Have you ever chosen to take “the scenic route”? Have you ever bought something on sale because the discount seemed too good to ignore? Felt “ripped off” because you got a bad deal or overpaid for something? Or have you ever purchased Girl Guide Cookies from a young fundraiser who knocked on your door?
Sometimes it’s about the most enjoyable way to get there, not just the fastest. We love getting a good deal. We hate getting a bad deal. And generally, we like to have a positive impact on the world and people around us. These seem to be obvious and easily relatable ideas to all of us, but there is one simple thing they have in common: Transactional Utility. We encounter examples of Transactional Utility Theory every day, without even thinking about it.
Transactional Utility Theory was developed by Nobel Prize Winning Economist, Richard Thaler. Essentially, it measures the satisfaction consumers derive from a Transaction/Purchase. Professor Thaler has detailed this clearly and focuses specifically on Pricing and its influence. Transactional Utility is the quantified satisfaction we get from the process of buying a good with reference to price. If we think something is priced less than it should be, then we derive Transactional Utility from the discount we receive. It feels good to get a good deal.
Conversely, if we think the price of something we bought is more expensive than the reference price we sometimes feel ripped off. Just imagine the $10 beer you buy at a sporting event, or paying $6 for a bottle of water at the airport. It doesn’t feel good.
Transactional Utility is then combined with Acquisition Utility for the final measure of all Utility we get from that purchase. Acquisition Utility is the total satisfaction the “thing” we purchased will give us.
But as the consumer marketplace has evolved, the way we buy things has changed, and the things we care about buying has also changed. We can look to Identity Economics, Political & Socio-Economic factors, Demographics, and many other topics which discuss the influences on our purchasing habits.
But most of this can be summarised and explained quickly and neatly by merely extending our application of Transactional Utility Theory beyond price references alone. By expanding this theory to include Externalities which are known to the consumer, and the Experience felt during the transaction, we unlock two key dimensions where additional utility can be identified and measured.
To help investigate these ideas, and to help illustrate them, I created a simple survey which was completed by almost 100 volunteers from around the world. Here is a link to the survey, to play along from home:
Let’s first address the idea that there is Utility to be derived from the Experience of the transaction itself. A transaction could be the process of purchasing a good online, in a grocery store, through our mobile phones, or any other place we go to buy something. But we can also look at non-monetary or commercial scenarios where we can demonstrate this phenomenon. Let’s look at travel.
For example, if we need to travel to work then the Acquisition Utility can be measured by the value of us getting to our destination. The Transaction Utility or Disutility derived from the act of getting to our destination will reflect our Experience of that journey. Question 1 in the survey addresses this idea:
Almost every respondent to the survey chose the second option to this question. There are two ways to look at this that I can discern. First, taking the typical route yields Negative Transactional Utility as we feel “ripped off” that it is taking three times as long to travel a journey for which the standard reference is 5 minutes. So taking a farther route yields no negative Transactional Utility but delivers the same Acquisition Utility, yielding a more preferable route. The other perspective is that it is merely more enjoyable to drive continuously than it is to sit still waiting in traffic. We can postulate that the experience of driving yields greater Transactional Utility than the satisfaction or lack thereof delivered by sitting stuck in traffic.
So if we control out any potential cost or emission implications, we see that the more enjoyable experience provides a more attractive economic proposition based on a higher total utility. Perhaps nervous drivers may be more attracted to the familiar route, or wait in traffic. In this case, the choice to remain on the slower route with traffic congestion may be appealing for opposite reasons. Either way, the individual preference is achieved and measured by combining sum of Acquisition Utility with the Transactional Utility delivered by the preferred experience.
Let’s look at this in another way. As the first line of this article mentions, the simple act of us choosing to “take the scenic route” somewhere is a great example of Transactional Utility being gained. We are willing to take longer to get somewhere because of the satisfaction we will feel from the experience provided by the route. By adding the factor of time we can explore how individuals are willing to sacrifice Time for heightened Experiences, and the value they place on each. We could explore the seemingly inverse relationship between “Time” and “Experience”, looking for an equilibrium which will maximise both within the transaction, but this is best left for another conversation… Probably with a real Economist.
Back to my main point…. Simply put, Transactional Value of the Experience will measure against Transactional Value of Expedience in this context to determine which option yields the higher Transactional Utility. But in either case, there is clear Transactional Utility which factors into the decision making process.
