The flawed decision maker

Noticing that I haven’t been to the gym in a (very) long time, my other half has tentatively suggested that I cancel my membership (and save some money too).

This should be an easy decision. You see, even though I like some of the classes on offer at my health club, I much prefer going out for a run. I am deterred by neither heat nor cold, and even made a public commitment to running 2013 kilometres this year. So… why didn’t I quit, yet?

Enter mental accounting or…. how human beings are terrible decision-makers.

Much as we like to think of ourselves as rational entities, we really are not very good at processing economic information. We are quite bad, actually. Our ‘mental accounting systems’ fall into various traps, meaning that our assessment of a given situation changes depending on how the situation is described, even if the actual problem does not change, and our preferences remain the same.

Looking back at my health club membership decision, I can identify at least three mistakes.

Anchoring

Anchoring refers to the unconscious focus on a particular point and allowing the calculation to be influenced by that point.

In my case, the calculation is anchored on the status quo. So, when calculating the value of running vs. the value of gym membership, I am not really comparing one with the other, but instead comparing each one with the current situation (i.e. the anchor) – namely, that I am a (paying) member of the health club, already. In other words, I am focusing on keeping the gym membership vs. giving up access to the gym… and we don’t like losses, as described next.

Losses weigh more than gains

Let’s assume that I value my gym membership (B) at exactly the amount I have to pay each month (C) i.e., B = C. If that is the case, cancelling the membership means that I loose B but have extra C in my pocket, and because B=C I should be indifferent. But I am not. And that’s because changes coded as ‘loss’ weigh more in my decision than the exact same change coded as ‘gain’.

As established in the point above, the starting point for my calculation is giving up the existing membership. Doing that means that I gain C (extra money in my account) and loose B (value of my gym membership) and the outcome is C-B = 0. But as I am naturally averse to losses, I end up with C > B !!

The trick here is to translate the B from the gym membership into the loss of whatever else I could do with the fee – say, getting tennis lessons for my son, or replacing my worn out trainers. That’s called the opportunity cost of my gym membership.

Pain of paying

When it comes to paying for something, it’s not just the amount that counts. How we pay also impacts on our mental calculation. While £100 paid in cash are worth the same as £100 paid by credit card or £100 paid by direct debit, the various payment modes have a very different effect on behaviour. Specifically, paying with cash results in less or smaller purchases (though it may lead to higher usage levels).

A related effect is paying per unit consumed vs. paying a lump sum amount – for instance, paying every time I go to a class vs. paying a monthly membership. As discussed in the video below, paying per unit consumed may lead to lower consumption levels and, more interestingly, to lower reported satisfaction levels.

The trick here would be to pay in cash… something that businesses are very keen to avoid, and that’s not just for administrative purposes.

Do you find yourself falling into these traps? How do you avoid them?