Entry 006 - Cash or Credit?

Today's entry examines a question which arose in a conversation with Aimee Hokanson and Bethany Spring, regarding spending behavior. Simply put, the question, which was not specifically addressed to the blog, but I found to be blog worth is:

"Does the payment mode (using cash, credit, or debit cards) impact the amount spent?"

While some people claim that the answer to this question is well established and boarders on common knowledge, I was actually surprised to see very little research. Although it is unclear why people feel that the answer to this question is common knowledge, it seems likely to a variety of misinformation posted on the internet may be the cause.

For example, one commonly cited study, among bloggers to financial gurus such as David Ramsey, favors the notion that people spend more when using credit cards. According to these sources, a study was conducted by Dunn and Bradstreet, who found that people, on average, spend 12-18% more when making credit card purchases, compared to using cash. Additionally, they are reported to have discovered that the average McDonalds transaction increased from $4.50 to $7.00, upon the company's acceptance of credit cards as a viable payment option. However, to date, I have been unable to find this report, and have viewed some sources which claim that even Dunn and Bradstreet are unaware of the validity these figures.

Remember, Ronald "loves to see you smile".

So, if this study is not valid (or worse yet, does not exist), why do a variety of individuals constantly cite it? Well, the citation could be erroneously propelled by credit card corporations. After all, if you are in charge of a business, why would you opt for a payment method which requires time, equipment, and money to process? According to Flagship Merchant Services, gateway, statement, and monthly fees for processing transactions could be anywhere from $25 - $45 a month (and those are the "best" processing fees). Add this with the notion that your credit card may be lost, or stolen, which could end up costing the consumer more than they bargained for, and there seems to be little reason to accept credit or debit cards.

"And how will you be paying Mr. Flanders?"

Regardless of where this misleading information came from, I have decided to stick with books, peer reviewed studies, and dissertations which I was able to access, in order to seek out the correct answer.

ARGUMENTS FOR AND AGAINST:

Regardless of which mode of payment you feel is most likely to prompt spending, there are logical and possibly valid arguments supporting either view. For example, those who feel that someone who has cash on them is likely to spend more will often argue that the person in question withdrew that money and has it on them, so that they could spend it. Essentially, the decision to spend that money was made as soon as they withdrew it from the bank. Additionally, people who favor this view may argue that the money is "burning a hole" in one's pocket, begging to be spent at the first available moment.

Money is the root of all evil!

Alternatively, others claim that using credit cards is more likely to prompt spending. Proponents of this view argue that that, in general, cards distance the consumer with the reality of monetary exchange. Additionally, credit cards are based upon exchanging money one does not have, for goods, with the promise that the money will be paid back. Thus, by a literal - and narrow - definition, people who use credit cards are spending more money than they have. The same argument would not hold true for debit cards, as that is an exchange from money which is available in one's bank, but debit cards may also be viewed as a form of distance.

I'm here to steal your soul!

EMPIRICAL DATA:

Retailers (Borgen, 1976; Huck, 1976), credit researchers (Hirschman, 1979), and popular writers (Galanoy, 1980; Merchants of Debt, 1977) generally argue that credit cards facilitate spending. However, it has been debated if this facilitation significantly exceeds that of cash. Given that the majority of data on this subject is correlational, it has been difficult to objectively determine whether or not credit cards actually prompt more spending.

Hand over your money or 

I will give you this credit card!

To date, the most comprehensive response to the question at hand was provided by Raghubir and Srivastava (2009), who conducted a series of studies attempting to ascertain whether or not payment mode makes a difference. In the first study, participants estimated how much they would spend using cash vs. credit cards for a restaurant meal. The results noted that people are willing to pay more when they use a credit card, versus cash. In a second experiment, researchers prompted participants to estimate food expenses for an imaginary Thanksgiving dinner, item by item. When participants considered the cost, the cash-credit spending gap closed, suggesting that people who are confronted with the reality of expenses, no longer allow the mode to influence their decisions.

