Select your localized edition:

Close ×

More Ways to Connect

Discover one of our 28 local entrepreneurial communities »

Be the first to know as we launch in new countries and markets around the globe.

Interested in bringing MIT Technology Review to your local market?

MIT Technology ReviewMIT Technology Review - logo

 

Unsupported browser: Your browser does not meet modern web standards. See how it scores »

{ action.text }

In a comedy sketch from the early ’60s, a bereaved Mike Nichols approaches funeral director Elaine May and asks for the “$65 funeral.” Items he thought would be included-the casket, the hearse, the driver, the burial-all turn out to be extra. Nichols ends up much the poorer, but only after enduring a torturous series of purchasing decisions. To Drazen Prelec, scenarios like this one illustrate a much neglected fact of economic life: while it always hurts to pay, some payment schemes make the suffering worse than it needs to be.

The guilt or anxiety we feel over parting with our shekels is a double-edged sword. On the plus side, the pain can keep us from overspending. But to our detriment, it takes some of the pleasure out of consuming. “There’s a kind of ‘moral tax’ that we incur when we pay for something,” says Prelec, an associate professor of management science at the MIT Sloan School of Management. “When you purchase any good, your enjoyment is reduced by the psychological cost of paying for it.” This may strike some as blindingly obvious, but Prelec contends the moral tax has yet to find its way into any economic model. More important, he says, consumers and marketers alike would benefit if they explicitly sought pricing and payment systems that “let people enjoy things without thinking about paying.”

Prepayment, for example. In studies Prelec has performed with George Loewenstein, a professor of social and decision sciences at Carnegie Mellon University, consumers have made it clear that they hate the feeling of being in debt. “For some types of expenditures,” says Prelec, “people claim they would prefer to prepay, even when there’s no financial advantage.” Vacations are such an expenditure. In one survey, consumers were asked to imagine they were planning a week in the Caribbean, at a cost of $1,200. Given the choice of making six monthly payments of $200 dollars either in advance or after their return, almost two-thirds of the respondents said they would rather prepay, even though they would incur a penalty in lost interest.

Similarly, once they’re abroad, people seem to find it easier to spend in foreign currency. “It’s almost like play money-it’s prepaid in the psychological sense,” Prelec says. He adds that Club Med is on to this psychology: guests buy beads to use instead of cash.

But the desire to prepay does not extend to all items. Most respondents to Prelec and Loewenstein’s surveys said they would prefer to buy heavy appliances on credit. Why the difference? “Our explanation is that if you buy a washer and dryer on an installment plan, you don’t feel as if you’re in debt because you are paying for service that you continue to receive. Whereas when you come back from a vacation, it’s history. You are in debt.”

Another system that can take the sting out of paying is the flat rate-a fixed fee for unlimited service. It’s well known that many people choose a flat rate for their local telephone service even though they would save money by selecting a plan based on actual use. But Prelec and Loewenstein’s research suggests that the “flat-rate bias” may be a common consumer preference. Picture this: Two people use the same health club 10 times a month. One pays a $100 monthly fee, the other pays $10 per visit. Now, who enjoys the health club more?

Most survey respondents chose the person who pays once a month. “When you buy at a flat rate,” says Prelec, “that’s a form of prepayment-you know what the monthly bill is, you can deduct it from your budget, and then you can enjoy the service as if it were free.”

Prix Fixe Preferred

In general, the fewer payment decisions a consumer has to make, the better. So when people are shopping for complex goods or services-items consisting of a basic unit plus add-ons-a product that is sold with everything included for a fixed price may enjoy an advantage over one requiring consumers to weigh the cost of each option. Examples of the latter abound. (Think funeral home or car dealer.) But Prelec also points to some products that have found success through all-inclusive pricing. The Wave, a popular high-end ($349) radio from Bose, for example, is sold through mail order and comes in only one model. The consumer avoids the typical audio-store experience of deliberating over competing brands and piecing together differently priced components. “The Wave radio is a self-contained unit with a single price,” Prelec says. “You don’t really know what each feature costs, so the moral tax is lower.”

Software packages that promise free upgrades fit this category well. Of course, the cost of the upgrades is factored into the price of the first version. “Still,” says Prelec, “that’s a more attractive package than one where customers know they’ll have to make a lot of subsequent decisions about incremental costs.”

But just as there are legitimate methods for lowering the moral tax on a purchase, there are also insidious ones. In surveying the pitfalls of consumerism, Prelec has one word for you: plastic. “If paying for something is a bitter pill, then credit cards provide a little sugar coating,” he says. They lessen the moral tax by giving the purchaser discretion over when and how much to pay. But in so doing, Prelec says, the cards “obscure the connection between debt and consumption. Mentally you feel as if your possessions have been paid for in full; you don’t have any sort of accounting system that says this fancy vase is only two-thirds paid for. Now suddenly there are all these credit card bills. What are they for?”

Perhaps not surprisingly, consumers surveyed by Prelec and Loewenstein rated credit card payments the most distasteful kind of expenditure, even ahead of parking tickets and dental bills.

Prelec is optimistic that technology will come to consumers’ rescue. “Smart cards”-now being developed as a potential substitute for cash-will contain chips that might help people track their expenditures better. And various prepaid cards (similar to some new phone cards) may ease anxieties about overspending. But in the meantime, Prelec says, the burden of lowering the moral tax may fall on producers: “We’re trying to tell them, ‘Look, people have some fundamental concerns about prices. Beyond just getting the number right, you have to create pricing systems-such as flat rates-that take into account the moral tax embedded in our psychology.’ “

0 comments about this story. Start the discussion »

Tagged: Communications

Reprints and Permissions | Send feedback to the editor

From the Archives

Close

Introducing MIT Technology Review Insider.

Already a Magazine subscriber?

You're automatically an Insider. It's easy to activate or upgrade your account.

Activate Your Account

Become an Insider

It's the new way to subscribe. Get even more of the tech news, research, and discoveries you crave.

Sign Up

Learn More

Find out why MIT Technology Review Insider is for you and explore your options.

Show Me