Imagine you are driving back from work on a hot, muggy evening, and want to pick up a bottle of your favourite beer to consume at home. While looking for your favourite drink, you realize that there is only one upscale restaurant selling your beverage. How much would you be willing to pay for that bottle of beer (to be consumed at home)? Now imagine that on a different but otherwise identical day, you discover that the only outlet carrying your favourite beer is a rundown shack down the road. How much would you be willing to pay to buy beer from that hole-in-the-wall outlet? If you are like most people, the chances are that you will be willing to pay more to buy your bottle of beer from the upscale restaurant even though you’re not consuming any of the “ambience” of that restaurant.
Whenever we make a purchase, we tend to derive two different kinds of utilities from it—acquisition utility and transaction utility. Acquisition utility is the classic economic utility that reflects the value you place on a product. It is based on the enjoyment you expect to get out of consuming the product. For example, the acquisition utility for a burger is likely to be high for a person who hasn’t eaten in two days compared to that for someone who has just finished a hearty meal. Transaction utility, on the other hand, refers to the value of the “deal” you receive, in comparison to your subjective judgement of what the item should normally cost. So, since you expect the costs of a luxury hotel to be higher than those of a roadside dhaba, you are willing to pay more for the same item purchased in the hotel compared to the dhaba, even if you’re not actually consuming the item in the hotel.
The transaction utility also includes the utility you receive from “getting a deal” on the product. As a result, economists find it odd that people will buy products they don’t really want or need (low acquisition utility) just because it is on sale. The satisfaction you get from getting the product at a good price is greater than the enjoyment you actually get from consuming the product. So, if you expect to pay Rs20 a kilo for tomatoes and are then informed by a friend about a promotion being offered by a new store where similar tomatoes are being offered for Rs12 per kg, the transaction utility for that exchange is significantly higher and this high transactional utility may be enough to trigger a purchase (or make you take a detour on your way home from work to stop at the new store) even though you didn’t really want any tomatoes that day.
Understanding the difference between acquisition utility and transaction utility can also explain why you may act in ways that classical economists consider non-rational. How much of a discount would a store have to offer to get you to go out of your way to shop with them? If you focus just on acquisition utility, you would think that the discount has to at least be enough to cover the costs of you going out of your way to buy the product. However, several studies have shown that the amount of discount you would need does not depend just on the costs of going out of your way to buy the product. Say you are interested in buying a fan that normally goes for Rs1,000. If your friend were to tell you that the same fan is available on sale for Rs750 at another store 10km away, most of us would be happy to travel the 10km to save Rs250. Now imagine another situation where you are in the market to buy an air-conditioner that typically goes for Rs25,000. Again, your friend points out that the same air-conditioner is available on sale for Rs24,750 at that other store. Studies have shown that many people in this instance are suddenly not willing to travel the extra kilometres to save Rs250. Why? A Rs250 markdown on the fan is a nice 25% discount, thereby making it an excellent deal, which provides high transaction utility. The same Rs250 discount on the air-conditioner amounts to a meagre 1% price drop. The transaction utility in the case of the air-conditioner is marginal, thereby resulting in a lower response to that promotion.
So, what are some practical implications of this phenomenon? As a consumer, you should keep in mind that the functional utility of a product is driven by its acquisition utility. If that utility is small or insignificant, one should resist the temptation of acquiring a product merely because the transaction utility is high. If you feel yourself tempted to buy a product on sale just because it is on sale or you feel it is okay to buy a product at a high price merely because the store looks upscale, stop and think about how much you will actually benefit from owning the product. Second, understanding transaction utility should help prevent us from being penny wise and pound foolish. If you fight to bring down the price of a kilo of mangoes from Rs25 to Rs20, there is no reason why you should trivialize the same Rs5 discount on a Rs1,000 purchase. You should value just as much an equal amount off a large purchase. Finally, when evaluating alternatives, the amount of additional money you are willing to pay for a convenient alternative should depend on the extent of convenience and not on the cost of the alternative.
Praveen Aggarwal is an associate professor of marketing at the Labowitz School of Business & Economics at the University of Minnesota Duluth and Rajiv Vaidyanathan is a professor of marketing and director of MBA programmes at the University of Minnesota Duluth.
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