Saturday, 13 March 2010

iPerbolic discounting

Imagine you have saved up £550 and you're ordering a new iPhone. The supplier is short of stock, so you'll have to wait a while. It is going to be despatched by post in 30 days and will arrive with you the next day: a 31 day delay. Then, at the checkout screen, the site offers you an express delivery option. For an extra £20, they can deliver it by courier so you'll get it on the 30th day. Would you pay £20 to have it one day earlier?

Now imagine you're ordering it from a different store and they have plenty of stock. It's going to be dispatched this afternoon and will arrive tomorrow. You see the £20 courier option: Is it worth £20 for courier delivery to get it in your hands in one hour? Alternatively, if you could travel to the shop and pick it up right now (which will take an hour or two out of your afternoon), would you do it?

I haven't done the experiment, but I'd bet you a lot more people would say yes in the second scenario than the first. Equivalently, they'll pay much more for courier delivery today than in 30 days. But what's the difference? You have your iPhone one day sooner in both cases. Is it worth £20 a day to have an iPhone? How about £10? £5? If you'd pay £5 for the courier, logically you'd pay over £1800 per year to own the phone. Do you think that's true?

A more sophisticated test would offer people a cheaper price for the phone itself from the 30-day mail order supplier than from the retailer who has it in stock now. I suspect that it would be easy to demonstrate some rationally-inconsistent preferences.

I'm in this situation right now. My phone was due to arrive on Friday and it hasn't turned up yet. I'm really rather keen to get hold of it. But before I ordered it, the paperwork sat in my inbox for about two weeks before I made the decision on which package to sign up for.

Clearly my cognitive incentives to get the phone in my hands have suddenly increased. This is a concrete instance of the classic cognitive bias of hyperbolic discounting, which is normally presented in terms of purely financial decisions. The iPhone example really brings it home to me though.

Possible explanations for this effect?

  • Greater saliency - I can almost smell the iPhone now; it's a part of my immediate future and therefore it's more likely to be on my mind. The utility of getting hold of it is more obvious to me - even if the underlying preference is the same as before, I'm more aware of that preference and thinking about it takes up more of my attention; thus I'm willing to pay more for the courier service than my normal valuation, to have that itch scratched.
  • Conversely, perhaps I didn't know my real preferences 30 days in advance. Maybe I really am willing to pay £20 for each day of my iPhone, but I just didn't realise it until the opportunity presented itself. Comparing these two explanation, there really isn't any objective way to determine my "real" preferences, so the two are probably equivalent.
  • You could argue that I have limited self-control and that, when it's offered to me, the temptation to have the iPhone now overwhelms my capacity to make rational decisions. Some explanations based in neuroeconomics take this position, looking at the activation of different brain regions which correspond to different kinds of decisions. But I don't really believe it - after all, even if I would pay £20, it's hardly plausible that I would be willing to pay £2000 to get the courier service, so there must be some kind of rational value comparison going on.
  • Naturally there a bunch of details that it's important to design out - like the fact that people may see it as less risky to buy things in a retailer, where they can see them first hand, than by mail order. These aren't explanations, though - just variables which need to be eliminated from the experiment.
  • In some scenarios a social ranking explanation could apply: if it's especially important to me to have the first iPhone on my block, or at least not to be behind my peers. But I've left this purchase so long that if anything, there's more pride in not having one yet.
Somehow cognitive biases are always more surprising when I notice them in myself than other. Also more illuminating.

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