose the latter. Option #3 seems like a
no-brainer; the digital edition appears to be free. However, this is a form of
subtle manipulation. As you may not know whether the digital is better than the
print edition, but you certainly know the print/digital edition is much better
than the print only. Since our brains can’t naturally determine the intrinsic
value, we use a few context clues to give us information. This incentivizes
companies to design pricing strategies to shift consumer preferences; sometimes
deliberately providing consumers with misleading information to maximize
profits.
Let’s assume it’s this company’s goal to secretly maximize the sale of option
#3. The company would purposefully place the inferior print edition for $18 as a
decoy. Decoying is a pricing method that nudges consumers into a particular
choice. Consumers naturally compare the print edition to the print/digital
edition because they’re the same price. As a result, many would opt for Option
#3 — thus increasing the company’s revenue.
Now let’s imagine if Option #2 — the print edition never existed and the prices
were as follows:
1. Digital edition for $10
2. Print/digital edition for $18
Consumers would have no incentive in purchasing the bundled version and would
opt for the digital-only version because it satisfies most of their needs for a
reduced cost. This is also known as the compromise effect.
## Compromise Effect
The compromise effect states that consumers would choose the middle option in a
selection set rather than the two extremes. The belief is consumers are
naturally risk-averse. There’s uncertainty in purchasing the cheaper product
with fewer features and the more expensive product with features you may not
need. Consequently, consumer preference often shifts towards the middle product
offering. Or in the words of the author, “Like an airplane pilot landing in the
dark, we want runway lights on either side of us, guiding us to the place where
we can touch down our wheels.”
You can see examples of this everywhere. At the time of this writing, Netflix
has three plans for video streaming: Basic, Standard, Premium. With the
compromise effect in mind, it’s probably safe to assume the Standard is their
most popular.
## My Takeaways
Human behavior isn’t as always rational as it seems. Everything is relative and
we naturally compare things to one another. We don’t know what shoes we want —
until we see our favorite athlete in them. We don’t know what phone we want —
until we compare several different models in stores or online. We don’t know
what career we want — until we see a family member, friend, or someone we admire
do it. Likewise, in consumer behavior, everything is largely contextual.
Consumers do not have a natural way of determining the price of an item, rather
they estimate the value based on the relative advantages it has against a
similar item.