Recently I read Predictably
Irrational. The book talks about human irrationalities. It’s a great
business related psychology book. I found two ideas relevant to why I like
companies with unique products. The two ideas are about relativity and
Always See Things in Relation with Others
The human brain is not equipped with a meter that
measures absolute value. So we usually rely on relativity. We look at things
around and compare. The picture below demonstrates this idea:
The two middle circles are the same size. But the one
surrounded by bigger circles looks smaller than the one surrounded by smaller
circles. We have no idea how big a circle is. We just look around and compare.
My personal example is when I looked for a phone
recently. I just need a phone to make calls and send messages. I don’t need a smartphone.
So, I used a simple, old phone for many years. But recently it broke. I decided
to buy a smartphone.
I found a used Google Nexus One on Amazon. It’s in very
good condition sold by a highly rated seller. It costs only $100. I was totally
impressed with its design at first sight. The specs look great for my need.
But it took me several hours to make a decision. That’s because
I compared it with other phones. A bigger screen would be better. A strong
battery would be useful. A Quad-core processor is definitely more powerful.
Jelly Bean looks cooler than Gingerbread.
Considering my need, I don’t think those phones are
different. But I still compared and had the urge to buy the best phone.
Finally, I chose Google Nexus One. (I’m quite a rational buyer!) I’m totally
satisfied with it although it seems obsolete compared with other phones.
My point is that we always look at things around us in
relation with others.
Rely on an Arbitrary Anchor
Beside relativity, people’s views on things are usually
influenced by some anchors. When it comes to price, we don’t know the value. So
we tend to rely on some arbitrary benchmark.
One example would be bargaining. In Vietnam, we always
bargain when shopping. If the listed price is $50, I would propose $30. If the
listed price is $30, I would like to pay $20. I have no idea about value. I
just know that it’s worth less than the listed price.
The U.S. version of this example would be a sale. Most
people want to buy clothes at 40-50% off the sticker price. They feel they
overpay when they pay the full sticker price. I think there are two anchors
here. The first anchor is the sticker price. The second is the percent discount
we usually get.
Won’t Know If a Product is Expensive without Comparison
We usually use both comparison and an anchor to value something.
We look at relative value between things and base our estimates on some basic
I think anchoring causes some misconception about Western Union (WU). When Geoff asked me
to analyze WU, my quick answer was “it might be too hard, the service is
expensive, and there can be a lot of changes.” But after I looked deeper, I
realized it’s not as hard as I thought. The service is not expensive like most
people think. Why did I think it’s expensive?
That’s because I always use PayPal to do money transfer
with friends. It’s free when I link my PayPal account to my bank account. My
experience with PayPal makes me think a money transfer fee should be close to
It’s different from the perspective of customers. I
talked to my cousin who went to work in Taiwan. He uses Western Union to send
money home every month. He’s highly satisfied with the service. Customers only
think a product is expensive when there’s a much cheaper alternative. Western Union
has a small price premium over competitors, but they keep the price
competitive. And PayPal is not cheap. PayPal International transfer from bank
accounts costs 0.3-3.3% fee and currency conversion. It costs over 3.4% to send
from debit card/credit card.
Can Be Manipulated
The idea about anchoring raises a problem in the
fundamental rule of supply and demand. There are two curves. The supply curve
tells how many units are available at each price. The demand curve tells how
many units customers want to buy at each price. The intersection of the two
curves indicates market price. The implication of the rule is that supply and
demand are two independent forces. But the idea about anchoring says that
demand can be easily manipulated by supply.
That’s why I think anchoring and relativity are relevant
to the profitability of selling unique products. Companies with unique products
can manipulate demand more easily.
Old Anchors by Being Unique
The example in the book is Starbucks (SBUK). We can be initially anchored to the price of
coffee at Dunkin’ Donuts or drinking coffee at home. How did Starbucks break
They make themselves unique through store ambience. For
example, their shops are fragrant with the smell of roasted beans, which are of
higher quality than those at Dunkin Donuts. They have fancy product names for
size like Short, Tall, Grande, and Venti, or for coffee like Caffe Americano,
Caffee Misto, Macchiato, and Frappuccino. The store experience is so different
that the previous anchor is no longer relevant.