Collectively, the results from these studies indicate that people may spend more when using a credit card, due to the expense seeming less real. Raghubir and Srivastava conducted two additional studies which examined gift certificates. In the first gift card study, results suggested that participants spend more when using a gift card than cash. In a second study, participants were given $1 gift cards which could be used to buy candy. Participants were instructed to put a gift card in their wallet for an hour, which the researchers argued, made the value card seem more real. Results indicate that people participants put the gift cards in their wallets; they were less likely to use them.

While the question of using debit cards remains unaddressed, the experimental studies outlined provide sound evidence for the notion that credit cards prompt more spending. For some reason, the use of cards seems to be less transparent when considering monetary exchange.

TRANSPARENT TRANSPARENCY: A HISTORICAL APPROACH:

Having read the previously stated arguments, one may wonder why using a card is viewed as distancing the consumer from their money? After all, if these cards are little more than money, why should it make any difference as to its form? Although the aforementioned study provides some data as to the cause of credit cards facilitating spending, the answer remains somewhat elusive. Sources have suggested that while credit cards do prompt spending, there is no special aspect of credit cards which can be implicated for this cause (Federal Reserve System, 1968; Zipprodt, 1969). Thus, in order to fully understand the reasoning behind the theory proposed by Raghubir and Srivastava , a historical overview may be necessary.

According to historical data, the barter system was commonly used up to 100,000 years ago (Mauss, 1923). However, many cultures around the world soon developed the use of commodity money, as the barter system was limited to use between family and friends (Graeber, 2001). While money originally served as a medium of exchange, individuals were limited to the amount of wealth which they had gained to date.

Torg needed companionship, Gark needed food...

...what to do... what to do?

The concept of using a card for a purchase was first noted in 1887 by Edward Bellamy, author of Looking Backward (http://en.wikipedia.org/wiki/Looking_Backward). Bellamy used the term "credit card" eleven times throughout his novel. In the late 1920s, a variety of companies developed a device called the "Charge Plate", which was issued by large-scale merchants to their regular customers. Since the 1960s, credit card use has dramatically increased in the US (Duca & Whitesell, 1995), such that credit cards are now seen as a vital component of business, banking, and personal money management (Clark, 1975; Savage, 1970).

The reason that a historical approach may allow for additional insights is that, for most of the known economic history, money was used as the primary exchange. It stands to reason that given the explosion of technological advances that devices such as credit cards are likely to be viewed as positive and convenient. However, much of the technology which allows us to monitor credit is hard to obtain (try getting your credit report in five minutes), or at the very least, requires individuals to be proactive (banks may push for online banking to save paper, but also require you to login to monitor your finances). Essentially, the concept of a credit card is new, and it may not be highly associated to our personal finances in the same way that that money is.

CONCLUSION:

As credit cards become more common place, the cash to credit card gap may dissolve. However, until then, research suggests that you may be more likely to spend more when using a credit card. This may sound bad at face value; however, there is nothing inherently wrong with using a credit card. After all, where would the world economy be if entrepreneurs were not able to secure funding for their projects?

Well, for one, Trump would be broke.

If you ask me, a world with Donald Trump is a small price to pay for the convenience afforded to the general public thanks to credit cards. Credit cards require the user to be fiscally aware, and somewhat proactive with their finances, which, if you ask me, is not a bad thing. Although some individuals still end up over their head in debt, I would argue that this is the fault of an unregulated fiscal sector which felt it was too big to fail.

I guess we'll have to sell one of the kids.

On a final note, I will admit that the research presented here is not too conclusive. Additional studies are needed. After all, there could be some third variables which need to be controlled for to see whether or not the pattern would hold. For example, age, experience with credit, or even whether or not students in the study had money in their wallets in that fourth study could all influence the results. While some could argue that the difference may hinder on a variety of personality traits, or individual differences, it is important to approach the subject such that one determines if an effect exists or not. Once an effect is established, it would be useful to consider these others variables and how they may strength or reverse the observed relations.

