Two economic reasons gamification works to increase profits for firms

My ECONS101 class has been covering pricing and business strategy this week. So, I was interested to read this article in The Conversation last week, by Adrian Camilleri (University of Technology Sydney), which discusses 'gamification' in the context of business:

Gamification – the use of game elements in non-game contexts to increase participation – is on the rise.

Businesses use it to attract customers, boost sales and motivate employees to complete activities to drive profits.

The global gamification market is expected to increase in value from AU$23.6 billion in 2024 to AU$74.8 billion by 2029. This is the total revenue generated from products and services related to gamification, including software, platforms and applications.

The use of goals, points, badges, opportunities to level up and leader boards is now common in many industries ranging from education to health and wellbeing...

There’s a good reason why gamifying in business is growing – it works.

It works so well some engagement platform providers advertise gamifying a platform will increase website traffic by 50% and double social engagement.

Academic research is mounting to support the claim gamification increases customer engagement, which in turn increases positive word-of-mouth and boosts brand loyalty.

A good example is the annual McDonald’s Monopoly promotional marketing game. Based on the classic Monopoly board game, customers receive game pieces with their purchase of certain menu items.

By collecting these pieces, they can win prizes, either instantly or by completing sets. Of course, some pieces are rarer than others, encouraging customers to keep spending until they get a full set.

According to one analysis, the chance of winning a major prize is well over one in a million.

Camilleri 's article focuses on psychology (extrinsic and intrinsic motivation) to explain why gamification works in business. However, there are also complementary economic explanations for why gamification works, so let me provide two that use the economics I cover in my ECONS101 and ECONS102 classes.

First, gamification works because it locks customers into buying from a particular seller. Customer lock-in occurs when customers find it difficult (costly) to change once they have started purchasing a particular good or service. The seller can then profit by increasing the price for their locked-in customers, or by selling them complementary goods or services.'

Take the example of the McDonald's Monopoly promotion. Once a customer starts collecting the Monopoly game pieces, there is a switching cost of going to eat somewhere else - the opportunity cost of missing out on additional Monopoly game pieces, and the chance to win a big prize. That switching cost, albeit small, is enough to encourage customers to go back to McDonald's more than they otherwise would. This explanation also covers the loyalty schemes that Camilleri uses as an additional example (as I have discussed before here).

Second, gamification generates transaction utility. Usually, we consider transaction utility arising when a consumer feels that they are 'getting a good deal', and this makes them happier (higher utility) with the process of purchasing, and more likely to buy (as I have discussed before here). Camilleri uses the example of the 'Temu wheel of discounts', which provides a perfect example of this. But with gamification, the discount may not even be necessary in order to generate transaction utility. If the game is fun or rewarding in its own right, then the consumer will receive utility from playing the game (which is another form of transaction utility).

So, while extrinsic and intrinsic motivation may be good explanations for the success of gamification, there are economic explanations that are equally helpful in understanding why gamification may be a successful strategy for business.

Framing, loss aversion, transaction utility, and reusable coffee cups

This article in The Conversation yesterday, by Sukhbir Sandhu, Robert Crocker, and Sumit Lodhia (all University of South Australia) caught my attention, because it nicely illustrates some of the concepts from behavioural economics that I discussed with my ECONS102 class last week:

Many cafe owners offer discounts ranging from 10c - A$1 to customers who bring in their own reusable cups.

But our findings reveal these discounts are ineffective in changing consumer behaviour.

A cafe owner we interviewed described how, despite providing a 20c discount for reusable cups, she didn’t think saving money motivated her customers:

The regulars were people who’d happily drop in a dollar tip into the jar kept on the counter. They were therefore not that concerned about 20c discount.

We know from previous behavioural psychology literature consumers are more likely to be what’s called “loss averse” as opposed to “gain seekers”. In other words, people hate paying extra for takeaway coffee cups more than they like getting a discount for bringing their reusable cups.

So, if you own a cafe, focus on making consumers pay extra for choosing takeaway coffee cups rather than offering discounts for reusable cup use. It’s more likely to motivate customers.

Let's say that a cafe owner wants to encourage customers to use reusable cups. They might do this because of concern for the environmental effects of disposable coffee cups, or the cafe owner might simply recognise that disposable cups cost them money, and so offering to fill a customer's own cup must be slightly more profitable for the cafe owner, because then they don't incur the cost of providing a cup.

