The £3.95 You Spent to Save £3.95
You add four pounds of something to avoid a four pound delivery charge and feel like you have saved money. The economics of why shops split a price this way is better understood than the psychology of why it works.
Key takeaways
- Splitting a total into a base price plus a surcharge changes how it is judged, because the headline gets attention and the add-on gets less.
- Gabaix and Laibson show that hiding part of a price can be a stable market outcome where some consumers are inattentive, not a passing trick.
- The firm that unshrouds a hidden fee to compete may not profit from doing so, which they call a curse of debiasing.
- Chioveanu and Zhou model firms competing on price frames as well as prices, and find them randomising frames to obfuscate comparison.
- In that model, more competitors can mean more frame complexity, higher industry profits and lower consumer surplus.
You have done this. The basket comes to twenty-six pounds, delivery is three pounds ninety-five, free over thirty, and you go back through the shop looking for something around four pounds so that the postage goes away. You find it. You check out. You have now spent more money than you were going to, and the feeling you are left with is the feeling of having saved some. That gap between the outlay and the feeling is the whole subject, and it is not a story about shoppers being foolish.
Our position is that this is not stupidity and not really a trick either. It is what happens when a price is split into parts, and the economics of why firms split it is better understood than the psychology of why it works on you.
Split the price and watch
Put a price in front of people as one number and they evaluate one number. Put the same total in front of them as a base price plus a surcharge and something changes, because the two parts do not get weighted equally. The headline gets attention. The add-on gets less.
A free shipping threshold is that arrangement turned into a game. The retailer has told you there is a number at which one component of the price disappears, and the disappearing component is small, salient and irritating in a way the base price is not. Postage feels like a penalty. Four more pounds of product feels like shopping.
Check what this is not
One thing to clear away first, because it is the explanation everybody reaches for and it does not fit.
There is a well-known result from Xavier Gabaix and David Laibson about shrouded add-on prices: the ink for the printer, the fee on the transfer, the excess on the policy. In a market containing some inattentive consumers, hiding a cost can be a stable equilibrium, and the firm that competes by revealing it may be unable to profit from doing so. That is a real and important finding and we cite it elsewhere.
It is not what is happening here. A free shipping threshold hides nothing. The fee, the threshold and the saving are all announced, usually in a coloured banner. Whatever is going on with delivery thresholds, information suppression is not it, and any account that reaches for shrouding has misread the tactic.
What is going on is about arrangement, not concealment.
Postage feels like a penalty. Four more pounds of product feels like shopping. The retailer did not invent that difference. It just priced against it.
Look at the frame, not the number
Ioana Chioveanu and Jidong Zhou supply the account that does fit. They model sellers of an identical product competing on both prices and price frames, meaning the ways price information is presented.
Frame choices affect how comparable offers are, and can cause confusion and lower price sensitivity. In their equilibrium, firms randomise their frame choices, obfuscating comparison and sustaining positive profits. And here is the part worth quoting at anybody who believes competition solves this: an increase in the number of competitors can induce firms to rely more on frame complexity, which may raise industry profits and lower consumer surplus.
More competitors, more frame complexity, lower consumer surplus. That is a possibility result in a model and not a measured regularity in a market, which is worth saying plainly. It is still not the story anyone is told about competition.
Stop blaming the shopper
The popular version of this is that shoppers are being fooled, and we think that is both unkind and slightly wrong.
Adding four pounds of something you will eventually buy anyway, in order to avoid a four pound charge for nothing, is a defensible decision. Shipping is a pure cost with no product attached. A tin of the coffee you drink weekly is not. If the threshold pushes you into buying something you were going to buy within the month, the arithmetic is closer to neutral than the sneering suggests.
The failure is narrower and it is this. The threshold sets the reference point, and it presents the choice as one between two ways of spending more.
A word on that phrase, because this publication has been rude about the literature it comes from. Reference-point effects sit next to anchoring, and our replication piece notes that anchoring has gone from the best illustration of behavioural priming to a case cited against it. So we are not resting the argument on it. What the threshold does is observable without any of that theory: it removes an option from the screen. The reference-point language describes the removal; it is not the evidence for it, and if the whole reference-point literature evaporated tomorrow the missing third option would still be missing. The third option, paying the postage and buying nothing else, is never on the screen, and it is the one that tells you whether the top-up was real.
Do this instead
Compare the two totals, not the two feelings. Twenty-six plus three ninety-five is twenty-nine ninety-five. Thirty plus nothing is thirty.
Now read that honestly, because the sneering version gets the arithmetic wrong. Five pence more, and you have four pounds of goods instead of a delivery charge. If the four pounds buys something you would have bought anyway, that is a good trade and the threshold did you a favour. If it buys something you invented on the spot to clear the bar, then you paid five pence more than the postage route and came away with four pounds of something you did not want. The five pence is the real figure, and it is smaller than the sneering version claims. What the sneering version gets right is the four pounds, which is not an extra loss on top of the five pence but the thing you have to want for the trade to work at all.
The whole question is which of those you just did, and the checkout is designed so that you do not ask.
Keep a list. The threshold only works against you when you have to invent a purchase on the spot. If you already know the three things you will need next month, the top-up is genuine.
And treat frequent shopping at one retailer as the real decision. The threshold is doing its job across your year, not across this basket.
Ask who paid for the confusion
Two shops can charge you the same money and leave you feeling differently about it, and only one of them will have had to be better at anything.
That is the wider cost of frame competition, and it is why the Chioveanu and Zhou result should bother anybody who assumes markets grind towards clarity. When presentation is a competitive weapon, effort goes into presentation. The firm that wins on frames did not win on price, product or service, and the customer paid for the difference without being able to see where it went.
Sources
Gabaix, X., & Laibson, D. (2006). 'Shrouded attributes, consumer myopia, and information suppression in competitive markets.' Quarterly Journal of Economics, 121(2), 505-540. Shrouding may occur in an economy with some myopic or unaware consumers; where add-ons have close substitutes, a curse of debiasing arises and firms cannot profitably debias consumers by unshrouding add-ons; in equilibrium two kinds of exploitation coexist. doi:10.1162/qjec.2006.121.2.505
Chioveanu, I., & Zhou, J. (2013). 'Price competition with consumer confusion.' Management Science, 59(11), 2450-2469. Identical sellers compete in prices and price frames; frame choices affect comparability and may cause consumer confusion and lower price sensitivity; in equilibrium firms randomise frame choices to obfuscate price comparisons and sustain positive profits; an increase in the number of competitors may induce more reliance on frame complexity, boosting industry profits and lowering consumer surplus. doi:10.1287/mnsc.2013.1716
A note on scope: this article does not claim that adding a needed item to reach a threshold is irrational. It argues that the comparison almost nobody makes is with paying the delivery charge and buying nothing else.