NOTE: If you have a question for me to research and answer please submit it as a comment, or send it to ELKronos@aol.com / Facebook.com/ELKronos. Submit your name and location if you wish to opine.

CITATIONS:

Borgen, C. W. (1976). Learning Experiences in Retailing: Text and Cases, New York: Goodyear.

Clark, F. (1975). Bank Credit Cards: Attitudes and Decisions of Selected Retail Merchants in Arkansas and Missouri, unpublished dissertation, University of Arkansas, Department of Business Administration, Fayetteville, AR 72701.

Duca, J.V., & Whitesell, W.C. (1995). Credit Cards and Money Demand: A Cross-sectional Study. Journal of money, credit and banking, 27, 604-623.

Federal Reserve System (1968), Bank Credit Card and Check Credit Plans, Publication Services, Division of Administrative Services, Board of Governors, Washington, D.C. 20551.

Galanoy, T. (1980). Charge It: Inside the Credit Card Conspiracy, New York: G.P. Putnam Sons.

Graeber, D. (2001). Toward an Anthropological Theory of Value, 153-154.

Hirschman, E. (1979). Differences in Consumer Purchase Behavior of Credit Card Payment System. Journal of Consumer Research, 6, 58-66.

Huck, L. (1976). Making the Credit Card the Customer. Banking, 68, 37, 80, and 83.

Mauss, M. (1923). The Gift: The Form and Reason for Exchange in Archaic Societies. 36-37.

Merchants of Debt (1977). Time Magazine, 109, 36-40.

Raghubir, P., & Srivastava, J. (2008). Monopoly money: The effect of payment coupling and form on spending behavior. Journal of experimental psychology: Applied, 14, 213-225.

Savage, J. (1970). Bank Credit Cards: Their Impact on Retailers. Banking, 63 (1), 39, 92.

Zipprodt, C. (1969). Bank Charge Cards-An Evaluation. The Journal of Consumer Credit Management, 1, 10-19.

Entry 001 - Odd Pricing:

All of my cool friends are blogging (Erin Yosai & Sara Davis), and while I cannot claim to be greater than or equal to their level of "coolness", it is 2AM, I am wide awake, and thus, I have decided to blog.

Although my friends have shared the intimacies of their lives, my life is far less interesting, meaning I do not have much to share. However, what I would like to share with you are the answers to odd questions. It could be that you want to know where a saying came from? Perhaps you want to know whether or not a piece of information you heard is true? Or maybe you just want to know if something could actually happen? Regardless of your question, I intend to partake in my favorite activity (reading empirical research) so that I may answer your question!

If you have a random question for me to research and answer please submit it as a comment, or send it to ELKronos@aol.com / Facebook.com/ELKronos. Submit your name and location if you wish to opine.

THE QUESTION:

The question of the day (week, month, year, whenever I feel like updating) was submitted by Justin LeBreton of Milford Maine. Justin writes....

"Would a customer really feel they were getting a better bargain if the price of an item was listed as $4.99 as opposed to $5.00?"

What Justin is referring to is the notion of "odd pricing". For those of you who are unaware, "odd prices" are said to lead to increased sales. These odd prices have also been referred to as "magic prices", "charm prices", "psychological prices", "irrational prices", and "intuitive prices" (Boyd & Massy, 1972; Dalrymple & Thompson, 1969; Gabor, 1977; Kreul, 1982; Monroe, 1990; Rogers, 1990; Sturdivant, 1970). In the retailer realm, it is commonly accepted that if a price is reduced by one penny, the item is more likely to be purchased.

THE ORIGINS:

There are some discrepancies regarding where these prices originated. One source (Schindler & Winman, 1989) theorized that odd pricing originated after pricing became fixed in the United States. Before the Civil War ended, customers used to haggle with retailers over the price of an item (Georgoff, 1971). However, shortly after the war ended, prices were fixed. Retailers at the time wanted to remain competitive, and given that the value of a penny was worth $1,009,374,100 in the 1860*, many prices were listed as ending with .99.

