Daniel Kahneman Helps Me Decipher Discount Strategies….and So Much More!
I started focusing on discount strategies last summer when my husband and I visited a small town in Wisconsin. We were traveling to Chicago for his 50th high school reunion, and decided to spend a few extra days in Lake Geneva, Wisconsin. The tourist magazine in our hotel had an ad for a fudge shop that sold “Mackinac Island” fudge. Conjuring memories of the delicious fudge from my childhood trip to Mackinac Island, Wisconsin, I was intrigued.
My husband and I went to the fudge shop and asked “what makes it Mackinac Island fudge?” We were told it is the process of making the fudge on large marble tables that originated on Mackinac Island. I was further perplexed that a ½ lb slab of fudge cost $11.00, but there was a special: if you bought two slabs you got one free. We left the store with three slabs, and spent $22 plus tax. Without the special, we likely would have purchased one slab for $11. I considered this marketing strategy to be bordering on genius, and I began paying close attention to discount strategies.
Technically, this was a 33% discount because we bought two slabs and got one free. What I found more amazing was that the discount strategy enticed me to spend $22 rather than $11, so the fudge shop owner doubled his revenue! I suspect many customers spent $22 in the shop due to their creative marketing ploy. An added bonus was that I was a happy customer, leaving the shop with three slabs of fudge when I expected to only buy one. We ate one slab during the trip, and froze the two remaining slabs when we got home.
Pondering this discount strategy led me to Daniel Kahneman’s research. Kahneman is a cognitive psychologist who won a Nobel prize in economics in 2002. He devoted his entire career to studying human behavior, and wrote a fascinating book titled Thinking Fast and Slow. He determined there are two ways we make decisions, and he labeled them System 1 and System 2. System 1 is fast, intuitive, and emotional. It runs automatically and cannot be turned off. It allows us to complete the phrase “bread and …….,” to go into a restaurant and know that we will sit in a chair at a table, and to drive the same route each day to our office. System 1 is working when we have an established habit. It runs on autopilot.
In contrast, System 2 is slow, and is required in complex computations and analysis. Examples include filling out a tax form, comparing two washing machines for overall value, or doing due diligence when selecting a financial planner. Only System 2 can follow rules.
Neuroscientists have shown that rational thinking (System 2) originates in the prefrontal cortex, which sits immediately behind our forehead. This is where contemplation occurs, such as weighing the pros and cons of an idea. The human brain has evolved with a larger prefrontal cortex than other animals, which allows us to consider different points of view. Or, to ponder concepts such as which discount strategies works best, and why.
Established habits (System 1) are stored in the basal ganglia portion of our brain, which is sometimes called the “ancient” or “reptilian” brain. Kahneman warns us that System 1 is eager to provide us with first impressions, intuitions, and feelings—all without any rational thought or analysis. Accepting the quick answers provided by System 1 can lead to irrational decisions, as shown in the following example which Kahneman describes as emotional framing.
Physicians at Harvard Medical School were given statistics about the outcomes of two potential treatments for lung cancer: surgery and radiation. The five-year survival rates clearly favored surgery, but in the short term, surgery was riskier than radiation. Half the participants were given statistics about survival rates; the remaining half received the same information in terms of mortality rates. The two descriptions of the short-term outcomes of surgery were:
- The one-month survival rate is 90 percent.
- There is 10 percent mortality in the first month.
You can predict the results. Surgery was much more popular when physicians were given the first statement. In fact, 84 percent of the physicians chose it. For the physicians who were given the second statement, 50 percent chose radiation. Kahneman offers advice for not allowing System 1 to lead us to make irrational decisions:
“The way to block errors that originate in System 1 is simple in principle: Recognize the signs that you are in a cognitive minefield, slow down, and ask for reinforcement from System 2.”
His advice to slow down and deliberately engage System 2 is pertinent for many current dilemmas. An obvious one in the United States is political views, where many people seem to be relying on peer pressure (System 1), rather than contemplating the pros and cons of one candidate versus another, which would require utilizing System 2.
Another issue involves the war between Russia and Ukraine, where the unprovoked invasion by Russia is leading to death and devastation for Ukrainians. Russians are also paying a high price for Putin’s aggression, so it is difficult to understand the logic.
Or, how about the attack on Israel on October 7, 2023 by the Hamas terrorist organization, based in Gaza? The attack was horrific with Israel reporting roughly 1,200 deaths and 240 people kidnapped (per Lior Haiat of Israel’s foreign ministry on 11-10-23). Americans are left using System 2 to determine if the Israeli military response in Gaza with over 30,000 deaths and 70,000 wounded (as cited by the Gaza Health Ministry on 2-29-24) is justified. Engaging System 2 to try to make sense of wars and violence seems essential.