When we prefer the scenic route…
A(Utility from Getting There Alive) + T (Utility from the Experience) > A(Utility from Getting There Alive) + T(Utility from Getting There Quickly)
When we need to get there urgently…
A(Utility from Getting There) + T (Utility from the Experience) < A(Utility from Getting There) + T(Utility from Getting There Quickly)
As the Acquisition Utility is the same in both sides of the equation, then we are merely measuring the Transactional Utility offered against the other Transactional Utility reference. If the acquisition of getting ourselves to our destination is the purpose of this “transaction” then the optimal choice in our understanding of Utility Theory must mean we should always prefer to optimise the time of travel as an absolute, not as a detail of the experience. The journey itself should have no bearing on the utility we derive from getting to the desired location. But we have clearly demonstrated that the satisfaction/utility we derive from the positive experience of the journey is important to identify and consider.
Let’s Go Buy Some Cookies
We can also extend this thinking to processes of buying goods. We have all had moments where we are caught waiting in line to pay for something. We accept this, we understand the rhythm and orderly process by which this goes.
Imagine you are waiting in line to pay for groceries. Waiting in line to pay for stuff is miserable. There is nothing pleasurable about this, but we have accepted this as a necessary burden to acquiring things we want. When the line moves more expediently than normal, we are pleased. We experience Positive Transactional Utility. When the line moves more slowly than normal, we are frustrated. We experience Negative Transactional Utility. Sometimes the queue can be so long we decide it isn’t even worth waiting. The negative utility of waiting so long in line actually exceeds the Acquisition Utility of what we were going to buy.
In this final example, one could make the case that it is the opportunity cost of the time spent waiting which is too great to sacrifice, but I postulate that in most cases where the decision is made to avoid the queue it is often a result of Negative Transactional Utility.
As the Retail Marketplace evolves we see an ever-increasing application of new technologies which influence the transactional experience across all sectors. Payments and Banking evolved from Cash to Cheques to Credit Cards to Debit Cards to Contactless Payments to Apple Pay to Apple Watches and so on. Soon we will think about buying something and the money will have left our accounts with one mere thought!
Keeping with the grocery shopping queues theme, we have seen similar technological evolutions as the conveyer belt was added to the checkout line, to self-check outs, and now we see the dramatic innovations from Amazon Go in their Check Out-Less concept. All the buzz is about “Frictionless” processes and experiences. But the growth of “Frictionless” innovations are simply examples of efforts to increase Transactional Utility. Added utility is derived from an improved experience measured against the status quo, or standard levels of friction in a given transaction.
But this has created an Arms Race of sorts in a very competitive sector. Most Grocers and Supermarkets offer the same or substitutable products. Thus, in order to maintain market share they must focus primarily on innovations which continue to deliver higher Transactional Utility. Again, we encounter this dichotomy of Experience vs Time as this evolution is highlighting a bifurcation in these two directions. Innovations either reduce friction, or enhance the experience to deliver higher Transactional Utility. As new technologies mature and become ubiquitous, the status quo shifts to new positions changing our reference point. So, what yielded high Transactional Utility 5 years ago likely yields much lower Transactional Utility today, and in some cases potentially Negative Transactional Utility.
Let’s Go Buy Some Cookies & Save Some Kittens
In addition to technology/experience, the efforts by some brands to leverage their positive societal impacts and these externalities as ways to add value to their Grocery offering and other businesses. Whole Foods, Toms shoes, and many other businesses promote the positive externalities their companies affect, and the negative externalities they avoid. Typically we rationalise the attraction of such firms as merely altruistic, or a part of Identity Economics, social pressures, etc; but if we investigate the idea that these Externalities, when known to the consumer, can affect the Utility gained we see that they are important to measure as part of the Transactional Utility.
Questions 2–7 of the survey explore this, with some inclusions of Prospect Theory added to the mix for fun. I guess the idea of Tversky and Kahneman asking their questions with Kittens and Cookies is slightly amusing to me. Also, their proven theory serves as a good control to help support the results yielded from my other questioning.
Here are slides showing the Questions and Summarised Responses:
Unsurprisingly, in questions 2 & 3 where there is no price differences, everyone, aside from one concerning kitten abuser, chooses to save kittens and to avoid harming any kittens. While overly simplistic, we are able to simply show a positive and a negative externality which influences the selection. In questions 6 & 7 we adjust this proposition slightly with our presentation of price. Traditional Utility Theory tells us that the selection should choose the optimally priced option. The consumer will gain the same Acquisition Utility in both cases as the cookies are the same. Transactional Utility Theory would also support that hypothesis as, in these examples, the price differences for the same good should imply there is a deal and/or a “rip off” presented. However, the clear preferences from respondents is to maximise the benefits, and minimise the harms, associated with the noted externalities despite the price differences. This demonstrates a clear and obvious affect of Transactional Utility derived from an externality. These externalities clearly have no attachment to the Acquisition Utility gained from the cookies yet have an identifiable impact on the choices.
