Mental Accounting

Session 5

A gift from the Greek!

My mother is a homemaker and I work for XLRI. In July, I
saw a sweater in Pune Central Mall which is priced at
Rs. 3629/-. I handled it, admired it but ultimately did not
buy it. My mother gifted me the sweater in October(for
my birthday!). Between July and September 2015, my
income remained constant and so did all other variables
that should effect price. Yet I was happy to get the gift
of a product that I was not happy enough to purchase!

My luck..
This year, I received an increment of around Rs. 30000
p.m. My lifestyle has almost remained the same.
I got a Income Tax refund (never expected) of Rs.
18000/-. I blew it up on dinner at Reagents.

Games people pay!

Surdeep and Akhil are poker freaks, and both are lucky people!
Both therefore decide to play a poker game. Akhil (also an investor
of some repute), read in the morning ET that the share prices of
Infosys (of which he owns 2500 shares) have gone up by Rs. 1.
When they have played poker for a while, Surdeep has won 2500
and has a current hand of queen high flush and immediately
takes a bet of Rs.500/ Akhil is evens on his game, however, now has a king high flush,
but still folds the current hand!
Surdeep wins, and Akhil comments well, if I had his luck, I would
also have taken the bet!

Problem with the Economics pricing

The economist looks at a price as a constraint i.e. Price is a hurdle to be crossed by the
customer in determining its net utility. This thought persists even among managers who look at
satisfaction = benefits costs!.
The economist looks at price in an objective manner i.e. objective rules and guidelines rule the
price fixation. This means that price has a rationale , a meaning that can be justified using
rational arguments!
The economists thinks that a customer reacts to the price. This means that price is outside
the preview of customers psychological makeup. Price cannot influence a customers utility
function. What is does is to increase or decrease units consumed, but in no way increases or
decreases the utility derived from the product
Therefore:
Economic theory (as is known now) is incomplete (since it is normativeWhat should happen, rather than
positivist what happens)....the theory is difficult to apply!
Product focused; rather than consumer focused; not much use for us in marketing
The theory is incomplete. It talks of concepts that are un-observable, the concept of utility, for example,
therefore operationlisation is tough!

The issue..
One of the running themes of pricing research is that
judgments of monetary value have much in common
with sensory judgments like brightness, loudness,
warmth, coldness, or intensity of odors.
How does a sight-impaired man walk in his own house?
The person can navigate familiar surroundings because
he has memorized where the furniture isthis is called
compensation not keenness of vision. Just because a
person can knows a price of a product , does not
mean he can understand the products value!

Coherent Arbitrariness
I know the difference that a hard-bound book edition
should be priced more than a paper-packed
one.however what should be the price of the
hardbound edition?
Relative valuations are stable, but actual rupee (dollar)
amounts are wildly arbitrary. Somewhat like our grading
system?
Therefore, coherent arbitrariness.

The truth.
Prices rarely denote value. They are just made up
numbers which unfortunately carry a lot of conviction
because ..customers are morons and so are the
business-persons!

A God called Gustav Fechner (18011887)

Whatever we know on psychophysics today, we owe it
to this man!
He tried to answer the age old question Can subjective
experiences be compared or communicated? Or in
other words Is my red, your red too? How do I know?
Perhaps these questions are way too philosophicalbut
from a value viewpoint these are critical for pricing!
Can I get a group of customers to agree upon a value
for a product? If I cannot, how do I price?

Weber-Fechner Law

Where
p= perception
k= constant
S= new stimulus
S0=old stimulus

The relationship between stimulus and perception

is logarithmicthat is, if stimulus varies in
geometric progression, perception varies in
arithmetic progression. For example, if the
stimulus is changed by 3 times, the perception may
be only twice the originalsimilarly if the stimulus
is now changed again 3 times, i.e. now 9 times, the
corresponding perception is just 3 times.

The problem of anchor..

The stars cannot be seen in the daytime because the
sun acts as an anchor. Anything we see or not see is
in relation to the anchor.
Let us see another example.

A crime
Consider the crime of that you willfully and without
provocation murdered your own mother.
Now write down a crime that is half as bad.

Another Crime
Consider the crime of that you willfully and without
provocation murdered your own mother.
Consider the crime of cheating in solitaire while playing
with yourself.
Now devise a crime that is exactly halfway between the
two.

Types of Anchor..
Contrast Anchor: When you compare two stimuli
Response moves away from the anchor

Assimilation Anchor: When you have only one stimuli to

take.
Response moves closer to the anchor.

Why does all this happen?

Principle of Fungibility Money has no colour
I give you a gift of 1000/ I give you a gift of 1000/- and tell you that I gave you that out of the
budget that I had created to take my mother on a pilgrimage

Consumption depends on how much wealth you have, not on

its source. If we both have 3 million USD, you have worked
your a.. out for it and I have been gifted it by my benevolent
uncleour attitudes towards consumption will be the same!
This is central to economic thought.
This is not true so far as consumption behavior goes! People do
not treat money as fungible. So, how does it effect behavior?

