LP Login

Think Big. Move Fast.

Pretty interesting article in the current edition of the Economist about the psychology of discounting:

A team of researchers, led by Akshay Rao of the University of Minnesota’s Carlson School of Management, looked at consumers’ attitudes to discounting. Shoppers, they found, much prefer getting something extra free to getting something cheaper. The main reason is that most people are useless at fractions.

Consumers often struggle to realise, for example, that a 50% increase in quantity is the same as a 33% discount in price. They overwhelmingly assume the former is better value. In an experiment, the researchers sold 73% more hand lotion when it was offered in a bonus pack than when it carried an equivalent discount (even after all other effects, such as a desire to stockpile, were controlled for).

This numerical blind spot remains even when the deal clearly favours the discounted product. In another experiment, this time on his undergraduates, Mr Rao offered two deals on loose coffee beans: 33% extra free or 33% off the price. The discount is by far the better proposition, but the supposedly clever students viewed them as equivalent.

73% higher sales is an astonishing number that comes simply from positioning the same discount differently. Of course, this only helps if you are making a positive contribution margin on the sales!

This reminds me a bit of  Prize-Linked Savings accounts, basically savings accounts with a lottery ticket attached (that is bought by slightly lowering interest rates):

One way to think of these “prize-linked” accounts is that they can offer an expected market return, but in an innovative way. They pay a guaranteed return below market interest rates, but also provide a lottery ticket whose value makes up the difference.
To be specific, a lottery-lined savings account could offer a lower rate of interest, but also say a one-in-a-million chance of winning $1m for each $100 deposited. Mathematically, the expected return is the same, but the chance to win $1m makes the account much more attractive.
Britain has historically led the way with these sorts of savings opportunities, starting with the “million adventure” lottery in 1694. Households were offered 100,000 tickets at £10 each, with poorer groups able to club together to buy fractions of tickets. Holders received a 6 per cent annual return for 15 years, plus the opportunity to win a prize of between £10 and £1,000. Historians suggest the programme was popular and successful. More recently, much the same theory was seen in the UK’s Premium Savings Bonds, which offer the opportunity to win a prize but no base interest rate. From Brazil to Germany, Mexico to New Zealand, a variety of other prize-linked savings opportunities already exists.

This is another example where reframing the same economic returns can change user behavior. I wonder if framing a 33% off sale so that people buy at full price but with “Every third purchase free” might increase sales overall. Has anyon had any experience with this?

UPDATE: Recently found a really fun and relevant post on pricing experiments that is worth reading from conversionXL.

  • Nathans Schor

    Jeremy,
    First of all, great topic. It’s another reason I always open the Lightpseed email.

    There is another approach possible here. Instead of offering the reward as a ‘gift’ from the seller to induce purchasing, what if the reward was offered to the buyer at ‘no-cost’, explaining that the product has a cost but that charge was, in this case, reduced to zero.

    It’s the reason for the two seemingly similar deduction that matters. With ‘no-cost’ we are justifiably compensating the buyer for collaborating in the sales process and thus saving the seller marketing costs (for example, by exposing their purchasing intent information). In other words, a ‘no-cost’ reward is rightly earned by the buyer where ‘free’ is granted by the seller and typically viewed suspiciously by the buyer.

    Although semantically similar, ‘free’ and ‘no-cost’ are at polar opposites. The former is a seller-centric inducement to purchase, riddled with insincerity and so ubiquitous as to be worthless. On the other hand, the latter is customer-centric because it rewards buyers for explicitly collaborating in the sale transaction, thereby lowering the merchants costs.

    I’m working on a business model based on that distinction. I’m confident that once buyers appreciate the difference they will recognize the power they bring to the sales transaction.
    Nathan Schor nathans@netmeals.net

  • http://www.facebook.com/matt.mihaly Matt Mihaly

    At Iron Realms we ran that same experiment a couple times in the early 2000s and while we never quantified the number, it was pretty clear that there’s no doubt that giving a 25% bonus (on the virtual currency users buy from us) got us more in total revenue/participant during the promotion than a 20% off sale is (same thing). I suspect that since people are largely looking at the absolute numbers, the bigger the number you’re working with, the more effective it becomes to price with a bonus rather than as a discount. I’d also bet that there price points where the bonus multiplier is a whole number stand a chance of being less effective. It’s easier to implicitly recognize that a 100% bonus is the same as half off than it is to recognize that a 25% bonus and a 20% discount are the same thing.

  • http://www.facebook.com/svajian Stephen Svajian

    We have some interesting data on this. Would be happy to share, but would prefer to do so privately. If you email me at steve @ ybuy.com, we’ll send you some info on the way people respond to discount messaging.

  • http://twitter.com/teyc Chui Tey

    I don’t think maths is the problem in the case of the bank accounts. Transaction costs play a role as well. When the amount of money deposited is small, and the difference in interest of 0.1% is marginal to the depositor. The potential upside however, is sufficient to make the transaction worthwhile. The whole VC model is based around big upsides.

  • http://www.kixeye.com Paul

    @Matt My personal feeling is that discounts make the object seem less valuable (the seller values it less) while bonuses make it seem more valuable (have even more of our great product) – Speaks to the confidence the seller has in its product I think.

  • http://www.redbubble.com/people/Pilgrim mhosking

    Interesting. We have been testing free shipping vs discounts at Redbubble and free shipping consistently outperforms. Will try some other related creative options.

  • http://lsvp.wordpress.com jeremyliew

    Martin, Petflow has found the same thing.

  • http://www.facebook.com/chadledford Chad Ledford

    Even better, what if you offer a reward as an incentive to share the product. Offer free shipping if they share a product with their friends. We’ve seen great success with this using AddShoppers.com including lower cart abandonment and huge increases in social traffic.

  • Pingback: People still can’t do math – and what it means for pricing « Lightspeed Venture Partners Blog