The only person on earth who decides whether you save money or not is: YOU!

Recently, I wrote why the prospective gain of “saving money” should not influence your decision making process. In essence, I am the opinion that you should not buy a house to save on taxes or that you should not eat a low-fat burger to lower your calorie intake. But why does the “and save money” argument influence us so much?

Let’s consider this scenario. You pass by your local gas station and see the following price information:

• Cash – € 1,30 per liter
• Credit – € 1,35 per liter

The product this gas station offers is the same, but the difference in price is due to the method of payment. From a business perspective, this can be totally legit, since the owner of the gas station has to pay a certain fee to process credit card payments. This information can be interpreted in two different ways. This pricing is either a penalty to the customer who wants to pay with plastic, or it is a reward to the customer who pays cash. But how you interpret this information depends on your own expectations regarding payment methods at gas stations. If you are more used to paying with your credit card, you will probably say “Hey, thats unfair!”. But if you use cash anyway, you’ll probably say “Hey, nice!”. It is either a gain or loss of 5 cent, depending on your personal expectation what the default should be. It also depends on the default price you have in mind. If you think that € 1,30 is the normal price, you consider credit payment as a penalty. But if you think that € 1,35 is the normal price, you would see the cash payment as a discount. Whether loss or gain depends on your perspective.

In other words, you are not able to determine whether the 5 cent difference is a discount or a penalty from the information above. You need an anchor price, something that tells you what the price should be. Nobel-prize winning psychologist Daniel Kahneman and his colleague Amos Tversky call this the “framing” effect (Kahneman and Tversky, 1984: “Choices, Values and Frames” American Psychologist, 39, p. 341-350).

In case your frame for gasoline prices is € 1,35, the 5 cent would represent a discount. If your price is € 1,30 there is no benefit for you when you pay in cash and a penalty if you want to pay with credit. But if your reference price is  € 1,25, even the cash alternative becomes a rip-off.

In case of gasoline prices this all is not a big deal. Prices are usually transparent and you can easily find a reference price. But what about other products? Think about complex products that do not solely compete on price. How do you determine the reference price for a dinner at a restaurant, a vacation, college education or plastic surgery? Is the offer you have been made a discount or a penalty? How do you know? Before we answer that question, I would like to discuss the thing I refer to as the power of legitimacy.

The Power of Legitimacy

We human beings have the tendency to attribute a huge chunk of legitimacy to things as soon as it is written on paper or stated as a fact. Take a piece of paper, write down “out of service”, stick it on the elevator door and observe. You will not believe how much confusion this will generate. Some people will see the sign and immediately head to the stairs, others will wait in front of the elevator, hoping that the elevator will magically repair itself just in that moment. Some people will push the button and that will create even more confusion because the apparently kaputt elevator seems to work fine. “Maybe it will stuck halfway and I have to stay in the elevator the whole weekend with the accounting guy from the 13th floor with greasy hair and I’ll miss Janes’ birthday party and her awesome sisters, just because I didn’t read the sign, which someone nice put it up to warn me!… I’ll take the stairs”. It is just a piece paper, but we believe what is written. While only 55% of American people vote, nearly 98% check out of their hotel room before 13:00 hrs. You know why? Because that’s what the little sign in the room says: “Checkout until 13:00″. We have the habit not to argue about something that is written down on a piece of paper.

Framing your perception with the power of legitimacy

Let’s get back to the gas station example. Consider you are the owner of the gas station and you can write an additional line above this price information. We assume that you are completely indifferent whether customers pay cash or with credit and that your 5 cent surcharge covers all expenses involving the credit card transactions. Further we assume that you don’t know what the customers’ reference price is. What would you write? Would you write that your business rewards people who pay cash, or would you write that your business penalizes people who pay with a credit card? I guess it is obvious that you would choose something like “Pay cash and save 5 cents per liter!” over “Pay not in cash and we charge you an extra 5 cent per liter!”. But why would you do that?

The reason for that is that the gain of 5 cents seems more appealing to customers than the possible loss of 5 cents. In other words, the negative emotional feelings resulting from a loss of 5 cents have a higher impact on you than the positive emotional feelings resulting from a 5 cent gain. This area of study is called prospect theory. This theory tells us that we perceive the impact of losses bigger than the impact of gains. In other words, we are loss averse.

Keeping that in mind, you want to put something on your sign that is perceived as more favorable by your customers, even though you don’t know their reference price. Once it is written down on a sign, the power of legitimacy steps in: “Pay cash and save 5 cents per liter!”. There, it’s written: “I save 5 cents per liter!” is what we say, because.. ehm… jup, the sign says so.

You are the one who decides

No matter what you buy, keep in mind that whether you save money or pay a surcharge depends on “your” reference price and not what the business owner has put on his sign. There is a chance that I buy something that you might consider as highly overpriced, but which I see as a bargain. There is nothing wrong with that. That only says that we “frame” the price of the product in a different way. However, a marketing slogan that says “Book a vacation with XYZ and save money” is a bold move, keeping in mind that they don’t have the slightest idea what my reference price is. It is similar to saying “Buy our product because its better”. Better than what?

So, if you hear the “and save money” argument the next time, think about your reference price. Don’t fall for the power of legitimacy and take the fact as granted. You are the one who decides whether you save money or not. Not the person who is trying to sell something to you.