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Personal Finance FAQ

Do Low Prices Deceive You?

Razor thin
Who wants five blades when you can have six?

“Give away the razor. Sell the blade.”
–Every MBA professor for the past fifty years

“IT CHEAP!”

That’s my Monkey Brain’s favorite saying. He knows that the soft spot in my heart is finding something on sale or something cheap. This is one of the few places where Monkey Brain and I have our interests aligned. We both like low prices.

However, Monkey Brain has trouble doing math. He isn’t familiar with the term Total Cost of Ownership, sometimes known by its acronym TCO. Monkey Brain often confuses cost and value. Actually, he doesn’t really care about value. He just cares about cost. Lower cost means he can go out and buy more things!

There are many instances where it benefits the seller to attempt to hide additional costs associated with a low up-front price. As M.I.T.’s Xavier Gabaix and Harvard’s David Laibson show, marketers have no incentive to educate customers about hidden fees because the uneducated customers will pay them, and educating the customers just shows them how to avoid the additional costs.

Let’s look at a couple of examples.

How many times have you checked in at an airport and been behind someone who expresses surprise, disgust, and then resignation at a checked bag fee? The person in front of you probably saw that the airline had the lowest fare, booked it, and went merrily to the airport, forgetting (or being ignorant of) the checked bag fee that is rampant throughout the airline industry. The airline has no incentive to remind this customer of the fee beforehand, lest he pack a carry-on and the airline lose the checked bag revenue.

The same holds true for hotels. Many hotels, particularly business hotels, still charge a wifi fee, even though guests could walk down the street and get free wifi for the cost of a cup of coffee at a café. Why do they do this? They charge the fee because they know that there is an inconvenience to packing up your laptop, heading down to the café, buying a cup of coffee, and then using the wifi. What if you need to surf the web at 3 AM? Good luck finding that open café. Hotels realize that there are people who will pay for the “convenience” of in-room wifi, and the inconvenience is not enough to get others to switch to a different hotel. Educated consumers will find alternatives, but it’s in the hotel’s interest to capture a reservation and then, once the guest is there, show the sign for the $19.99 wifi fee.

Monkey Brain sees the low initial costs and reaches out for them like a pile of bananas. Monkey Brain doesn’t like to do the additional work and searching to determine what something will truly cost. He sees the first price and becomes anchored to it.

Here’s how to fight the impulse to think that the first price is the best price:

  • Do a little more digging. Look at the website and also look on a search engine such as Google or Bing for additional fees. It’s worth spending the time up front before you’re mentally committed to a purchase to determine the total cost of ownership. Otherwise, you’ll feel mentally committed, the perceived switching costs will be too high, and you will just pay the fees. If you have a printer at home which eats ink cartridges, you know this feeling.
  • Reframe the cost away from the “sticker price.” Because of the anchoring bias, we mentally affix the first price we see to whatever it is that we’re buying. We have to fight this bias – the marketers want us to think of the low price first. That’s why car dealers advertise prices and then mention, in hurried and low voices, “tax, tag, title, and add-ons.” They want you to anchor on that base price and not deviate.
  • Don’t make the purchase right away if you don’t understand the total cost. It’s easy to become emotionally involved in a decision, and, as research has shown, you cannot concurrently have analytical and emotional thoughts. Want to read more about the conflict between emotional and analytical thinking? Subscribe to my 52 week Financial Game Plan and it will be a part of the series you receive!

Monkey Brain likes low numbers when it comes to price, but he doesn’t like to think about other numbers which are involved. That’s why it’s important to step back, evaluate, and properly think about the total cost of a purchase. If you can avoid add-on fees, then marketers will actually subsidize your purchase with the purchases of the unsophisticated Monkey Brain buyers.

Have you ever bought something you thought was inexpensive only to find out it cost a lot more than you expected? Tell us about it in the comments below!

By

Jason Hull, CFP®, was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business.

You can read more about him in the About Page.

2 replies on “Do Low Prices Deceive You?”

There are called marketing strategies for a reason. They lure the consumers to buy even if they don’t need it. And yes, they are quite effective. And I’ve been deceived a lot of times bu this. Sometimes I am aware, sometimes, I have no idea.

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