Kahneman, Cookies, & Kittens:
With Questions 4 & 5 designed around Prospect Theory, the results here confirm their proven behaviour. Respondents are Risk Averse when contemplating the gains, and Risk Seeking in their hopes to avoid harming any kittens.
This is consistent with our other Cookie/Kitten questions. While respondents overwhelmingly choose to save kittens where possible, and avoid decisions where the externalities harm kittens, the responses are 10% higher when avoiding harm to the kittens compared to merely saving them. Another supporting example of people’s aversion to loss in general. I find this interesting, if not unsurprising, and also affirming of the results overall.
Naturally, it’s hard to imagine a direct correlation between our cookie purchases and the resulting affect on kittens. But for the purposes of this exercise, I thought it was important for these externalities to be as far removed from the good being purchased to emphasise the detachment from acquisition utility.
Ok… But how does this matter in the “Real World”?
In the real world the consequences of such externalities can be equally detached and seemingly unrelated. If we look at the wine market, we find many troubling examples of important externalities which affect consumers’ utility maximising options. Large multi-national corporations produce endless brands of wine which crowd Supermarkets and Retail shelves around the world. While these companies’ operations are not necessarily morally exploitive, their affect on individual wine producing regions is significant, especially in contrast to smaller artisanal producers. Most importantly, for the context of this conversation, are their contributions with profits and revenues to local economies.
First, large industrial wineries can easily exploit the imbalanced relationships with their supplying farmers to suppress fruit prices. They can also squeeze smaller-scaled producers from accessing the market with their own wines, which seem overpriced in comparison if they can even reach the market. Second, and most importantly, these large companies are often multi-national corporations with little commitment or connection to local regions. As a result, the bulk of profits made from the resources of these regions are extracted from the local area. By contrast, local artisanal producers in these regions offer a far more positive impact on their local economies. When profits remain wholly within these rural regions, they are able to cycle through the community more easily and multiple times as they pass through the various businesses within the local economy.
If we assume that both a large industrial producer and a small artisanal producer can create equal wines which offer the same Acquisition Utility, it is not hard to imagine the positive and negative externalities these different wines can affect. Purchasing the large industrial wine could perpetuate poverty or disparities in a specific rural community by depriving impactful revenues from the local economy. Conversely, purchasing the small artisanal producer’s wine could have a direct affect on that village’s butcher being able to buy his child new clothes for school, for example.
This example may seem dramatic, but when we consider wine producing regions with significant poverty and wealth disparities such as South America, South Africa, Eastern Europe, etc. these issues and imbalances are significant and real. Beyond wine, these externalities affect almost all agricultural sectors in a similar way around the world.
“If a kitten dies in the woods and no one is around to hear it, does anyone care?”
While proving and demonstrating the tangible effect of externalities on utility and decision making may seem obvious and helpful, identifying this reality solves nothing on its own. It merely highlights the importance of our need to present better information to help consumers maximise their utility in the marketplace. The Transactional Utility or Disutility from an externality affected by the purchase of a good can only be measured if this affect is known to the consumer. If you are oblivious to the fact that your cookie preferences are hurting kittens, then how can you know to avoid that product?
This demonstrates the problem with Information Asymmetry in the Marketplace. How can people maximise their outcomes with through a purchase if they do not have access to all relevant information surrounding the good or service? Who is exploiting this information imbalance? And what can we do to improve this decision-making environment?
“We don’t make money when we sell things. We make money when we help customers make purchase decisions.” - Jeff Bezos, CEO/Founder of Amazon
Part 2 — Asymmetric Information & Wine Coming Soon…
About the Author:
Derek Morrison is a Wine Judge and Retail professional based in London, UK. A self-described “failed economist”, he focuses most of his professional energy on finding ways to rectify information asymmetry in the marketplace so businesses can deliver enhanced outcomes for their customers. He also tastes and buys wine for business and pleasure. You can watch him drink it on camera as the host of the Web Series/Podcast called “Bring Your Own” aka @BYOPodcast