How do we decide how much we are willing to pay for things?

Let’s take black pearls as an example:

The interesting thing about black pearls is that when they were first introduced to the market there was essentially no way to gauge how much they were worth: were they worth more or less than white pearls? Most people instinctually believed that white pearls were still more desirable. But then the black pearl discoverers had an lucrative insight: take these unfamiliar black pearls to a famous jeweler and have them displayed next to the more precious gems: rubies, sapphires, and so on. The result still lives with us today: black pearls are now worth more than white pearls.

Dear Readers,

And as always, many thanks for all your help.

Dan

Here is a letter I got last week:

Dear Professor Ariely,

I have something of a story that intrigued me along the lines of your ‘dishonesty’ experiments. My wife’s cousin (I’ll call her Mary) is generally a nice, honest person. She and her fiancé found an iPhone on vacation. They decided to keep the phone, a nice item of value. Soon after, the owner started calling repeatedly (his name comes up on the screen). Mary chose to not answer the phone. After many calls were unanswered, the calls stopped. Mary kept the phone.

Mary’s situation is special because it is an instance where the lost object can ‘communicate’ with the finder and ‘ask’ to be returned. To what extent and to how long would the average person wait before answering? Would they directly refuse to return the item, or demand compensation?

What if you could rig a phone to deliver a series of text messages that become increasingly personal? Would the finder then feel more connected to the owner, feel empathy, and be more likely to return the phone?

As a side note, the owner of the iPhone was able to remotely shut down the phone so nobody could benefit. The unfortunate outcome is a lost phone. The upside is the empowerment given to the owner, who as a last resort just stops the functionality.

What do you think?

Jack

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Dear Jack,

I think that there are two very interesting points here:

The first is that Mary probably realized that if she answered the phone she would feel obligated to return the iPhone to its owner. And since she did not want to give it up, she simply did not answer the phone. This act is in essence a very sad type of self-control.  Generally we try to exert self-control when we want to assure that we will behave well (save money, take medications, not procrastinate), but here Mary was trying to avoid the temptation that would have made her behave in a kind way.

The second interesting idea is that people are more likely to return items that are more personal. Text messages are one extreme example of this principle, but maybe it would also work for wallets with pictures, books with names, cloths with initials, etc.

Not sure if this helps, but maybe we could learn something from Mary’s behavior.  And for sure don’t leave any valuables unattended during thanksgiving.

Irrationally yours

Dan

I have recently been asking people around me what they think makes a good gift.  And I don’t mean specific items like sunglasses or one of my books (which are all excellent ideas); I was looking to find some of the basic principles and characteristics of good gifts.  One of the best answers I’ve gotten so far is this: “A good gift is something that someone really wants, but feels guilty buying it for themselves.”  What is interesting about this answer is that the ideal gift from this perspective is not about getting the person something that they can’t afford, or something that they have no idea that they want – it is all about alleviating guilt connected with the purchase of a highly desirable (yet guilt invoking) item.  So, lets consider two ways in which good gifts can eliminate guilt:

Case 1* Imagine that you are walking by a storefront and you notice a beautiful coat that is just the right cut and color.  You walk in to check it out, and up close it is even more beautiful.  But then, you look at the price tag and you discover that it is about twice as expensive as you originally guessed, and after 30 seconds of painful deliberation you decide that you can’t possibly justify paying so much for a coat – and you go on your way.  When you get home, you find out that your significant other has purchased that same exact coat for you … from your joint checking account.  Now, ask yourself how you would feel about this. Would you say a) “Honey, this is very nice of you, but I have weighted the costs and benefits earlier and decided that this coat is not worth the money — so please take it back immediately” or b) “Thank you so much, I love it, and I love you!”  I suspect that the answer is b. Why? Because by getting you the expensive coat, your significant other got you what you wanted without making you contemplate the guilt associated with the purchase.

Case 2** Imagine that you have just finished a fantastic meal and have the option to pay with cash or with a credit card.  Which one will “hurt” a bit more?  You probably think that paying with cash will be a more miserable way of spending your money – but why?  Because, as Drazen Prelec and George Loewenstein show, when we couple payment with consumption, the result is a reduction in happiness. When we pay with a credit card the timing of the consumption of the food and the agony of the payment occur at different points in time, and this separation allows us to experience a higher level of enjoyment (at least until we get the bill).

