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

Also by William Poundstone

Big Secrets
(1983)
The Recursive Universe
(1984)
Bigger Secrets
(1986)
Labyrinths of Reason
(1988)
The Ultimate
(1990)
Prisoner’s Dilemma
(1992)
Biggest Secrets
(1993)
Carl Sagan: A Life in the Cosmos
(1999)
How Would You Move Mount Fuji?
(2003)
Fortune’s Formula
(2005)
Gaming the Vote
(2008)

Priceless

The Myth of Fair Value (and How
to Take Advantage of It)

William Poundstone

Hill and Wang
A division of Farrar, Straus and Giroux
New York

Hill and Wang
A division of Farrar, Straus and Giroux
18 West 18th Street, New York 10011

Copyright © 2010 by William Poundstone
All rights reserved
Distributed in Canada by D&M Publishers, Inc.
Printed in the United States of America
First edition, 2010

The perceptual illusion on page 37 is copyright © 1995 by Edward H. Adelson.

Library of Congress Cataloging-in-Publication Data

Poundstone, William.

Priceless : the myth of fair value (and how to take advantage of it) / William Poundstone.—1st ed.

      p. cm.

Includes bibliographical references and index.

ISBN: 978-0-8090-9469-1 (hardcover : alk. paper)

1. Pricing. I. Title.

HF5416.5.P66 2009

338.5’2—dc22

2009015726

Designed by Jonathan D. Lippincott

www.fsgbooks.com

1  3  5  7  9  10  8  6  4  2

To Larry Hussar

Part 1

  1 The $2.9 Million Cup of Coffee

  2 Price Cluelessness

  3 The Myth of the Boomerang

Part 2

  4 Body and Soul

  5 Black Is White

  6 Helson’s Cigarette

  7 The Price Scale

Part 3

  8 Input to Output

  9 Lunch with Maurice

10 Money Pump

11 The Best Odds in Vegas

12 Cult of Rationality

13 Kahneman and Tversky

14 Heuristics and Biases

15 The Devil’s Greatest Trick

16 Prospect Theory

17 Rules of Fairness

18 Ultimatum Game

19 The Vanishing Altruist

20 Pittsburgh Is Not a Culture

21 Attacking Heuristics

22 Deal or No Deal

23 Prices on the Planet Algon

Part 4

24 The Free 72-Ounce Steak

25 Price Check

26 Shilling for Prada

27 Menu Psych

28 The Price of a Super Bowl Ticket

29 Don’t Wrap All the Christmas Presents in One Box

30 Who’s Afraid of the Phone Bill?

31 Breakage and Slippage

32 Paying for Air

33 Cheap and Cheaper

34 Mysteries of the 99-Cent Store

35 Meaningless Zeros

36 Reality Constraint

37 Selling Warhol’s Beach House

38 Groundhog Day

39 Anchoring for Dummies

40 Attention Deficit

41 Drinking and Deal Making

42 An Octillion Doesn’t Buy What It Used To

43 Selling the Money Illusion

44 Neutron Jane

45 The Beauty Premium

46 Search for Suckers

47 Pricing Gender

48 It’s All About Testosterone

49 Liquid Trust

50 The Million-Dollar Club

51 The Mischievous Mr. Market

52 For the Love of God

53 Antidote for Anchoring

54 Buddy System

55 The Outrage Theory

56 Honesty Box

57 Money, Chocolate, Happiness

Notes

Sources

Index

In 1994 an Albuquerque jury awarded Stella Liebeck $2.9 million in damages after she spilled a piping-hot cup of McDonald’s coffee on herself. This resulted in third-degree burns and precious little sympathy from the American public. Late-night comics and drive-time DJs turned Liebeck into a punch line. Talk radio pundits saw the lawsuit as Exhibit A to What’s Wrong with Our Legal System. A
Seinfeld
episode had Kramer suing over spilled coffee, and a website inaugurated the “Stella Awards”—booby prizes for the wackiest perversions of the justice system.

Liebeck’s injuries were no joke. Her grandson had driven her to the McDonald’s drive-through window. They bought the coffee, then pulled over and stopped the car so that Mrs. Liebeck could add cream and sugar. She steadied the cup between her legs as she pried off the lid. That’s when it spilled. Liebeck racked up $11,000 in medical bills for skin grafts on her groin, buttocks, and thighs. The tricky question was, how do you put a price on Liebeck’s suffering and McDonald’s culpability?

Liebeck initially asked the fast-food chain for $20,000. McDonald’s dismissed that figure and countered with a buzz-off offer of $800.

Liebeck’s attorney, New Orleans–born S. Reed Morgan, had ridden in this rodeo before. In 1986 he sued McDonald’s on behalf of a Houston woman who also had third-degree burns from a coffee spill. In his most mesmerizing Deep South baritone, Morgan advanced the legally ingenious theory that McDonald’s coffee was “defective” because it was too hot. McDonald’s quality control people said the coffee should be
served at 180 to 190 degrees Fahrenheit, and this was shown to be hotter than some other chains’ coffee. The Houston case was settled for $27,500.

Morgan monitored subsequent coffee lawsuits closely. He knew that in 1990 a California woman had suffered third-degree burns from McDonald’s coffee and settled, with no great fanfare, for $230,000. There was one
big
difference. In the California case, it was a McDonald’s employee who had spilled coffee on the woman.

Since Liebeck had spilled the coffee on herself, logic would say that her case was worth a lot less than $230,000. Morgan ignored that precedent and used a controversial psychological technique on the jury. I will describe that in a moment. For the time being, I will represent it with a row of dollar signs:

$   $   $   $   $   $   $   $   $   $   $   $

The technique worked. As if hypnotized, the jury awarded Liebeck just under $2.9 million. That was $160,000 in compensatory damages plus $2.7 million in punitive damages. It took the jury four hours to decide. Reportedly, some jurors wanted to award as much as $9.6 million, and the others had to talk them down.

Judge Robert Scott apparently thought the jury award was as outlandish as almost everyone else in America did. He slashed the punitive damages to $480,000.

Even with the reduced award, an appeal from McDonald’s was inevitable. The eighty-one-year-old Liebeck wasn’t getting any younger. She soon settled with McDonald’s for an undisclosed amount said to be less than $600,000. She must have recognized that she had hit a home run and wasn’t likely to repeat it.

Skippy peanut butter recently redesigned its plastic jar. “The jar used to have a smooth bottom,” explained Frank Luby, a price consultant with Simon-Kucher & Partners in Cambridge, Massachusetts. “It now has an indentation, which takes a couple of ounces of peanut butter out of the product.” The old jar contained 18 ounces; the new one has 16.3. The reason, of course, is so that Skippy can charge the same price.

That dimple at the bottom of the peanut butter jar has much to do with a new theory of pricing, one known in the psychology literature as
coherent arbitrariness.
This says that consumers really don’t know what anything should cost. They walk the supermarket aisles in a half-conscious daze, judging prices from cues, helpful and otherwise. Coherent arbitrariness is above all a theory of relativity. Buyers are mainly sensitive to relative differences, not absolute prices. The new Skippy jar essentially amounts to a 10 percent increase in the price of peanut butter. Had they just raised the price 10 percent (to $3.39, say), shoppers would have noticed and some would have switched brands. According to the theory, the same shopper would be perfectly happy to pay $3.39 for Skippy, just as long as she doesn’t know there’s been an increase.