If you’re satisfied, you’ll go back to the store. Once
you get used to spending $2.20 on a small cup, you may see $3.50 for a medium
or $4.15 for a Venti as normal. That’s because you have an anchor price for a
small cup. Paying some more for a bigger cup is normal.
I’m amazed at how Zara changes customer behaviors. They
introduce thousands of designs every year. But they produce limited copies for
each design. They usually sell out a design within 2 weeks. So, customers know
that if they don’t buy, the item would be sold out quickly. And they know Zara
rarely offers sale. With little time to look for alternatives to these unique
items, customers tend to buy immediately (at full price!).
is Usually Determined by an Established Anchor
Sometime, price is determined by an established anchor. That’s
common in content business. Products are unique, and companies don’t compete on
price. If people like a product, they’ll pay a common price. That’s why movies
don’t compete on price at movie theaters. That’s why a video game usually costs
The established anchor can also be changed. That’s my
concern with Nintendo (NTDOY). They
make casual games, not hard-core games like Call of Duty. With the rise of
mobile games, people may get used to a new price range for casual games. It’s a
big problem for Nintendo if the anchor their games are compared to drops from
$40 to $2.
Anchor Improves Perceived Value
Anchoring explains the retail strategy for fashion
brands. Companies want to anchor the value of their products as high as
possible. Prada wants to open stores next to Gucci. Gucci wants to be next to
Prada. They both want to keep themselves far away from Zara while Zara want to
be as close to them as possible.
The similar example in Predictably Irrational is when
James Assael, the king of pearl, introduced Tahitian black pearls. He bought
advertisements in the glossiest of magazines, which put Tahitian black pearls
among diamonds, rubies, and emeralds.
On the contrary, I think it’s a stupid idea for Hulu to
hope to convert free service customers into using pay service. They anchor
customers with a free service. That’s a very hard anchor to break.
The value of free is astronomical. Amazon (AMZN) was able to boost sale when they offer free shipping
for order over $25. That’s because customers may want to buy unnecessary books
just to get free shipping. But when they offer 10 cent shipping for order over
$25, sale didn’t improve at all. So, I would guess the free anchor is very hard
It’s different from giving a free trial. Giving a free
trial is a great idea. It doesn’t create an anchor. It actually helps to
increase perception value thanks to value of ownership. Basically, when you own
something, you value it more. We tend to value things that we own by fear of
loss. Customers after the free trial period may value the service more and are
more likely to subscribe.
Can Result in Pricing Power
Companies with unique products may also have pricing
power. When the products are not anchored to any price, the company can have
more freedom to increase price. It’s harder when there are comparable products
That’s why I prefer Games Workshop to giant Mattel (MAT) or Hasbro (HAS).
Hasbro and Mattel produce toys for the mass market. Their
pricing power is limited. Each toy is unique but it’s still a toy. Toys as a
category have to compete with other entertainment products. The price of other
products is out of Hasbro’s and Mattel’s control. And people can compare those
products with toys.
Also, there’s an anchor for toy prices. The price sweet
spot is from $10 to $20. Hasbro saw volume decline when they increased price
from $19.99 to $21.99. I think this has something to do with the way people buy
toys. Parents and grandparents usually buy toys on holiday. They tend to buy
several gifts at a time. A family with 2 kids may want to buy 5 toys. They have
a budget for toys because they also buy gifts for their spouse or friends. So,
they may not want to spend over $20 for a toy.
Games Workshop is another story. Those unfamiliar with
Games Workshop should read the discussion about the company at Interactive
Investor. Games Workshops produces hobby products instead of
toys. People are willing to spend a lot of money on a hobby. I don’t think that
people dedicate time and money to more than one hobby. Even if they do,
Warhammer is cheaper than most hobbies. By positioning Warhammer as a hobby,
Games Workshop aligns pieces of plastic with hobby products like golf clubs. People
don’t value a hobby product by how much it costs to produce. They value it by
the enjoyment they get. So, Game Workshop increases price every June. Hobbyists
complain but they still buy and enjoy.
So, I think relativity and anchoring are powerful ideas
in learning customer behaviors. I think companies with unique products can have
pricing power thanks to the lack of comparison and price anchor. They can also
improve value perception by getting closer to other high value unique products.
And when there’s no comparison, companies just need to maximize the price they
can sell, and make sure that customers enjoy the products.
Talk to Quan about Relativity and