Tuesday, December 8, 2009

How Price Discounts Affect Purchasing Decisions

When we see a consumer item deeply discounted, we tend to react in one of two ways:

1. “What a bargain! I’ll take five.”

2. “I knew those things were no good.”

Sometimes we see a low price as an opportunity, and other times we see it as a sign of low quality. In their paper, Motivating Discounts: Price Motivated Reasoning, researchers On Amir and Erica Dawson sought to find out what determines which way we react. It turns out that our reactions are determined by what we thought of the product before seeing the discounted price.

If we’re already attracted to a product, then we see a discount as a bargain. If we’re neutral or negative about a product, we see the discount as a sign of low quality. A curious side effect of our behaviour is that deep discounts “discourage purchases by all except those who liked the product in the first place.” We’re less likely to buy a deeply discounted unfamiliar product than we are to buy it at the regular price.

We can see this happening among investors in individual stocks. When XYZ Corp. shares take a tumble, fans of XYZ are happy to buy more, but those who don’t like XYZ see the price drop as confirmation of their opinion that the company is failing.

If the Amir and Dawson results apply to stocks then we can expect investors looking at XYZ stock for the first time to be less likely to buy shares after the price falls than before the price falls, even if they know of no specific reason why the price dropped.


  1. As long as you know what quality is, you are ok. The problem is you only know that something is quality in the long run, you can hope it is, in the short run, but only time will prove you right or wrong.

  2. Two problems with stocks:
    1) the real quality/value can and does regularly change with time
    2) too many investors do no research so their notion of good deal is only based on the most recent price or news items, or the last thing that passed through their head

    Though I'm ready to accept that the paper is correct in what it says, I cannot see how that helps one make good investing decisions. I think it's back to basics .... gather lots of information about the company and where it is headed, then decide if the price reflects the implied value of your conclusions.

    Nevertheless I displayed behaviour option 1 "bargain!" recently when I bought a brand new 2008 model Callaway 3 metal at less than half price. I think Callaway and the shop were trying to induce another motivation by such discounting - convincing golfers that new models are worth the much higher price by the steep discount, by saying in effect the old model is option 2 "crap". Recently pro golfer Robert Allenby was interviewed on TV (he won this tournament) describing his bag of clubs and mentioned that his
    3 metal is seven years old. Um, are new model clubs that much better?

    The moral: always ask yourself why it is price reduced.

  3. Canadian Investor: I agree that these findings may not be able to help investors make good investing decisions. However, it may help some investors to not make bad investing decisions through this apparently widespread cognitive error. Good luck with your "cheap" 2008 model Callaway 3 metal.

  4. MJ, so far the Callaway (we are still golfing here in Scotland at this time of year, you know) has been "crap" on about 40% of shots, fairly priced on 40% and a "bargain" on 20%. It is the fault of the club, is it not?