To think some more about this example, imagine that I own a restaurant and I realize that on average people eat 50 bites and pay $50.  One day you come to my restaurant and I tell you that because I like you so much I will give you a great price and charge you half price – only 50¢ per bite. In addition, I will also charge you only for the bites you eat, and you will not have to pay for the bits that you don’t eat.  What I will do is serve you your food and stand next to you with my notebook open and mark in it each bite you take.  At the end of the meal I will charge you 50¢ for every bite you took.  I think you will agree that this would be a fantastically cheap meal relative to the regular price, but I also suspect you will agree that the process will not be much fun.  Most likely, every time you take a bite you will be thinking “is this worth it?” and in the process not enjoy the meal at all.  Woody Allen might have said it best in the Manhattan taxi ride when he turns to his date to say, “You look so beautiful, I can hardly keep my eyes on the meter.”

The lesson here is that when the timing of consumption and payment are close together, the experience ends up being much less pleasurable. From this perspective you can think about gift certificates for iTunes, drinks, movies, etc. as gifts that not only get people to experience something new, but also get them to experience something guilt-free, and without the pain of paying.

In summary, I think that the best gifts circumvent guilt in two key ways: by eliminating the guilt that accompanies extravagant purchases, and by reducing the guilt that comes from coupling payment with consumption. The best advice on gift-giving, therefore, is to get something that someone really wants but would feel guilty buying otherwise.

May this be a joyful gift-giving season – and in case you want to get me something, I love gadgets, but feel extremely guilty buying them.

Dan Ariely

A shorter version of this post has appeared at the WSJ

[* This example is based on a paper by Dick Thaler, “Mental Accounting and Consumer Choice,” Marketing Science, 1985]

[** This example is based on a paper by Drazen Prelec and George Loewenstein, “The Red and the Black: Mental Accounting of Savings and Debt,” Marketing Science, 17(1), 4-28, 1998]

Here is a letter I got from Mary Kate Dilworth ….

Dear Dan,
Hello.  My name is Mary Kate Dilworth, and I am a junior at Thomas Jefferson High School for Science and Technology in Alexandria, Virginia. Last summer, I read a copy of Predictably Irrational, and now it sits on my bedside table because I reference it so often in my life.  I find the chapter on social v. market norms particularly applicable to my life (I am in several volunteer organizations that regularly do fundraising projects).

Today, for example, my school’s Russian Honors Society had an Election Day bake sale.  In years past, various goods have had set prices, but this year we chose to make it donation-based.  What a difference it made!  When one woman bought a cupcake, she reached for a one dollar bill and asked about the price.  When I told her there was no set price but donations-only, she put the one back in her wallet and pulled out a ten.  Your suggestion to switch to social instead of market norms was a great one-thank you so much!

Sincerely,
Mary Kate Dilworth

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Dear Mary Kate,

This is great, and I am delighted that you are taking lessons from the book and implementing them.

Next time think about trying both versions and measuring more directly the difference.  It would be interesting to know if the effect is driven by a few people who give much more, by many people who give a bit more, or perhaps by more people becoming interested in the bake sale (or maybe all of these).

And good luck in your next implementation.

Dan

Thanks to all the people who participated in the probabilistic promotion for “The Upside.”

The average response to “would you buy this book without this promotion was 72% (on a 100% scale), and the average response to “would you wait longer was 62% (on a 100% scale). This means that this promotion worked mainly for people who were going to buy the book anyway at some point. But, there seems to be a substantial group that would have not purchased the book without this promotion.

There were people from all over the US, and some from outside the US — and the winner that was selected at random is from Washington DC.

I hope this was fun for everyone, and if you have any other suggestions for creative promotions, let me know — I am happy to try more things.

Irrationally yours

Dan Ariely

If you practice kicking a soccer ball with your eyes closed, it takes only a few tries to become quite good at predicting where the ball will end up. But when “random noise” is added to the situation — a dog chases the ball, a stiff breeze blows through, a neighbor passes by and kicks the ball — the results become quite unpredictable.

If you had to evaluate the kicker’s performance, would you punish him for not predicting that Fluffy would run off with the ball? Would you switch kickers in an attempt to find someone better able to predict Fluffy’s involvement?

That would be absurd. And yet it’s exactly how we reward and punish managers. Managers attempt to make sense of the environment and predict what will result from their decisions.

