Priceless: The Myth of Fair Value (and How to Take Advantage of It) (22 page)

Another beer problem: Joe Sixpack is reaching for a brew on the market shelf. There’s a premium beer that costs $2.60, and a bargain brand that’s only $1.80. The premium beer is “better” (whatever that means). Connoisseurs have rated the premium brand 70 out of 100 in quality, while the bargain brand is only a 50. Which should Joe buy?

Joel Huber and Christopher Puto, then a professor and grad student at Duke University’s school of business, posed this dilemma to a group of business undergraduates. The students preferred the premium beer by a 2-to-1 margin.

Another group choose among three beers, the two above and a third with a rock-bottom price of $1.60 and a quality rating in the basement (40). Not a single student wanted the super-cheap beer. Yet it affected
what they did choose. The proportion of students choosing the original bargain beer rose to 47 percent, up from 33 percent. The existence of the super-cheap beer legitimized the bargain beer.

In another set of trials, the three choices were the original bargain and premium beers, and a super-premium beer. Like many upscale products, this was much more expensive ($3.40) and only a little better in quality (rated 75). Ten percent of the students said they’d choose the super-premium beer. An astonishing 90 percent chose the premium beer. Now nobody wanted the bargain beer.

It was like pulling the strings on a marionette. Huber and Puto found they could make the students want one beer or the other, just by adding a third choice
that few or no one wanted
.

Choosing an American beer
ought
to be simple. A profusion of blind taste tests claim that avid drinkers can’t tell Budweiser from Miller from Coors. Since all mass-market beers taste pretty much alike, the one trade-off is between price and quality (and you have to wonder whether “quality” is an illusion of marketing).

Look at the chart on the previous page. The ideal beer would be both cheap
and
high quality, falling in the upper left-hand corner. I don’t have to tell you, that’s not the way beer or life works. There is usually a correlation, however loose, between price and quality. That means that brands tend to fall in a diagonal line from lower left to upper right.

In order to raise the market share of the bargain brand A, Huber and Puto found, you need only offer a cheaper option C. C becomes a “decoy.” It probably won’t get much of the market itself, but it will exert an attraction effect, shifting consumer choices downscale to the original bargain brand A. Likewise, adding a high-priced decoy D (instead of C) pulls consumers upscale, augmenting the market share of the premium brand B.

After the choosers had stated their choices, Huber and Puto asked them why they had chosen as they did. The answers made a certain amount of sense. Those who had chosen the middle-priced option of three described their decision as “safe,” a “compromise” choice. The cheapest beer might taste terrible, and the most expensive might be a ripoff, but one in the middle of the pack ought to be okay.

Huber and Puto’s paper, published in a 1983 issue of
The Journal of Consumer Research
, is now a foundation of contemporary marketing. They remarked, however, that businesses had already intuited these ideas. Anheuser-Busch’s Budweiser was the nation’s best-selling premium beer when that company began an aggressive promotion of a super-premium brand, Michelob, in the 1960s. Were it true that beer drinkers know exactly what they want and how much to pay, Michelob would have cannibalized the market for Budweiser. Instead, the total of Budweiser and Michelob sales increased. Huber and Puto argue that Michelob made Budweiser appear “less extreme, less expensive, and less elite.” Some Budweiser drinkers switched upscale to Michelob, but this was balanced by buyers of cheaper beers switching up to Bud. In other words, Michelob ads made some Miller people switch to Budweiser. Overall, Anheuser-Busch came out ahead.

The attraction effect has been used dynamically. In 1961 Procter & Gamble introduced Pampers, a brand of disposable diapers. Originally, Pampers’ competition was cloth diapers. The disposables were seen as being more convenient and far more expensive. In 1978 Procter & Gamble rolled out a higher-priced brand of disposable diapers, Luvs. Besides
capturing whatever market existed for upscale disposable diapers, Luvs presented a contrast, convincing cloth diaper users that Pampers was not such a pricey indulgence after all. By the mid-1990s, times had changed again. Parents had switched to disposable diapers, except for a minority of the environmentally sensitive. Procter & Gamble decided it could use a downscale decoy more than an upscale one. Starting in 1994, Luvs was respositioned as a bargain brand.