The problem of Framing (Taversky

and Kanheman (1981)

The way a problem is subjectively evaluated is as

important as the objective value of the problem
For example
Compare between a decrease in price from Rs. 30 to Rs. 20
and from Rs. 130 and 120! (relevant)from a rational point of
view (fungible), a person should evaluate both these
decreases the same way, but this is not true

Given the name Prospect Theory or some people call it

Mental Accounting (Thaler, 1981, 2008).

The question of Power rules

It is Diwali. My neighbour decorates his house with
electric lights. I want my house to be twice as bright as
my neighbour. How much should I spend on lights as
compared to my neighbour?
According to the Power rules.I have to spend 4 times on light
to have twice as bright as my neighbour.

An experiment with watches showed that it was

necessary to pay 8.7 times to get a watch twice as
desirable.

Watch pricesin USD

Watch
Timex
Swatch
Cartier
Rolex

Price
40
150
3000
30000

Is Rolex 10 times as valued as a Cartier?

Rules of behavioral theory

Reference point rather than absolute figures are
important, so the focus is rather difference in prices
than absolute price levels!
Gains are concave while losses are convex, this gives us
the phychophysics of value
Loss function is steeper than gain function.
We value more what we have rather than what we do
not have.
A person will take more care about his existing value rather
than run after some future value

The problem of
value
Subjective Value
Psychologic
al gain of
less than
$100

Objective Loss
of $100

Objective Value
Objective
Gain of
$100

Status Quo Point

Psychologi
cal loss of
more than
$100

What does all this mean?

Price encapsulates both value creation and value
capturing.
Essentially we are telling the customer that please take
my product (value creation) and pay me a price (value
capturing)
So, how should a customer react to different losses and
gains.
Let us see some issues.

Let us assume that a product has two

outcomes, x and y
Situation 1--You are only adding value, i.e. x and y are
both positive.
Because gains are concave, v(x) + v (y) > v (x+y)which
means that never warp all Christmas presents in one pack.
Therefore, segregation is preferred.

Situation 2You are deleting value i.e. x and y. (x and

y are positive).
Because losses are convex, v(-x) + v(-y) < v (-(x+y))which
means that sell bad news together. Therefore, integration is
preferred.

 Situation 3Mixed Gain, i.e. a customer gains x and

loses y and x > y; so there is a net gain. Here since v(x)
+ v (-y) < v (x-y), integration is preferred. Give the good
and bad news together. Infact, since valuation of losses
are more steep than gains, sometimes v(x) + v (-y) <0;
but v (x-y) is always positive since x>y. This is called the
principle of cancellation.

 Situation 4: Mixed losses: If the customer

gains x and loses y and x<y; so there is a
net loss. For this the strategy depends on
how much is x<y.
If x is far less than y, then segregation is
preferredThe Silver lining principle.
If y is almost equal to x, then integration
principle is preferredsince the loss is
cancelled to a large extent by the gain

Summary
Segregate Gains
Integrate Losses
Cancel smaller losses against larger gains
Segregate silver linings

But does all this work?

The concept of a transaction utility

Unto a stranger you mayest lend
upon usury: but unto your brother
thou shalt not lend upon usury.
Deuteronomy (20), but what if you
are Pulkit Agarwal?
In BSchool, I was not a rich person. So,
I used to charge a nip of OM for every
assignment I did for others! Was it fair?

My music lessons
My teacher charges me Rs. 1250/- per month.. For 4
hours.
I felt as if I am cheating her. So, suo motto, I increased
the charge to Rs.1500/- per month..
Why?

 In Exchange relationships, buyers and sellers fair price

concept is higher for strangers than friends
In exchange relationships, sellers fair price is higher
than buyers. But in communal relationship, this
reverses i.e. buyers fair price is higher than sellers.
Legitimacy in profit making leads to a higher perception
of fair price by both sellers and buyers.

Leads us to how do customers

evaluate a Transaction
I bought a apple ipod, at a discount of 15% in Dubai. It
translated to around 13000 INR. I checked the price of
this product in India after purchase. It was 13600 INR. I
felt cheated! Why?
Note that 13000 INR is a great price for the apple ipod,
but I am still unhappy. Why?
Often this is the crux of the problem in pricing! Great
value but poor deal! The difference between acquisition
utility and transactional utility!

How does acquisition and

transactional Utility interact
Acquisitional Utility--Suppose value of the product (ipod) is 13000
INR. What does this mean technically?
Suppose somebody gives me 13000 INR or Ipod as a gift, I shall be
indifferent! This is the evaluation process.