The problem is that there’s plenty of random noise in competitive strategic decisions. Predicting where the ball will go is equivalent to deciding whether to open a chain of seafood restaurants on the Gulf Coast. The dog running off with the ball is the BP oil spill. When the board reviews the manager’s performance, they’ll focus on the failed restaurants. The stock is down. The chain lost money. Since the manager’s compensation is tied to results, he’ll incur financial penalties. To save face and appear to be taking action, the board may even fire him—thus giving up on someone who may be a good manager but had bad luck.

The oil spill example is an extreme case. In the real world, the random noise is often more subtle and varied—a hundred little things rather than one big thing. But the effect is the same. Rewarding and penalizing leaders based on outcomes overestimates how much variance people actually control. (This works both ways: Just as good managers can suffer from bad outcomes not of their own making, bad managers can be rewarded for good outcomes that occur in spite of their ineptitude.) In fact, the more unpredictable an environment becomes, the more an outcomes-based approach ends up rewarding or penalizing noise.

In the last year I’ve asked many board members how much of a company’s stock value they think should be attributed to the CEO’s strength, and the answer is surprising. They estimate that you’ll get about 10% more stock value, on average, from a good CEO than from a mediocre one. Implicit in that estimate is the understanding that many outcomes are outside a leader’s control.

We can’t entirely avoid outcome-based decisions. Still, we can reduce our reliance on stochastic outcomes. Here are four ways companies can create more sound reward systems.

1. Change the mindset. Publicly recognize that rewarding outcomes is a bad idea, particularly for companies that deal in complex and unpredictable environments.

2. Document crucial assumptions. Analyze a manager’s assumptions at the time when a decision takes place. If they are valid but circumstances change, don’t punish her, but don’t reward her either.

3. Create a standard for good decision making. Making sound assumptions and being explicit about them should be the basic condition for getting a reward. Good decisions are forward-looking, take available information into account, consider all available options, and do not create conflicts of interests.

4. Reward good decisions at the time they’re made. Reinforce smart habits by breaking the link between rewards and outcomes.

Our focus on outcomes is understandable. When a company loses money, people demand that heads roll, even if the changes are more about assuaging shareholders than sound management. Moreover, measuring outcomes is relatively easy to do; decision-based reward systems will be more complex. But as I’ve I said before, “It’s hard” is a terrible reason not to do something. Especially when that something can help reward and retain the people best able to help you grow your business.

This post is based on my column at HBR

Recently Nina Mazar and I have been playing with the idea of probabilistic discounts.  The basic question is whether people would prefer a fixed discount of X% (lets say 10%) over a fixed probability X% of paying nothing for the product (lets say 10% chance of paying nothing).  So far it seems that probabilistic discounts are a huge hit.

So – I decided to try a type of probabilistic promotion for my second book (“The Upside of Irrationality”).  Here is the deal:

If you buy “The Upside of Irrationality” in any version (physical, e-book, enhanced e-book, or audio) between now and Nov 20^th, keep your receipt, follow this link, and fill in your information.

If you are selected (at random) I will invite you to have dinner with me (now, is this a positive or negative experience?)

Interested?

p.s I travel so much that I am sure we can find a time and location that would work well.

In many past experiments we have shown that people are often overly excited about things that are FREE (see Predictably Irrational).  An interesting opportunity to further look at this behavior presented itself when a few weeks ago a nightclub in New York City promoted an event with “free tattoos,” and we just had to check it out to see if the offer would tempt people to get one…

A large open room in an old industrial building with three wooden picnic tables lined up end to end in the center of the room. The tattoo station was a small portable table, two folding chairs and a cheap floor lamp.  Our research assistant, with her clipboard, was by far the cleanest and most official looking person around.  And when she offered to help the tattoo artist by taking the names of the people in line, he was delighted. In the 5 hours she was there (from 9pm to 2am) a total of 76 people signed up for free tattoos.

Who are these people?

The line for free tattooed was composed of the same number of males and females. The age range was 18 (underage for the event) to 47, with an average of 26.  As they were deciding to stand in line for the free tattoo we asked the participants how drunk they were at that point, and the average level of reported drunkenness was surprisingly low at 2.64 on a scale from 1-11 (however, it was later discovered that a better question to ask may have been “How intoxicated, drunk or high do you feel right now?”).

What were they getting?

