Monday, July 16, 2012

Using time to heal payment wounds

Ever noticed those print and billboard ads for expensive cars that tell you how little per week you have to pay to own the latest model?  Welcome to "duration neglect", our tendency to ignore the time period over which we would need to repay and concentrate instead on the size of the repayments.

Short-term bias
Lurking behind duration neglect is the behavioural principle of short term bias.  In effect, we can better understand the impacts of something in the short rather than longer term. That means I can more easily make an assessment of the impacts of the repayment on my financial circumstances in the coming weeks and months, but I can't readily comprehend the impact having to make the repayment every period over the term will have on my lifestyle.  Added to that, I can easily see the benefit the product I am buying will have, but I will be fuzzy on whether I'll still be enjoying it in two years time.

Big ticket items like cars and mortgages use duration neglect to great effect. For example, say I was going to buy a fancy car for $89,000.  Weekly repayments over 12 months would be $1,700.  Let's spread that out over 24 months instead. Wow, now only $856.  Seems obvious, but that doesn't mean every business is using this "duration neglect" to best frame their costs.

1. Soften the blow
As all shrewd business folk know, when a customer baulks at the price it is sensible practice to reduce its impact.  Whilst discounts are an obvious strategy, breaking the payments down into time periods is another useful tactic, for instance marketing the weekly or monthly value with greater prominence than the yearly value*.  Phone companies are masters at this. I mean, who would want to pay over $1,700 for an iPhone for two years? Much more tolerable to pay $72 a month.

Remember that having a conversation with a customer about what the total value means when you think of it over a daily, weekly or monthly period is different from actually marketing, contracting and structuring your payment terms this way.  The first is helping the customer contextualise the amount they will spend by using smaller units ("it's like two coffees a week"). The second is this plus a contractual arrangement that has implications for your business cash flow.

(*Please confirm your legal obligations as they relate to disclosure of the full value over the contract period.)

2. Consider the peak-end rule
The peak-end rule in behavioural economics effectively means that people judge the experience based on the highest/lowest point and the conclusion.  Now if they receive the goods immediately and pay the balance later, this will obviously be a high point. For that reason I'd suggest getting as much money at that point as possible, when excitement is at its peak.

But what if my customer is cash-strapped? Fair enough, and "buy now, pay later" can be a very effective inducement. In that case, better to have instalment options so the customer doesn't get slugged at the end.  Paying a big sum for a couch that now has stains and dog hair on it will hurt.

If they are layby-ing (paying by instalment) and receive goods at the end, you can consider making the final payment the largest to again couple it with the benefit of the product.

So the key lesson for businesses from duration neglect is to consider how best to discuss and structure your costs. Of course, I would also caution you to consider the financial circumstances of your customer and comply with your legal and ethical obligations.

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