How about the Roe vs Wade issue in the United States? I always wondered how the folks who are opposed to abortion rights for women could describe their stance as pro-life. I am definitely pro-life, but I believe women have a right to make their own decisions about health care. If I disagree with them, am I anti-life? Or, am I pro-choice? Perhaps I am pro-human rights and pro-women’s rights.
How about the gun lobby? They say “guns don’t kill people….people kill people.” Yet, my heart aches for the many people who are exposed to random violence from guns – especially the parents and siblings who lost loved ones in the many school shootings in America. System 2 forces me to ponder these issues.
Let’s return to a less stressful topic. Kahneman’s research (and System 2) led me to wonder about the effectiveness of commonly used discount strategies. There are strategies for 20% or 25% off site-wide, which I consider to be transparent and fair, and there are the “buy one, get one at 50% off (BOGO@50%) off strategies. This equates to a 25% discount, but only if the two items purchased cost the same amount.
Otherwise, the discount may be much lower because the 50% off is on the less expensive item. This is a bit deceptive, and can lead to a very small discount if the consumer does not engage System 2.
Then there are the “up to 40% off” deals, where the item I am interested in is often not discounted at all. The deception in this strategy sometimes makes me angry, and I wonder how other consumers react to misleading strategies. How do retailers gauge the effectiveness of their discounts? If they discount too often, consumers expect a discount at all times. If they don’t discount, some consumers may stop buying because they only want to make a purchase if they are receiving a discount.
In early November, my husband and I traveled to Denver to visit our daughter, and our hotel was in the Cherry Creek shopping area. After being frugal for far too many years, we gave ourselves permission to spend money, and boy did we have fun! We bought a winter coat for my husband at a North Face store at 25% off, which we considered a great deal. I found a winter coat at Nordstrom’s, and then patiently watched online for it to go on sale (25% off) on Thanksgiving Day. We found deep discounts at some stores, and virtually no discounts at others.
In mid-November, I began looking for Patagonia base layers for my husband as a Christmas gift, and could not find any sales. I paid full price, but continued to monitor Patagonia clothing on Patagonia’s website and REI’s website. Surprisingly, Patagonia didn’t announce a sale until January 10, 2024, and it is an “up to 40% off sale.” The base layer items are not included in the sale. I wondered if this is because Patagonia sells items for winter sports, so it is too early (in the winter season) to discount them? That would be logical. Or, is it because Patagonia wants to avoid discounts whenever possible, and they believe their clientele is loyal enough to be willing to pay full price? (I resolved this question when Patagonia and REI started offering attractive discounts in late February). Presumably, retailers are hesitant to discount too much, which may hurt their profitability, the prestige of their brand, and the viability of their firm long-term.
The pandemic drastically changed buying habits for many consumers. I am much more likely to order online now, even when I would prefer to try on a clothing item first. Online retailers are accustomed to large numbers of returns. Years ago, I don’t recall expensive cosmetics ever being discounted. It is now easy to find discounts when buying online from major department stores. Some stores—such as Bloomingdales and Nieman Marcus—offer gift card rewards, such as the “spend $200 get a gift card for $50” or “spend $2,000 get a gift card for $500.” From the retailer’s standpoint, this strategy makes more sense than providing a discount, because it ensures the customer will be coming back to spend the gift card at a later date.
The timing of discounts has also changed. I found plenty of attractive discounts in early November 2023. The discounts lessened after Thanksgiving and through Christmas. In mid-January they were back, with high-end clothing brands offering deep discounts to entice customers to buy their “old” merchandise to make room for new merchandise for spring. Several outdoor specialty sites offered big discounts in February.
Discounting has now become routine for many retailers. This year is a leap year, and several retailers offered 29% discounts online for a few days around February 29. I’ve learned to be patient, and wait for sales before I buy. Retailers may not be happy with this tactic, but I suspect they track my buying patterns so it is not a secret.
Daniel Kahneman’s work is important to me. I engage System 2 frequently. It allows me to delve into the discount strategies of retailers, and ponder far more important issues. Daniel turned 90 on March 5, 2024. Happy Birthday, and thank you, Daniel Kahneman.
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Donna Skeels Cygan, CFP®, MBA, is the author of The Joy of Financial Security. She owned a fee-only financial planning firm for over 20 years and is now writing a new book that will be published in 2025.