Another theory regarding odd prices is derived from an explanation of anti-theft (Harper, 1966; Hogl, 1988, Sturdivant, 1970; Twedt, 1965). Before the introduction of odd pricing, cashiers used to pocket money from the register. However, with the introduction of ending items with .99 cents, cashiers were forced to open the register after nearly every transaction, which made it more difficult for them to pocket cash.

Finally, another theory of the odd pricing is said to have evolved from a price war in at a Texaco in Waco, Texas. Retailers were so anxious to get the upper hand, they started slashing prices by the cents to offer customers a better deal. However, regardless of the origins, odd pricing is extremely common in modern retailing (Schindler & Wiman, 1989), and it is here to stay.

WHY MIGHT THE EFFECT OCCUR:

The next time you go to a store, look around, and you will likely seem items listed as $19.99 or $49.95, as opposed to $20 and $50. According to Wilkie (1990) there are several reasons why this phenomenon may occur.

• Rounding Illusion: It has been theorized that customers approximate prices they pay by a lower integer/decimal rather than a higher price. Thus, if a price is 19.99, people will believe the price is $19 as opposed to $20 (Boyd & Massey, 1972). As a result, consumers may be more likely to "anchor" (Tversky, & Kahneman, 1974), on the first numbers (e.g. "19") as opposed to the full price ("19.99"). 
• Getting Change: People like to get change, and it is theorized that by reducing the price of an item by a few cents, customers may feel that they are getting more back for their purchase.
• Attractive Digits: Some have claimed that people feel that a number like 9,999 is "nice", which serves as an advertising mechanism, as it will attract the attention of more customers.
• Image of Discount: Stores try to create the illusions that they have slashed prices, and by cutting the cost of an item (even by one cent) they can claim that the item is on sale.
• Memory Constraint: It has also been theorized that consumers have a limited capacity for storing accessible information. This means that reducing the price of an item by even one cent will be likely to produce an increased expectancy in sales (Brenner & Brenner, 1982).

While there are many reasons as to why this occurrence may exist, the question remains as to whether or not reducing the price of an item by one cent actually increases sales.

DOES THE EFFECT ACTUALLY OCCUR:

According to Georgoff (1971), although a price illusion may occur for some products, the net effect of sales is weak at best. Lambert (1975) goes on to suggest that reducing based on odd prices is only likely to produce increased sales under some circumstances. Additionally, Dodds and Monroe (1985) found no evidence for a difference in perceived quality, value, or willingness to buy products regardless if the prices were reduces by one cent. Furthermore, Gabor and Granger (1964) found some support, noting that consumers had a higher intention to purchase items when they were reduced by one cent.

This is a tough question to answer, because economic research would dictate that purchasing is related to price, such that as a price decrease, it stands to reason that more people would buy it. Thus, the real question is not whether dropping the price of an item by one cent will increase sales (because lowering the price by any amount should), but rather whether or not decreasing the price of an item by one cent increases sales beyond that which would be predicted by the price index.

GENERAL DISCUSSION:

Economic theory purposes that quantity demanded increases when price is reduced. This means that as a price is decreased, people are willing to be more likely to buy it. One study conducted by Gendall, Holdershaw, & Garland (1996) found that individually, the differences between expected and actual purchase probabilities were not significant; however, the overall effect is unlikely to occurred by chance. This suggests that some items may not produce an effect, but collectively, marking items down by one cent may increase sales.

While the cause of odd pricing has yet to be determined from the studies mentioned, it has been noted that pricing an item to end in 99 cents creates a marked odd pricing effect as opposed to ending the item with 95 cents. This may tentatively support the notion that prices ending in ".99" are more likable than those which end at a more "even" integer.

