[Pricing Nugget #031] Pay and Ye Shall Consume

Imagine the last year is over. New Year's Eve has just passed, and you made a serious New Year's resolution: You want to lose weight and go to a gym more regularly than before.

So, you sign up for a gym membership, and you go there quite frequently, but all of a sudden, halfway through the year, your attendance drops.

The good news. It might not be your fault. Maybe you just chose the wrong payment plan?

Do you know about the sunk cost effect or the sunk cost fallacy?

People tend to neglect costs that have already been cured when making a decision in the present.

Let's look at two examples.

1. “A family pays $40 for tickets to a basketball game to be played 60 miles from their home. On the day of the game, there is a snowstorm. They decide to go anyway but note in passing that had the tickets been given to them, they would have stayed home.”
2. “A man joins a tennis club and pays a $300 yearly membership fee. After two weeks of playing, he develops a tennis elbow. He continues to play (in pain), saying, 'I don't want to waste the $300!’”

In both cases, you see that a cost incurred in the past and cannot be made undone (it is "sunk") determines your decision today.

Why is that? People track benefits and costs in so-called "mental accounts".

They book the value they perceive and the prices they pay. In general, people hate to close an account that is in the red.

So what do they do? They try to get more value by consumption to end up with a positive balance.

This explains the sunk cost fallacy or the sunk cost effect: people neglect the sunk cost – i.e., they do not forget the prices they paid.

Suppose consumers perceive a mental account as being in the red. In that case, they try to get into the black again by increasing the value through more consumption.

But what happens if the perceived costs associated with the mental account become smaller?

The negative balance also shrinks, and the need to increase the value through more consumption also reduces.

Researchers have found that payments – i.e., the objective price (blue bar) – are perceived as smaller over time (red bars). So the subjective, the perceived price decreases the more time passes since it has been paid. After a few months, you forget about it, and the payment becomes less painful.

In this way, the cost side of a mental account shrinks over time and reduces the need to consume more to get your mental account, for example, for a gym membership, into the black again.

Let us turn to a real gym.

Researchers used actual gym membership data for semi-annual members and tracked the number of gym visits for the six months after the first payment.

Then they calculated the fractional attendance in the month of payment. The fractional attendance is the share of visits on the total number of visits over the six months.

The fractional attendance in the first month is 0.35. This means 35% of all visits within the six months happened in the first month. This fractional attendance drops to 25% in the second month after the payment to 16%, 11%, 7%, and 6%.

If we baseline the number of visits to the first month, in the last month, five months later, the attendance drops by 83% compared to the first month after the payment.

The consumption of gym membership or the number of attendances drops over time.

Semi-annual plans are not ideal for sticking to consistent workouts. What about other payment plans? 

The same researchers looked into gym membership data for different payment plans. They found that a monthly payment scheme delivers the most consistent number of attendances to a gym over a year.

The attendance starts pretty high for an annual payment plan and fades out. For a quarterly payment plan, you have four peaks; for semi-annual payment plans, you have two attendance peaks.

The monthly payment plan is more or less flat. 

What did we learn?

Today we learned how to raise the odds of sticking to your New Year's resolution of attending the gym more often and consistently.

But in general, we learned how you could influence the consumption of your products and services via your payment scheme. It would help if you looked at the mental account balance of your customers and the timing and frequency of the payments for your products and services.