Putting aside any cost differences, cafe owners could discourage their customers from disposable cups by making coffee sold in disposable cups more expensive. We know that when something is more costly, rational consumers will buy less of it. This also makes coffee in reusable cups relatively cheaper, and so would encourage some consumers to switch. Let's consider two different framings of the price difference: (1) consumers who use a reusable cup receive a 20 cent discount; or (2) consumers who use a disposable cup have to pay an extra 20 cents. 

How many consumers would switch? If consumers were purely rational, it wouldn't matter how the price difference was framed. A 20-cent discount for using a reusable cup and paying 20 cents extra for a disposable cup are exactly the same (provided the prices are the same in each case). Both options would lead to the same number of customers switching to a reusable cup.

Now here's where some behavioural economics comes in. Consumers (like every decision-maker) are not purely rational, they are quasi-rational - they are affected by cognitive biases and use heuristics when making decisions. Framing makes a difference to quasi-rational consumers, but it's not clear which framing should make consumers use fewer disposable cups.

One of the cognitive biases that quasi-rational decision-makers are affected by is loss aversion - decision-makers dislike losses much more than they like equivalent gains. In this case, the loss in utility (or satisfaction, or happiness) for the consumer from paying 20 cents extra for a disposable cup, is 'worth' much more than the gain in utility (or satisfaction, or happiness) for the consumer who receives a 20-cent discount for using a reusable cup. So, we would expect the 'loss framing' (20 cents extra) to have a much bigger effect on consumer behaviour than the 'gain framing' (20-cent discount). 

However, another cognitive bias that affects consumers is transaction utility, which I have blogged about before. Transaction utility recognises that consumers not only receive utility from the good or service that they purchase, but also from the act of purchasing. If a consumer feels that they are 'getting a good deal', this makes them happier (higher utility), and makes them more likely to purchase. So, based on transaction utility, we would expect the 'gain framing' (20-cent discount) to have a bigger effect on consumer behaviour than the 'loss framing' (20 cents extra).

Given that Sandhu et al. found that the negative framing had a bigger effect overall, it appears that the loss aversion effect is larger than the transaction utility effect. It would be good to see more research on this though, that disentangles those two effects more.

Overall, the takeaway message from this research is that if you, as a seller, want to steer consumers away from something using a price difference, present it as involving a loss to them (they have to pay extra). On the other hand, if you want to steer consumers towards something using a price difference, present the alternative as involving a loss to them. At least until this has been investigated a bit more, it appears that paying extra is a more powerful motivator for changing consumer behaviour than a discount.

Junk food discounts at supermarkets

In The Conversation yesterday, Adrian Cameron (Deakin University, and no relation of mine) and others wrote about junk food discounts at supermarkets:

Half-price chips, “two for one” chocolates, “buy one get one free” soft drinks: Australian supermarkets make it very easy for us to fill our trolleys with junk food...

We looked at supermarket specials over a year to see how healthy they were. The results of our research, published today, show junk foods are discounted, on average, twice as often as healthy foods...

The way supermarkets choose what products are on special each week is complex.

Food manufacturers pay large premiums to have their products featured in supermarket catalogues, at end-of-aisle displays or near the checkout. The arrangements between food manufacturers and supermarkets are often governed by contracts that specify the way products are to be promoted.

Food manufacturers and supermarkets know unhealthy food is often bought on impulse, making price discounts a great way to entice customers to make those impulse choices.

This was quite timely, because last week I covered pricing strategy in my ECONS101 class, and the week before that we covered elasticity. The combination of elasticity and pricing strategy, along with transaction utility from behavioural economics, do a good job of explaining what supermarkets are doing, and why.

Consumer demand for junk food is likely to be relatively price elastic. Most junk food items are relatively inexpensive, so they take up only a small proportion of our income, and that is associated with relatively more elastic demand. They also have many substitutes (there are lots of items to choose from), so our demand for any particular item is also likely to be relatively more elastic. Finally, they tend to be luxury items (in contrast with necessities), which also have relatively more elastic demand.

When demand is elastic, a change in price has a bigger effect (in percentage terms) on the quantity that we purchase. So, a 10 percent price discount on an item with elastic demand will lead to an increase of more than 10 percent in the quantity purchased. That increases revenue for the seller. [*]

This also explains why they would discount junk food items but not fruit or vegetables. Fruit and vegetables are necessity items, not luxuries - they have price elasticities of demand that are less than one (as noted here). So, fruit and vegetable sales do not respond much to a decrease in price, so discounting them would decrease revenue for the seller. Discounting fruit and vegetables is a sure-fire way for a supermarket to destroy their profitability.