Collectively, the notion of odd pricing is still debatable. However, it does appear that odd pricing is likely to produce an increase in sales among specific items, for a specific portion of the population. The next time you are out, and see a price listed at $19.99, ask yourself, do you round down to $19, or up to $20 when describing the price? Pending how you answer this question may reflect whether or not this tactic is effective toward your purchasing habits.

Finally, as a side note, it should be mentioned that the first few numbers may be most likely to stick with an individual when considering the purchase price. However, any priming effect this focus has elicited on an individual is unlikely to result in persuading individuals to buy the item who originally had not intent to purchase said item. According to North, Hargreabes, & McKendrick (1999), subliminal priming effects do not persuade individuals to do what they had not considered, but rather serve as a means to push them in a specific direction. Thus, if an individual focuses on $19 as opposed to $20, and decides to buy an item, the intent to buy said item must have originally been present.

CITATIONS:

Boyd, H.W. and Massy, W.F. (1972), Marketing Management, Harcourt Brace Jovanovich, Orlando, FL.

Brenner, G.A. and Brenner, R. (1982), “Memory and markets, or why are you paying $2.99 for a widget?”, Journal of Business, Vol. 55 No. 1, pp. 147-58.

Dalrymple, D.J. and Thompson, D.L. (1969), Retailing - An Economic View, The Free Press, New York, NY.

Dodds, W.B. and Monroe, K.B. (1985), “The effect of brand and price information on subjective product evaluations”, Advances in Consumer Research, Vol. 12, pp. 85-90.

Gabor, A. (1977), Pricing: Principles and Practices, Heinemann Educational Books Ltd, London.

Gabor, A. and Granger, C.W.J. (1964), “Price sensitivity of the consumer”, Journal of Advertising Research, Vol. 4, December, pp. 40-4.

Gendall, P., Holdershaw, J., & Garland, R. (1996). The effect of odd pricing on demand. European Journal of Marketing, 31, 799-813.

Georgoff, D.M. (1971), Odd-Even Retail Price Endings, Michigan State University Press, Ann Arbor, MI.

Harper, D.V. (1966), Price Policy and Procedure, Harcourt, Brace and World, New York, NY.

Högl, S. (1988), “The effects of simulated price changes on consumers in a retail environment - price thresholds and price policy”, Esomar Congress Proceedings, Lisbon.

Kreul, L.M. (1982), “Magic numbers: psychological aspects of menu pricing”, Cornell Hotel and Restaurant Administration Quarterly, Vol. 23 No. 1, pp. 70-5.

Lambert, Z.L. (1975), “Perceived prices as related to odd and even price endings”, Journal of Retailing, Vol. 51, Fall, pp. 13-22, 78.

Monroe, K.B. (1990), Pricing: Making Profitable Decisions, 2nd ed., McGraw-Hill, New York, NY.

North, A.C., Hargreabes, D.J., & McKendrick, J., (1999). The influence of in-store music on wine selections. Journal of Applied Psychology, 84, 271-276.

Rogers, L. (1990), Pricing for Profit, Basil Blackwell, Cambridge, MA.

Schindler, R.M. and Wiman, A.R. (1989), “Effects of odd pricing on price recall”, Journal of Business Research, Vol. 19, pp. 165-77.

Sturdivant, F.D. (Ed.) (1970), Managerial Analysis in Marketing, Scott, Foresman and Company, Glenview, IL.

Tversky, A. & Kahneman, D. (1974). Judgment under uncertainty: Heuristics and biases. Science, 185, 1124-1130.

Twedt, D.W. (1965), “Does the ‘9 fixation’ in retail pricing really promote sales?”, Journal of Marketing, Vol. 29 No. 4, pp. 54-5.

Wilkie, W., (1990), Consumer Behavior, New York: John Wiley & Sons, 2nd edition.



*NOTE: The value of a penny in the 1860s may not actually have been $1,009,374,100.