Overall, the tattoos people wanted were very creative. Some notables were the phrase “Holy Snacks” on the inside bottom lip; one 27-year-old male wanted a Nintendo controller tattooed onto his left ribs; there was a request for a penis tattoo, and a few people wanted some version of infinity in English or in Swahili (Umilele).  Another notable groups were the 4 individuals that did not know what they wanted, but knew that they wanted some free tattoo, and 5 individuals that did not know where they wanted it.

Was it the FREE?

When we asked the people in line for the free tattoos if they would get the tattoo if it were not free, 68% said they would not.  They were only getting it because it was free.   We also asked the participants if they knew that there were free tattoos being offered at the party.  The 90% that knew they would be giving away free tattoos were asked two follow-up questions.  First, when asked when they made their decision to get a tattoo that night before or after arriving at the party, 85% said they made their decision before arrival and 15% made the decision after arriving.  When further asked, on a scale of 0-100, how likely did they think they were to get a tattoo that night, people were on average 65% sure they would be getting a tattoo.

As the research assistant was collecting the data, another tattoo artist (not the one that work working that evening, but a competitor) stopped by to tell give us her opinion about the free tattoo practice. This petite brunette, with a medallion tattoo on her lower sternum, felt it was her responsibility to tell us in gory detail about all the unhygienic and potentially health hazardous practices she had witnessed throughout the evening. She talked about how a contaminated paper towel had been passed around and how an obvious necessity missing from the set-up was any sort of disinfectant. She said all these practices could cause these people to contract a blood disease like Hepatitis, HIV, etc. Whether her concerns were valid or not, it became clear to us that the real cost of tattoos are not their price, but the odds for infections and long-term illness.

You decide:

The results indicate that the power of “free” is surprisingly influential.  When we face a decision about a tattoo, one would hope that the long term permanency of the decision, coupled with the risks of getting different types of infections would cause people to pay little attention to price, and certainly not to be swayed one way or another by the power of free.  But sadly, the reality (at list in the nightclub scene in New York) suggests that the power of free can get us to make many foolish decisions.  So next time, when you are facing a decision about a “free” offer, my suggestion would be to imagine what you would do if the price was not free and instead it was very cheap (maybe $1) — and ask yourself if this would change your behavior.  And if you would make a different decision if free was not involved, maybe this is a good sigh that the decision was not that good to start with?

Every profession is bound by written and unwritten rules and policies; some of them are set by organizations while others are an integral part of the occupation you choose. For example, doctors have to swear by the Hippocratic Oath, lawyers cannot divulge any privileged attorney-client conversations, and priests cannot reveal what was said to them in the confessional. The same kind of ethical code exists in the profession of accountancy because it is a means of public service. As Robert H. Montgomery put it, “Accountants and the accountancy profession exist as a means of public service; the distinction which separates a profession from a mere means of livelihood is that the profession is accountable to standards of the public interest, and beyond the compensation paid by clients.”

However, accountants are plagued by deep ethical dilemmas – there may be times when their employers ask them to twist and tweak the financial position of the company because they’ve had a bad year. The usual spiel given is that they’re definitely going to rake in the profits in the months that follow and that the deficits that have been covered up this year will more than be taken care of in the years to come. So the accountant is left wondering if he/she should be loyal to their professional ethics or show loyalty to the company that has hired them.

To overcome this type of problems, ethics is taught as a subject when you choose to study accountancy, because you are responsible not just to your employer, but also to the general public who believe in your reports and statements and take important decisions based on your word. An important question here if course is how effective are ethics classes, and even if they are successful how long would their influence last (a week? a month? a year? 2 years?).  It is hard to believe that taking one or two classes on ethnics while studying accountancy is going to have a long term effect, and most likely higher standards and more strict definitions of continuing are needed (and maybe also higher frequency of education).

In other cases accountants are torn between reporting misbehaviors that are going on and between minding their own business – should they open up a can of worms and be at the center of a controversy or just take heart in the fact that they were true to the ethics of their profession? This type of cases present the “action inaction bias” where in general people view their own actions as much more important than inactions – which means that accountants are more likely to care about their own actions than about reporting the actions of others.  Yet, accountants must remember that they are accountable for not just their actions, but also their non-actions, if either tend to affect the public adversely.

Overall the study of accountancy, and understanding its challenges is not only important in its own right, but it also provide an important case from which to view problems of conflicts of interest

By-line:

This guest post is contributed by Omar Adams, he writes on the topic of online accounting degrees . He welcomes your comments at his email id: omaradams47@gmail.com.