The one psychophysics term on the lips of Prada store managers is “anchor.” In the luxury trade, that describes an obscenely high-priced article displayed mainly to manipulate consumers. The anchor is for sale—but it’s okay if no one buys it. It’s really there for contrast. It makes everything else look affordable by comparison. “This has been a strategy that goes back to the seventeenth century,” Paco Underhill said recently. “You sold one thing to the king, but everyone in court had to have a lesser one. There’s the $500 bag in the window, and what you walk away with is the T-shirt.”

Today the strategy can mean five-figure handbags and seven-figure watches. In the midst of the grimmest recession since the 1930s, Ralph Lauren was hawking a “Ricky” alligator bag for $14,000. Hermès has a watch for $330,000, and an even million will buy Hublot’s One Million $ Black Caviar Big Bang watch “with 322 black diamonds invisibly set to conceal any sign of metal.” (The metal being concealed is 18K white gold.) Who would pay $1 million for a watch? That is exactly what you’re supposed to ask yourself. The follow-up question is how much
would
you pay for a really nice watch? These are similar to the questions posed in anchoring experiments and probably have the same result.

An anchor price tag is like the dazzling white ring in S. S. Stevens’s experiment. It makes the drabber shades of shopaholic gray look like a bargain. High prices also work like shills. They convince shoppers that
somebody
must be paying that kind of money (otherwise why would they have it on display?). This is not necessarily a correct conclusion. Hublot
made only one million-dollar watch (and cagily identifies it as a special order). Hermès made two of its $330,000 watches, and ultra-expensive handbags are often one to a flagship store. The illusion of an authentic supply-and-demand market for such things is aided and abetted by the
Robb Report
and the celebrity press. Eva Longoria was photographed carrying a Coach “Miranda” bag in hot blue python skin! Whether she paid list for it is beside the point.

Even in the best economic times, luxury stores are Potemkin villages, existing to convince aspiring materialists of a world richer, more spendthrift than it actually is. Marketing consultant Dan Hill of Sensory Logic said that successful stores use high-priced items to create “a mixture of anger and happiness.” Upper-middle-class consumers are
angry
because they can’t afford the gear featured in the store and worn by celebrities. The knee-jerk reaction is to get
happy
by buying something else.

One of the key insights of behavioral pricing is that items that don’t sell can change what does. Amos Tversky liked to tell this story. The Williams-Sonoma chain, known for high quality and prices to match, once offered a fancy breadmaker for $279. They later added a somewhat bigger model, pricing it at $429. Guess what happened?

The $429 model was a flop. Unless you’re running a boarding school, who needs a bigger breadmaker? But sales of the $279 model nearly doubled. Clearly, there were people charmed by the idea of a quality breadmaker from Williams-Sonoma. The only thing that stopped them from buying was the price. It seemed high at $279. Once the store added the $429 model, the $279 machine was no longer seen as such an extravagance. It could be rationalized as a useful product that did nearly everything the $429 model did, at a bargain price. Adding another price point, even though hardly anyone chose it, increased the price consumers were willing to pay for a breadmaker.

As far as Tversky could tell, Williams-Sonoma didn’t plan things this way. Since then, retailers have gotten wise to contrast effects in prices. Extending the work of Huber and Puto, a 1992 paper by Tversky and Itamar Simonson laid down two commandments of manipulative retail. One is
extremeness aversion
. They showed through surveys (involving Minolta cameras, Cross pens, microwave ovens, tires, computers, and
paper towels) that when consumers are uncertain, they shy away from the most expensive item offered or the least expensive; the highest quality or the lowest quality; the biggest or the smallest. Most favor something in the middle. Ergo, the way to sell a lot of $800 shoes is to display some $1,200 shoes next to them.

