People prefer cash back or a free gift to wild discounts

What would you choose a rebate or a discount – five ways why a rebate works

In prospect theory, which a descriptive theory of how people choose under risk, how options are framed affects the choice a person will take. When alternatives are presented people prefer options posed as gains rather than as reduced losses. An example to illustrate what I mean is the case of a discount verses a rebate in a car purchase. A rebate cheque is valued much more by a consumer than a discount on the price even when the financial parameters are identical in value. So a rebate cheque of $2000 is valued more in the eyes of a consumer than a discount of $2000 on the retail price. So in these credit crunch times the rebate in Germany for scrapping your old car is right on target as far as generating extra demand is concerned – however whether this is just pulling forward sales we shall see.

The reason for this is in the way we consumers look at the options before us. When a discount is offered on a good that discount is integrated into the original purchase price – it is possible that this is something we all have learnt to do over time. Bombarded as we are by sales of sofas and other incidental goods that seem to be on constant 50% discount we no longer ‘see’ the original price and ascribe the discounted cost of the good as the reference price. Rebates on the other hand are disaggregated in our minds and processed separately from the purchase price. We interpret the rebate as a gain whilst the discount is seen as a reduced loss and when given a choice which has on the surface the same monetary value we chose the rebate.

This principle seems to apply also to gift items, free goods and other promotions, other things being equal we prefer to have the free items compared to an identical discount due to this process. One caveat here is that the premium must be valued – it is no use offering two for the price of one if the extra package of hot cross buns goes stale or the free item is just not interesting enough to excite interest like a tin of cat food when you do not have a cat! But a well thought through extra in a promotion can be seen as a nice gain for the consumer and can orient a choice in your direction. A lottery ticket is a example with the promise of huge gains that is seen by the consumer as highly attractive compared to the $1 discount price of the ticket. Think about how this also works by removing the choice of buying a lottery by the consumer and all those nasty rationalisations of having no chance of winning!

Another aspect of the way we make choices is the certainty effect – we prefer an option when the outcome is certain or known compared to the situation when there are probabilities at play. For example we prefer to accept an offer of $100 with 100% probability rather than an offer of $112 at a probability of 90% although the expected values are the same. This can be extended in some cases where the certain choice is materially much worse than the uncertain option.

Five aspects why promotions win over discounts

  • It is materially easy for the customer to visualise the gain and little mental processing is needed.
  • They value free promotions as they are seen as a gain rather than a reduced loss.
  • They integrate discounts into the price – the discounted price becomes the reference.
  • The separate the evaluation of promotions from prices.
  • They prefer the certainty of the gain (bird in hand syndrome).

So all in all offering a promotion in the form of a certain win for the customer works much more effectively than ever increasing (or continuous) discounts which are only serving to re-set the price points at ever lower levels.