Mental accounting and “free shipping”

Mar 5 JDN 2460009

Suppose you are considering buying a small item, such as a hardcover book or a piece of cookware. If you buy it from one seller, the price is $50, but shipping costs $20; if you buy it from another, it costs $70 but you’ll get free shipping. Which one do you buy from?

If you are being rational, you won’t care in the slightest. But most people don’t seem to behave that way. The idea of paying $20 to ship a $50 item just feels wrong somehow, and so most people will tend to prefer the seller with free shipping—even though the total amount they spend is the same.

Sellers know this, and take advantage of it. Indeed, it is the only plausible reason they would ever offer free shipping in the first place.

Free shipping, after all, is not actually free. Someone still gets paid to perform that delivery. And while the seller is the one making the payment, they will no doubt raise the price they charge you as a customer in order to make up the difference—it would be very foolish of them not to. So ultimately, everything turns out the same as if you had paid for shipping.

But it still feels different, doesn’t it? This is because of a series of heuristics most people use for their financial decisions known as mental accounting.

There are a lot of different heuristics that go into mental accounting, but the one that is most relevant here is mental budgeting: We divide our spending into different budgetary categories, and try not to go over budget in any particular category.

While the item you’re buying may in fact be worth more than $70 to you, you probably didn’t budget in your mind $20 for shipping. So even if the total impact on your finances is the same, you register the higher shipping price as “over budget” in one of your mental categories. So it feels like you are spending more than if you had simply paid $70 for the item and gotten free shipping. Even though you are actually paying exactly the same amount.

Another reason this works so well may be that people don’t really have a clear idea what the price of items is at different sellers. So you see “$70, free shipping” and you assume that it previously had a price of $70 and they are generously offering you shipping for free.

But if you ever find yourself assuming that a corporation is being generous—you are making a cognitive error. Corporations are, by design, as selfish as possible. They are never generous. There is always something in it for them.

In the best-case scenario, what serves the company will also serve other people, as when they donate to good causes for tax deductions and better PR (or when they simply provide good products at low prices). But no corporation is going to intentionally sacrifice its own interests to benefit anyone else. They exist to maximize profits for their shareholders. That is what they do. That is what they always do. Keep that in mind, and you won’t be disappointed by them.

They might offer you a lower price, or other perks, in order to keep you as a customer; but they will do so very carefully, only enough to keep you from shopping elsewhere. And if they are able to come down on the price while still making a profit, that really just goes to show they had too much market power to begin with.

Free shipping, at least, is relatively harmless. It’s slightly manipulative, but a higher price plus free shipping really does ultimately amount to the same thing as a lower price plus paid shipping. The worst I can say about it is that it may cause people to buy things they otherwise wouldn’t have; but they must have still felt that the sticker price was worth it, so it can’t really be so bad.

Another, more sinister way that corporations use mental accounting to manipulate customers is through the use of credit cards.

It’s well-documented that people are willing to spend more on credit cards than they would be in cash. In most cases, this does not appear to be the result of people actually being constrained by their liquidity—even if people have the cash, they are more willing to spend a credit card to buy the same item.

This effect is called pain of paying. It hurts more, psychologically, to hand over a series of dollar bills than it does to swipe (or lately, just tap) a credit card. It’s not just about convenience; by making it less painful to pay, companies can pressure us to spend more.

And since credit cards add to an existing balance, there is what’s called transaction decoupling: The money we spent on any particular item gets mentally separated from the actual transaction in which we bought that item. We may not even remember how much we paid. We just see a credit card balance go up; and it may end up being quite a large balance, but any particular transaction usually won’t have raised it very much.

Human beings tend to perceive stimuli proportionally: We don’t really feel the effect of $5 per se, we feel the effect of a 20% increase. So that $5 feels like a lot more when it’s coming out of a wallet that held $20 than it does when it’s adding to a $200 credit card balance.

This is also why I say expensive cheap things, cheap expensive things; you should care more about the same proportional difference when it’s on a higher base price.