Did you know that the human desire for fairness distorts their ability to make sound financial decisions? A business that understands how fairness can affect human perceptions can avoid unexpected, and often catastrophic outcomes by properly framing their marketing message.
As Dan Ariely, the author of Predictably Irrational is fond of saying; humans react irrationally. This is especially true when it comes to financial reasoning-and how they perceive price and value when fairness is part of the equation.
From a purely logical standpoint, when consumers evaluate any transaction, they should simply compare the value they receive to the price they pay. If a piece of advice they received can save them $10,000, they should have no problem paying $1,000 for it. Any logical person would make a $1,000 investment if it saved them $10,000 every day, since they received $10,000 in value for the price of $1,000.
However, being human we often do not respond logically. Real people not only compare value to price. but also factor in other elements when assessing a transaction. Fairness is one of those irrational factors that we let creep into our decision making and that is the subject of this post.
As consumers, we all have a fairness barometer. In fact, as consumers, we have an irrational propensity to punish companies based on our perception of fairness, even if our actions hurt us in the process. Allow me to explain with an example.
Some years ago, Coke began to equip its Coke machines with a thermometer that measured the outside temperature. The machines included a way to charge a little more for a can of soda on hotter days, and a little less on cooler days. From a purely economic standpoint, it was a true supply and demand problem that Coke was trying to address.
It takes more energy to keep the sodas cold on hot days and the demand for drinks were higher so they often sold out before they could be restocked. When Coke began to roll out the new machines, people hated it which they took out on the Coke brand. Coke was trying to solve a problem with what they thought was a win-win for both retailer and consumer, but consumers saw Coke as trying to gouge them, which they deemed as unfair. The whole incident got so ugly that CEO M. Douglas Ivester resigned over the incident.
However, why did consumers think it unfair for Coke to charge more on hot days, while the same people are not outraged about paying more for a mid-morning flight then one in the early morning, or more to fly on Mondays and Fridays than on Tuesdays through Thursdays? The answer lies in the fact that the Coke machine was perceived as charging more purely as a supply and demand issue that the consumer could not control, resulting in feelings of unfairness.
Airline tickets, while also priced based on supply and demand criteria, have an additional component of convenience. Not having to get up at o-dark-thirty to make a 6:00 am flight is a convenience that people perceive as fair. However, varying the price based only on supply and demand issues are perceived as unfair.
Two changes in marketing could have accomplished its goal without triggering fairness issues.
Had one coke machine been placed, say outside at a clubhouse for golfers to get a cold drink at the turn that charged them say $1.25, yet the club had another coke machine in the pro shop in the indoor tennis facility with air conditioning that charged only $1.00, consumers would have seen that the outside Coke machine was more convenient for them and accepted the difference in price.
Moreover, the prices at the Coke machine could have been raised to the $1.25 price citing a cost increase. and then made it clear in their marketing that they on cold days, they were offering a $.25 discount. A discount is always viewed better than a surcharge.
In another example, Netflix used to offer a DVD mail-in service, plus their streaming option for $9.99 a month. Netflix saw that users tended to use either the DVD mail-in service or the streaming option, but generally not both. Thinking they were doing the customer a favor, they split the services and charged only $7.99 for each service.
For most consumers, the cost actually went down by $2.00 a month. However, many consumers thought that Netflix was pulling a fast one so that they could charge them more. Even though most people used only streaming or the mail-in service, consumers thought that it would now cost them $15.98 to get both options which seemed unfair in their eyes. As a result, Netflix lost over a million subscribers because subscribers felt the pricing change was unfair.
The problem was that the Netflix DVD mail-in service and Netflix Streaming were both associated with the same business – Netflix. It suffered the same perception issues as the same Coke machine having two prices based on outside temperature. Just like separating the two coke machines to make the price difference associated with convenience, Netflix failed to share that one of the reasons for splitting the pricing was that it created a whole new business called Quickster for the DVD mail-in service. Had Netflix announced the split and then announced the price change, I’m sure it would have been perceived quite differently.
Charging more based on conditions that the consumer cannot control often raises feelings of unfairness. However, offering a discount for the same conditions seems more acceptable. Also, charging more if the consumer associates the increased price with convenience will be perceived as acceptable.
In the end, customer segmentation and charging one cohort more is a great way to boost profit margins, however, the messaging is equally as important, or you risk introducing the fairness effect which can have catastrophic effects and destroy your brand.
How can you use your understanding of fairness to make better business decisions around pricing?
