Something You Can’t Use at a Price You Can’t Resist
The juggler finished, giving my neighbor Marty and I a few minutes to compare the merits of a Challenger 605, Legacy 500 and Falcon 2000. When a tug on the shirttail and the appearance of a mildly-scary clown signaled the next act, Marty asked: “So which do you think is best?”
“They’re all great aircraft. To decide on best, lets nail down your mission profile by…” Before I could finish, Marty cut me off: “You know, I don’t really care which model — I just need a great deal.”
I admit it: I own a pair of Ferragamo shoes that blister my big toes after a couple hours. They were on sale for $250. Half a size small, I rationalized that they’d break-in, despite knowing better — Ferragamo shoes justify their $1,000 price (to me) with shocking longevity and unchanging fit.
I grok the allure of a bargain. Also fortune cookie wisdom: “A bargain is something you can’t use at a price you can’t resist”
But spending $12,500,000 on the wrong $14,000,000 aircraft because it seems like a great deal? The fu behind bargains is strong. Very strong. What are the forces behind such irrational behavior? And what about the impact of blockchain, 4IR social media, and AI/ML on markets and prices?
If you’ve been reading regularly, you know any single measure as a proxy for multiple factors brings into play Goodhart’s Law: the invisible hand that guides human interaction with measures. And price isn’t just any measure — it’s a very special one, as William Poundstone discusses in Priceless: The Myth of Fair Value.
Goodhart dictates that a price target (like asking-price or MSRP) has no correlation to value, until and unless someone accepts that price. If that happens frequently, it’s a liquid market. Only then, in a liquid market, and if it’s a fungible item, will market-price equal value (in that instant).
For liquid, fungible markets (NASDAQ, CME, etc.), 4IR — particularly algorithmic trading — is disruptive. Maybe destructive. This analysis says “it is difficult to imagine a situation with higher stakes, or more people held in the balance of mathematical formulas that were designed to generate profits, and nothing else.” I’ll leave it at that, in the hands of quants and philosophers — and keep my fingers crossed.
The rest of the world: shoes, lawyers, cars, restaurant hamburgers (and you)— to name a few — are non-fungible, often hedonic items in variably illiquid markets. This includes private jets (which are also opaque). The private-jet aftermarket illustrates evolving pricing concepts — with the added bonus that private jets are pretty cool.
Jets are non-fungible — identical private jets are a rare artifact of a fleet buyer like Netjets. A small group starts life as clones. Over time they gain an individual identity. Unlike rental cars, fleet-jets have prolonged service lives, so when they hit the aftermarket they’re really used — they usually set the bottom of the market and sell to the first reasonable offer. Purely based on price, a tail number ending in QS (Netjets) is a sure pre-owned bargain.
At the other end of the spectrum is the aircraft below: a virtually new Falcon 7X. Until dethroned by the 8X last year, it was the top of Dassult’s line — the aircraft of choice for a largely European customer base whose tastes run to Bordeaux rather than California Cabernet.
The pictured aircraft — loaded with options, and with distinctive livery — was delivered in 2013 to a Brazilian buyer who decided to sell the $60MM+ aircraft three years later, after barely more flight-time than a demo.
As in cars, color matters — it’s the immediate indictor of uniqueness. For most cars, silver is coveted and therefore valued — it’s white for trucks. Black is close to the top for all but luxury sedans. For aircraft — it’s white: specially, Matterhorn White. While each car brand has its own shade and nomenclature, Matterhorn White crosses all jet manufacturers as the standard of taste.
The distinctive paint of the Falcon above — which the owner personally designed — cost $200,000 more than standard white with accent-striping.
While “in residence” at Dassault Wilmington (who offers interim workspaces for the weeks or months it takes to repair and overhaul aircraft), I saw this 7X tugged to the paint hangar.
I loved the custom paint scheme — its a feature to me. But to the actual buyer it was a bug — they insisted on repainting it as part of the purchase so now it looks like this:
If the words love and hate pop up in a sale, the product is likely hedonic: purchased largely based on emotions. Every characteristic of a private jet — including the mere fact of ownership — combines to make it hedonic, so aesthetics (starting with livery) is important.
While it is the root of the word hedonism, in pricing terms hedonic doesn’t connote excess indulgence — only that emotions play a strong role. Aircraft and shoes are hedonic — batteries and paper clips, not so much. Maybe anyway. Neuroscience is starting to paint a different picture on buying decisions — that’s another post.
