Imagine that you’re at the cinemas, gone to watch the movie you had been waiting for since forever. During the interval, you venture out to buy some coke. The waiter asks you the size of the glass you wish to drink the coke in. There are 2 sizes-small, which costs Rs. 200 and the large one which costs Rs. 400. Naturally, you’re inclined to buy the cheaper one. Now, the waiter presents you with the middle size which costs Rs. 350. Suddenly, the large sized-coke doesn’t seem too expensive, does it? You think “what does a few extra bucks matter anyway?” and buy a large-sized coke for yourself. Congratulations, you were just tricked to overspend without realizing it, thus becoming prey to the decoy effect.
The middle-sized glass was actually a ‘decoy’ used by the salesperson to steer you away from the cheaper one and ‘nudge’ you to buy the expensive one. This is a common marketing strategy used by companies, based on a cognitive bias known as the “decoy effect” or the “asymmetric domination effect”. It refers to the phenomenon wherein consumers tend to change their preferences when presented with a third “asymmetrically dominated” option. Being asymmetrically dominated means being dominated in terms of quantity, price, quality, etc. in comparison to one option and partially dominated in comparison to the other option. In our previous example, the middle-sized coke was asymmetrically dominated as it was dominated fully by the large-sized coke in terms of quantity but only partially dominated by the small-sized coke. The decoy effect was first discovered in the 1980’s by Joel Huber, John Payne and Christopher Puto who tested it out on students by using beers, cars, TV sets, and restaurants. Initially, it was noticed in only marketing but it has gradually extended to areas of healthcare, recruitment and even politics.
So how exactly does it work? Consumers tend to be under considerable stress while trying to choose between various options. This is known as a “choice overload”. This variety of choices hinders their decision-making and the decoy effect plays exactly on this principle. It makes them consider for purpose of simplification only two attributes- price and quantity and induces them to think that they made a rational choice themselves.
The most popular examples of this effect have been noticed in The Economist’s and Apple’s pricing. Dan Ariely in his book “Predictably Irrational: The Hidden Forces That Shape Our Decisions”, presented his experimental research based on the subscription pricing of the Economist and deduced the operation of the decoy effect. In one scenario, the students had an option of buying either a web-only option priced at $59 or a print-only option priced at $125; 68% chose the cheaper web-only option. However, when presented with a third a web and print subscription option available for $125, 84% chose the expensive combined option. Apple preys on consumers too by decoy pricing. After the launch of the iPhone X, priced at a whopping $1,129.99, iPhone 8 and 8 Plus were priced at $799. iPhone X has a variety of desirable features- facial recognition, night mode, wireless charging and what not. To make consumers pay a four-digit price for iPhone X, Apple used iPhone 8 as a decoy, since it stood asymmetrically dominated when compared to iPhone X.
The decoy effect has been considered a component of behavioral finance as well. A study based on gauging investor stock purchase decisions when a decoy was introduced was done by Brittany Paris of the University of New Hampshire. 3 groups of investors were made wherein the first group was given a choice between 2 stock options with long-term growth and dividend yield as the two attributes to consider. However, the second and third groups were introduced to a decoy and were thus induced to react differently than the first group of investors. The first group was given two stocks: A and B. Stock A had a 20% long term growth rate and a cash dividend yield of 2% while Stock B had a long term growth rate of 10% and 7% cash dividend yield. In experiment #2, a decoy was introduced to make the participants choose Stock A. The decoy had a long term growth rate of 15% and a cash dividend yield of only 1%. In experiment #3, participants were induced to choose Stock C, the long term growth rate of which was 8% and a cash dividend yield of 4.5%.
Many opponents of the decoy effect argue that this is a form of “gaslighting” or “manipulation” of consumers by making them think they made a good decision. Proponents of this effect argue back by saying that in the end, free will exists and it’s up to the customer wholly whether to make the purchase or not. They say that the ends justify the means and justify by saying there are more malicious things done to customers than this. There is no correct solution to this. It’s not something illegal and hence can’t be accounted for.
However, what can be done on our part as consumers is educating ourselves. We must start adopting ethical and rational decision-making. Think carefully while you’re making a purchase and ask yourself- “do I really need that extra bar of chocolate?” Adopt practices to really keep a track of on what and how much you’re spending because the reality is, you could be overspending a lot but it is happening so gradually that you don’t even notice it. Paying attention and staying clear in your head can go a long way in helping you make an intelligent decision.