“Contrast effects are ubiquitous in perception and judgment,” Simonson and Tversky wrote. “The same circle appears large when surrounded by small circles and small when surrounded by large ones. Similarly, the same product may appear attractive on a background of less attractive alternatives and unattractive on a background of more attractive alternatives. We propose that the effect of contrast applies not only to single attributes, such as size or attractiveness, but also to the trade-offs between attributes.”

This leads to their second principle,
trade-off contrast
. Go into a leather goods store and there will be dozens of handbags, none of them indisputably the best by anyone’s standards. One bag is more practical, one is more stylish, another is a more interesting color, and still another is 40 percent off. The customer, being loss averse, is uncomfortable with this cornucopia of choice. She fears she will pick bag A and then decide she should have picked B . . .

The trade-off contrast rule says that when item X is clearly better than an inferior choice Y, consumers tend to buy X—even when there are many other choices and it’s impossible to say whether X is the best choice of all. Just the fact that X is better than Y is a selling point, and it carries more weight than it reasonably should. Apparently the shopper tries to reduce anxiety by choosing an item that can be justified (to herself, to a friend, to a spouse cross-examining her on the credit card bill). She is able to talk herself into X because it’s so much better than Y.

Trade-off contrast is particularly important in the luxury trade, where brands have flagship stores selling their own goods exclusively. On top of that, retailers with strong brands have great flexibility on prices (a shopper who
must
have a Jimmy Choo pump doesn’t care so much what other brands are selling for). Simon-Kucher’s consultants often find themselves in the position of scolding clients for setting their prices too low. “Luxury goods prices are not directly linked to any type of costs,”
one SKP marketing report drily lectures. “The art of luxury pricing lies in quantifying the value-to-consumer regardless of cost, competitor or market prices.”

Coach allots only one or two ultra-expensive bags to each of its flagship stores. They are displayed beautifully, with the price in as large and legible a typeface as decency permits. Coach does not sell many of these bags and would probably be happy to sell none at all. To give one example, they have a $7,000 alligator handbag and a rather similar bag, in ostrich leather, for $2,000. Most shoppers would be hard put to guess which is the $7,000 bag and which is the $2,000 bag. Some will think ostrich more exclusive than alligator, anyway.

For trade-off contrast to work, one choice must be “inferior.” Since nearly everyone, even a Coach customer,
does
care about price, anything that appears to be gratuitously overpriced is an “inferior” choice in one important respect. A $7,000 bag makes a similar $2,000 bag more desirable. (It’s so much less expensive, and it’s still got the designer label!) This results in increased sales for the $2,000 ostrich bags—which might otherwise have been rejected as too expensive, too willfully over-the-top.

The realities of fashion fit well into Simonson and Tversky’s two rules. Serious style has always been expensive, uncomfortable, shocking, out there. A select few, of flawless body and bank account, can carry it off. Everyone else settles for something a bit more comfortable, pricewise and otherwise. A handful of near-unattainable items can manipulate the great mass of consumers.

Prada believes in engineering the context. It paid over $1,700 per square foot for its Rem Koolhaas–designed store in SoHo and is forking over equally stratospheric rents. It would not devote floor space to goods that hardly ever sell unless there was a reason for it. Trade-off contrast is part of the cost of doing business, like advertising or window displays or “starchitect” designs. It’s not unusual to find items similar to the high-priced anchor selling for a tenth as much. Anyone who can’t swing that can always try the $300 sunglasses. Or the $110 mobile phone charm. The British Prada website hints at where the money is (online, at any rate). It offers 10 makes of women’s shoes, 23 handbags, and 54 “gifts”—trinkets like keychains, bracelet charms, and golf tee holders. At £60 for a bracelet charm, the profit margin must be staggering.