Rory and Revealed Preference

Revealed Preference

Watching the video of Rory Sutherland brought back memories of highschool economics.  I am a trained economist so these were indeed good memories as highschool was my first encounter with the profession I have chosen.  I don’t remember too much from the lessons save for one thing that my teacher said, a line that all of my classmates to this day will recite with a giggle.  Mr. Lirio said “you can’t ever be ripped off if you bought it”.  Now on first glance this phrase doesn’t seem to make a whole lot of sense.  Just getting back from China where most of the stores have “fixed” prices, there were several times that Kelley students found themselves shouting just that (Oh Sh*t I got screwed!!!) after they had found out that maybe they paid “too much”.  The phrase “I got ripped off” means that you paid too much for a physical good or the value of money you parted with is no way commensurate to the labor, capital and cost of resources to make the good.  But this phrase highlights Rory’s theory about intrinsic value. 

When you buy things, you do so by employing what an economist would term as “revealed preference”.  This goes back to Malcolm Gladwell video about focus group discussions and coffee.  Nobody in a room of people, in an environment of a fixed set of parameters, with guys hovering around with notebooks, will ever tell the “truth” with regard to their preference for coffee.  FGD’s may help in determining the explicit value of a good, the cost of the factors of production used to make the good or service, but it is in no way a viable gauge for intrinsic value, which oftentimes will vary wildly between consumers. (I really like my coffee dark and strong, seriously!)

Malcolm shares with us that people will not tell you what kind of coffee they like.  This is true, but their buying patterns with the product or other products may underscore the intrinsic values they cherish. 

Going back to Mr. Lirio’s statement that “you can’t be ripped off if you bought it”, I think he meant to say that as long as you bought it, at the time of the sale that the vendor and the buyer agreed on the price, the consumer stacked up all the value they perceived the good to have, both intrinsic and extrinsic.  When my sister buys a pair of $50 flip flops from Brazil I snicker and sneer knowing that I have the local brand, which is oftentimes of better quality and costs $3.  But perhaps my sister tacks on $42 worth of self-esteem with these Brazilian made footwear or she feels $42 richer and hotter when she wears them.  If she derives that from the flipflops, she’ll still feel “richer” and better off about buying the Brazilian made product compared to the $3 stuff I wear (although i do think they are actually made in China but heck its the logo that matters). 

Rory also had a very insightful example about potatoes and how to slightly modify consumer attitudes towards products.  Back in the 90’s, Toyota dominated the Philippine car market via first mover advantage.  Honda came in with its initial lineup and pretty much fell flat on their faces.  Sure Honda had a great name, if you were in the market for a motorbike but nobody wanted to buy a Honda car.  Then out of nowhere Honda decided to pull the potato trick.  Honda came back a few years later with a "revamped" line-up touting better looking models, seemingly better build quality and more powerful engines.  What did the trick however was to brand Honda Cars Philippines as “prestige cars” wherein buyers of Hondas in the Philippines were asked to sign a contract to never operate their vehicles for public transportation.  The mark of “prestige” in the end was nothing more than a gimmick as the government does not classify cars as such.  But the market ate it up as most people who wanted a BMW but could not afford one were now given a “new” choice for their luxury brand option.  The market may have never been able to communicate such a thing in a FGD but it sure did “reveal” it through their acceptance of a product.  The added intrinsic value was what moved people away from Toyota and to Honda.  The extra labeling caught on like wildfire and Honda has never relinquished its car segment dominance since then.  Subtle ways to alter consumer revealed preference can go a long way to shaping your company’s future.

So I guess the battle is knowing your market and why they buy things more so in the aspect of intrinsic value than the actual cost to manufacture a good because this is the real gauge and standard by which people shape their purchases.