So that distinctive paint-job cost the seller $450,000 — $200,000 at original purchase, and $250,000 to erase at resale. In a thicker (more robust) market, the distinctive paint might have fetched a premium, or at least been neutral. As it ended up, one mans’ treasure ended as another’s trash because market illiquidity prevented pairing participants with like aesthetic viewpoints.
To a single buyer, individuality can add value, while aggregated buyers — a market — value fungibility.
Even with unique items like this jet, buyers crave the wisdom of crowds to help determine value. Even knowing price and value don’t correlate, human psychology still wants them to. Prior sales — that someone has decided are comparable — guide perceived value. As with real estate, a jet-broker finds comps to support a price theory and become reference prices.
References are key: humans are poor at absolute measurements (how much does this bag weigh?), but good at relative ones (which bag is heavier?). We need a frame of reference to start. Poundstone says:
“People tend to be clueless about prices. Contrary to economic theory…..we make do with guesstimates and a vague recollection of what things are “supposed to cost.”
Each unique aspect: color, equipment, maintenance history, interior condition and aesthetics, has its own sub-scale — an opportunity for more cluelessness and, as a result, irrational behavior. As an example, older Falcons don’t have winglets (the vertical wingtip extensions). Because winglets aid performance and the aircraft looks newer — and most think cooler — they’re desirable. $650,000 to retrofit, yet once added, the resale “book” value is half that.
A pre-owned Falcon shopper planned on installing them, if needed, to his new jet. That would cost $650k — yet he’d only agree to factor in the $325k “book” value when considering already winglet-equipped aircraft.
What’s up with that?
Behavioral psychologists debate that question endlessly. One of the most respected, Amos Tverky, joked that his findings on behavioral decision theory — considered ground-breaking — were long-known to advertisers and car salesmen. Known as Prospect Theory (PT), it partially explains: What’s up with that?
In a nutshell, PT says we’re averse to any loss, and hate losing much more than we love winning — it takes a $200 gain to create positive feelings equal to the negative feelings of a $100 loss. Reference prices: comparable sales, original purchase price, or a friends purchase — take on outsize importance. Buyers anchor (an important PT term) to them. For buyers, decreases from the reference price (discounts) are perceived as gains, and increases as losses. Changes from the anchor matter more than absolute price, and (follow this) social reference for the reference price is important — $11,000,000 seems reasonable if your friend paid $12,000,000 (for items you believe — perhaps erroneously — are equivalent).
By the way, if you’re thinking “duh, I could have told you that” look back at Tverky’s joke — he agreed. Harvard’s Max Bazerman said “The math was added for acceptance, and that was important.”
In the 4IR world, purchase decisions are increasingly visible. Photos of hedonistic purchases spread quickly — the fashion industry is already transformed as a result (paradoxically, some pay publicists to spread these, others pay to keep purchases discreet, and yet others are paid to peel back that discretion).
Below, Treasury Secretary Mnuchin deplanes a government G550, which he flew — allegedly — to get a privileged view of the recent eclipse. Twitter was abuzz about what appeared like taxpayer funded sight-seeing — even more-so for his wife’s promotion of luxury brands Hermès, Roland Mouret, Tom Ford and Valentino.
Around the same time as Kahneman won a Nobel prize for PT (Tversky had passes away), marketers also got a lesson in Jungian psychology via The Hero and the Outlaw.
Jung described a collective unconscious with shared archetypes. For hedonic purchases, important Jung archetypes include the mother, the father, the wise-old-man, the hero and the trickster — and shadows. The Hero and the Outlaw uses these to create a standardized archetypal framework. In the following weeks, with notable psychologist Dr. Howard Teich, we’ll deep-dive into this.
Until then, recapping:
- Price is a very special measure. Poundstone writes: “There is a magnitude scale of overwhelming importance in everyone’s life. It’s called price.” At the same time, Goodhart teaches that if price is a target measure, it’s no longer a good one — so price doesn’t equal value.
- Humans look to references to decide fair price, usually via the wisdom of crowds.
- Those references, along with anchors, have an unnatural influence on what we consider a fair price.
- In an illiquid market, value doesn’t equal price — yet we try to create that relationship via comps.
Next time we’ll dig into the evolution of prospect theory in 4IR, how opacity impacts markets and how that’s changing, and more on Jungian psychology. Until then, here are some common Psychology & Neuroscience -based price tricks. You can use them as a seller — or watch out for them as a buyer.
