A Pepsi is the same price for everyone, right? We each pay the same physical amount of money and receive the same drink after all. But outside of this physical exchange exists a separate psychological price. Imagine it’s summer, one of only three days of British summer, and as the heat beats down in the park, you dig around your bag for a bottle of water. Disaster — the bottle’s empty. Your lips start drying, your head feels dizzy but out of the corner of your eye, you spot a vendor wheeling a cooler filled with ice cold drinks. For the price of every other Pepsi, despite the fact you would happily pay more, you instantly feel replenished and resume sunbathing before it inevitably starts raining.
Mental accounting is a concept from Richard Thaler and is the idea that money’s value is not absolute, but actually relative. In the example above the vendor sold the Pepsi at normal price despite the obvious opportunity to change a little extra. Most people would feel they got a very fair price, despite getting charged the normal rate. Context also has an important influence, how money is received will bend and contort the value attached to the money. In non-behavioural economics jargon, this essentially means a Pepsi is not always equal to another Pepsi.
Consider the below examples:
- Person A is 60 years old and has earned £800k over the course of their career.
- Person B is the same age and has only earned £300k. Fortuitously, in answering an email from a Nigerian prince, they’ve recently received £500k. Bringing their total net worth to £800k, minus the cost of a small transfer fee.
Conventional economics would see Person A and Person B as the same in all aspects while Behavioural economics sees a slightly different story.
Person A has earned money steadily across a long career and will have designated ‘jars’ of money for each aspect of their life: holiday, bills, savings, food or money for a rainy day. If any jar is running low, it’s difficult mentally to reassign budget elsewhere. It was found in the US that one in five people who took out high-interest payday loans, still had money in their savings account. The cost of incurring the interest rates on the high-interest loans was physically more bearable than the psychological pain of moving the savings jar to the bills jar. Such behaviour is completely irrational considering that the high-interest will erode savings in the long-term.
Person B will have the same amount of jars just with less cash stashed in them. A cash injection of five hundred thousand pounds leaves room for all sorts of irrational behaviour. Money that’s considered a ‘win’ is more likely to be spent gambling. Person B may decide to double down on their lucky moment and try to make it one million pounds. Perhaps, if the cash injection was passed on from relatives, the money would be spent on doing something of a higher importance such as donating to charity, as those that receive inheritance are more likely to do.
The advertising implication becomes clearer when you consider another of Thaler’s concepts: transaction utility. Essentially, consumers use a cost-benefit analysis when deciding what to buy. The cost of the product is subtracted from the perceived pleasure of owning the product. If the pleasure outweighs the cost, the purchase is made.
Traditionally advertising has tried to reach the audience with the highest perceived benefit. This makes intuitive sense as this audience is most likely to purchase. The opposite would be targeting people unlikely to use the product, which unsurprisingly isn’t a great business strategy. Mental accounting shows in actuality the opposite should be targeting those that perceive a lower relative cost, instead of a high relative benefit. Tipping the cost-benefit mental analysis into purchase.
This means finding the moments an audience perceives the relative cost to be less than the absolute. We could look at the difference in Person A and Person B and separate out how their wealth was accrued. Perhaps this could also mean separating the audience into their payment methods. For example, those that purchase with cash typically overestimate their spend by around 10% while those using contactless cards typically underestimate their spend (see Shotton’s The Choice Factory).
A Pepsi is therefore not always equal to another Pepsi. Why a Pepsi is purchased is mostly obvious — thirsty enough, tired enough or just enough of a craving. How a Pepsi is purchased is more difficult to analyse — payment, value of money used or context of recent monetary gains. Although on the surface the absolute price may always be the same, the mental accounting underneath will vary for each and every purchase. The why-how are two sides of the cost-benefit formula and entirely focusing on the why/benefit is a lost opportunity to address the formula from the other side.