Transactional UtilitySuppose, I believe that the price of a iPod is

16000 INR. A ipod at 13000 is a good deal. So, this is a judgment
process!
So every purchase situation is an evaluation process followed by a
judgment process! The sum of the utilities from both acquisition
and transaction give me the total utility from the object leading to
satisfaction/ dissatisfaction!
So, what is the nature of these utilities?

Nature of Prices
WTP: Willingness to paythis is the amount that a
customer is willing to giveup for the product. Either
have the money or product!
Price: That what is charged by the seller
Reference Price: That what the customer feels is fair
to pay.
Concept of Distributive Justice.

So, let us give it names


Note that z is a gain, p is a loss
A price paid if treated as a loss, may trigger, deep dissatisfaction. So, it is hedonistically inefficient to treat this as
segregated. Therefore is always integrated.
Note that both are losses
Therefore the difference will also be a gain if and a loss if .
Since losses are steeper than gains, this pain might wipe out
any gainfrom Acquisitional utility.


But for Bargain hunters can be negative.their entire life is
based on buying things because of a Bargain

Implication
to our discussion on Law of Equimarginal Utility
Refer

What happens is that a customer (due to moneys marginal

utility not being a constant), sets the utility of money based
on his income flow and degree of self control.
and

And finally sets

Implications of all we discussed to

Marketing
Compounding Rule Implications
Segregate gains: When a product has several positive
dimensions, it is important that each gain is evaluated
separately. If you see any of the TV ads for German Blade
Wallah vegetable cutter on TV, you could easily visualize the
example. Every use of the item is demonstrated separately
Each free gift is mentioned separately with its value!
Silver liningWhy are rebates announced when you could just
decrease the price and say new price?

 Integrate the losses: Whenever possible customer tend to

integrate the losses. The convexity of losses show that if we add a
loss of 50 INR to already existing 100 INR, the total value of this
loss will be less than 150 INR. Generally seen in automobile
industry when you keep adding options to the main product. Also
for insurance products! There was a insurance company that sold
a paint spill cover clause with a homeowners insurance!
Now do you realize why mass customization is such an attractive issue?
Indirect taxes is another example.

Cancellation: Is used in all economic transactions. We cancel the

+ve gain with the negative price. All, withholding taxes (income
tax in general)

 Implications for Transaction Utility

Sellouts and Scapling: Why does under (or over)-pricing occur?
Does demand-supply explain all? No. The presence of
Reference price controls prices! Though acquisitional utility
for a dinner at Taj may be high, this is water-downed by the
price that a customer ought to pay for a meal! So, for some
even this may be high! Generally speaking cherry pickers
have a need for higher transactional utility!

 The basis is that the relationship between the seller and buyer
is on-going! If it were not, then the seller would not care if the
buyer did not get transactional utility! An analysis of the
prices of different sporting events in America shows this trend

1983 World Series

$25-$30

1984 Super Bowl

All seats $60

1984 Indianapolis 500

Top price $75

1981 Holmes-Cooney
fight

Top price $600

So,
While, having a cold water bottle on a hot and humid
day is invaluable, a seller cannot double the price of the
same. This is because, they have to sell the product
even when the weather is normal!
Surge Prices: Why have some state governments
banned surge prices by Uber and Ola?
So, if there is a strong reference price available, a seller
has to weigh in short term gains with long term
relationships.

 But in case, I do charge lower than economic price for

products, I encourage black-marketeers. Is this good?
Actually good, since the seller gets to create a larger transactional
price without actually falling foul of the customers.
Secondly, most of the income is hidden. Many high demand products
are sold at prices that are not transparent. For example, many tickets
for favored cricket matches are given to agents or franchisees at
undisclosed prices (or for sponsorship amounts); who in turn scalp the
public this does not effect the main company!
Artists do thisA painting is transferred to an agent for sellingAuction
houseIn such a case the transaction disutility is transferred from the
artist to the Auction house! Another reason why channels are important!

Methods of raising prices

Sometimes the seller finds that the product is priced lower
than the market equilibrium pricehow does he raise price
without reducing transaction utility? There are three ways
One way is to explicitly suggest a higher reference price (MRPs).
Raise prices and then give a discount. Leads also to perceptions of
Quality!
Increase perceived value and therefore, the reference price
Zara Example.
Increased perceived value without increasing actual value
Bundle products

Change the product format so that p* is fuzzy!

Implications of Utility function

Gift giving: Make the product with higher k a gift!
Change the purchase criteria

Next the issue of reference Prices.

Soren Chemicals
What is the market size for Coracle? So, is the 1 st year sales goal of $1.5
million reasonable?
Why is Soren struggling to sell Coracle? Look at this from the view of
the selling process taking into account the
Channel Structure
Consumer Behavior

What is the worth of Coracle from a customers view?

At what price would the dealer/retailer be indifferent?
What should be the competitive parity price?
Based on your answers to 3, 4 and 5, could you diagnose the problem
with Coracle?