Economists have now discovered (or at least most of them have) that people are not efficiency robots, but they are what economists call “behavioral”, and what non-economists call “human”. What does this mean? Well, it turns out that people have biases, people can be lazy, people sometimes work against themselves and often make detrimental choices.
Before all the “humans” out there choose to laugh at economists, however, it should be pointed out that many people fail to see the behavioral in all of us. We often think we’re being perfectly rational in our decision making, when in reality we’re just being plain old human.
Exhibit A: The Bread Maker
When Williams-Sonoma first released the bread maker in the US, very few customers were interested. No one had felt a particular need to make their own bread before, and merely adding another kitchen appliance seemed like a needless bother, especially at a price tag of $275. Marketing endeavors were made in order to show the fun of bread making, as well as the freshness of bread, but people still preferred to buy their fresh bread, bake it in the oven, or to be happy with their store bought bread. Williams Sonoma was about to ditch the personal bread making idea altogether, but decided to hire a consulting firm as a last ditch attempt to improve sales. The firm suggested they create a second, more expensive model. This model, at $429, was designed to be much too expensive and big for household purposes, but should be placed next to the original model. Suddenly, the choice consumers faced wasn’t whether or not to buy an expensive bread maker, but which bread maker to buy. Since they were “rational” consumers, they of course chose the bargain at $275 rather than the bigger $429 model. This is called Price-Anchoring in economics-speak.
Exhibit B: Cheerios
When one shops at a store like Safeway, they have a choice between the Cheerios brand and the store brand (in this case, Safeway). The Cheerios brand will often cost twice as much as the store brand, yet many people prefer to buy it regardless. Why is this? Well, most will answer it is quality. Would you rather buy cereal from a company that specializes in quality cereal or from one that just makes it on the side on the cheap to make extra sales? But wait a minute, does this mean that Safeway has a factory making its own Cheerios brands and, if so, does it also make its own milk, coffee, frozen chicken and everything else that is a store brand? If so, where are all its factories and why is it spreading itself so thin? Is this really a viable business model?
The answer, of course, is no. Safeway doesn’t produce any of its own food, they merely distribute. So what are you buying when you buy the Safeway brand? Usually you’re buying Cheerios, or another expensive brand. The reasoning is that the cheapest and most expensive brands will not cannibalize each other, since they cater to different markets. This means it is profitable for Cheerios to sell a portion of its product on the cheap to Safeway and sell the rest at a high mark-up to consumers. Safeway, in the meantime, repackages the Cheerios and can sell them at a lower mark-up. Both firms end up making money, since they can use one product to cater to two very different consumer groups. The consumers, on the other hand, are being quite behavioral in their decision making when they buy cheerios.
Interestingly, even after knowing (and acknowledging) this fact many consumers will opt for the Cheerios brand. This is due to “signaling”, which is another topic for another post.
In what other ways do consumers behave irrationally?