JC Penney's Mistake? Assuming the Consumer Is Rational

Most of Us Prefer to Get a 'Bargain' Than Pay the True, Lower Price

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Some of my fondest memories as a kid were the days when my mom would arrive home from an all-afternoon grocery-shopping trip. The blue Country Squire station wagon with the fake wood on the sides would pull into the driveway, full of produce, staples and snacks from the three or four different grocery stores she'd visited. Feeding a family of seven, my mom was an expert at determining which stores had sale prices, which had in-store coupons and which had specials on the eight-packs of Coke or Pepsi. (We went through a ton of those.) Sometimes she'd arrive with a rare carton of Dr. Pepper. It was hardly ever on sale -- those were special days.

I couldn't wait to dig through each of the brown paper sacks. Every once in a while I'd find a new product, or something she wouldn't typically buy. When I found one of these surprises, like a jar of dry-roasted peanuts, I'd ask, "Wow. Peanuts. Cool. Why'd you get these?"

"It was on sale -- and I had a coupon for it," she'd proudly proclaim. "I saved seventy-five cents."

My mom got great pleasure in buying products that were on sale, and in finding ways to get more for our money. But, over time, as I got older I realized that maybe she got too much pleasure from it. She enjoyed saving money so much that she would purchase things because they were on sale, not because we needed them. "The deal was just too good to pass up," she'd say. In the end, my mom probably bought more, and ultimately spent more than if many of those same items had simply been marked at an "everyday low price."

But my mom's not unique. Most people are wired this way.

Last week, when I read about JC Penney's struggles to get consumers to understand the company's new pricing strategy that eliminates "sales," I chuckled and thought of my mom. CEO Ron Johnson's notion that they "need to better explain our pricing system" misses the point. JC Penney isn't wrong for trying to change the nature of retail. I'm rooting for them. But the company overestimated consumers' rationality to think that they would change their behavior so quickly.

JC Penney's desire to give more integrity to pricing -- eliminating the traditional retail game of inflating suggested retail prices so that they can be quickly discounted -- is admirable. And it makes logical, rational sense. For instance, a rational person would rather buy a $7 T-shirt for $7 than that very same T-shirt, typically listed at $12.99, marked down to $7.99 (almost a dollar more that the new price). But Penney's customers aren't buying more T-shirts, or the new pricing strategy. Johnson reported that his customers are making fewer visits and fewer purchases.

Why? The mistake JC Penney made was expecting consumers to behave rationally. As much as we prefer to think of ourselves as rational beings, loads of neuroscience studies over the past four decades have demonstrated that most decision-making actually occurs through a very fast, imperceptible wrestling match between: 1) the parts of our brains that control rational thinking, which center around slower, conscious, computational reasoning, and 2) the parts that control the non-rational aspects, which are fast, subconscious, intuitive and emotional.

This faster, intuitive, non-analytical functioning of the brain was introduced by Amos Tversky and Daniel Kahneman in the 1970s. Their compelling research, since built upon by many others, revealed that this non-rational part of our brain is what allows us to make some judgments and behaviors effortlessly, like driving to work without having to analyze every turn or recognizing whether the person walking toward you is your neighbor or a stranger. But environmental factors, memory and other stimuli can easily influence this intuitive processing into creating flawed judgments or distorted perceptions, which are referred to as cognitive biases. These distorted perceptions can also lead to phenomenon like stereotyping, or the halo effect, where we trust attractive people more than unattractive.

The cognitive bias at play in the Penney pricing initiative is an "anchoring effect," meaning that consumers are typically heavily influenced by a specific piece of information, which all other information is evaluated against. Suggested retail prices are the most common anchors. Even when seemingly inflated, a suggested retail price serves as an anchor for which all other pricing information is compared. For instance, while the $12.99 original price tag for the T-shirt might have been an inflated price, it still creates a subconscious anchor. While the consumer's rational side may know that it's a bogus price, the irrational side is excited that it can get the T-shirt for a bargain at $7.99. The discount creates the yearning to make the purchase. For some, it even gives them a slight feeling of euphoria, or a mini rush.

The reason JC Penney is selling fewer items is because the anchor is gone. A $7 T-shirt is just a $7 T-shirt. If you buy it, you're paying full price. And what our irrational brains have learned over time -- they do learn -- is that paying full price, no matter what the cost, is no fun. This doesn't make us crazy, just human -- and not nearly as rational as marketers think we are.

Tom Denari is president, Young & Laramore, Indianapolis, Ind.
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