However, elasticity by itself doesn't explain discounting, because if it was the only explanation, then the seller would better off to keep the price low permanently. A complementary explanation is transaction utility (as I discussed in this post earlier this year). When we buy an item, we get utility (satisfaction or happiness) from receiving the item (which we call consumption utility), plus we get utility from the transaction itself (transaction utility). If we feel like we are getting a good deal, that makes us happier about our purchase. It doesn't make us any more satisfied with the item itself, but it increases our transaction utility. Higher total utility (consumption utility plus transaction utility) makes us more likely to buy the item. By offering discounts on different items every time, they avoid giving consumers the perception that the price is lower, so each time a discount cycles back to an item, there has been time enough for consumer perceptions about the 'usual' price to reset.

So, if an item has relatively elastic demand (which is true for junk food, but not for fruit and vegetables) and the seller can make us feel good by offering a discount, then it can make sense for them to do so.

All of this is somewhat related to another practice of supermarkets, which is loss leading. That is where a seller sells some products at a loss in order to increase sales of other products. However, it seems unlikely that discounting junk food is an example of loss leading. As the quote above notes, junk food is an impulse purchase. In contrast, the ideal loss-leading product is one that has elastic demand and will therefore bring a lot of customers into the store. Nobody chooses their supermarket based on a discount for their favourite chocolate bar (I think?).

Anyway, none of this behaviour by supermarkets should be a surprise to us. It only takes a little bit of knowledge about consumer behaviour and price elasticity to explain why supermarkets discount junk food and not healthy food. The article finishes with:

Imagine what it would be like to shop at a supermarket where healthier food was on special more often, and with bigger discounts. Where customers were enticed by discounted fruit and vegetables instead of half price chips, chocolate and soft drinks.

You'll have to use your imagination. No such store exists, and if it did, you'd better get in fast because it's not going to last long before it fails.

*****

[*] Economists' usual assumption is that firms are trying to maximise profits, not revenue. For simplicity, I'm ignoring that assumption here. For a supermarket, with high fixed costs and the power to negotiate steep quantity discounts from suppliers, there probably isn't too much difference between maximising revenue and maximising profits.

Read more:

• Transaction utility and the behavioural economics of discounts
• Why we are sucked in by good deals for things we don't need

Transaction utility and the behavioural economics of discounts

Ralph-Christopher Bayer (University of Adelaide) wrote in The Conversation yesterday about the behavioural economics of discounting:

Because consumers are human beings, our actions aren’t necessarily rational. We have strong emotional reactions to price signals. The sheer ubiquity of discounts demonstrate they must work.

Lets review a couple of findings from behavioural (and traditional) economics that help explain why discounting – both real and fake – is such an effective marketing ploy.

When will firms offer discounts on their products? If they are profit-maximising firms (the assumption we usually make in economics), then they will lower prices if it increases profits. When prices are lowered consumers will buy more. That is the straightforward Law of Demand. However, lower prices don't automatically raise profits, because while the firm will sell more items, it sells those extra items and all the rest of the items that they could have sold at the higher price at the new lower price. Profits might even go down.

So, firms will only lower prices if it is more profitable to do so. However, if firms are better off with lower prices, you would (rightly) wonder why they need to discount - why would they ever offer the higher price, if they already know the lower price is more profitable? They should just start with the lower price.

There can be good reason for discounting. For some retailers, starting with a high price and discounting later has nothing to do with behavioural economics. For instance, consumers who wait until later to buy may have a lower willingness-to-pay (or be more price sensitive) than consumers who buy early. In this situation, it makes sense for the retailer to sell 'new season' items at a high price, but heavily discount those same items at the end of the season (this is what economists refer to as 'temporal price discrimination'). However, this is not what most retailers are doing when they discount items.

Most retailers are trying to take advantage of behavioural economics, as Bayer explains:

The prospect of buying something leads us to compare two different changes: the positive change in perceived value from taking ownership of a good (the gain); and the negative change experienced from handing over money (the loss). We buy if we perceive the gain to outweigh the loss.

Suppose you are looking to buy a toaster. You see one for $99. Another is $110, with a 10% discount – making it $99. Which one would you choose?

Evaluating the first toaster’s value to you is reasonably straightforward. You will consider the item’s attributes against other toasters and how much you like toast versus some other benefit you might attain for $99.

Standard economics says your emotional response involves weighing the loss of $99 against the gain of owning the toaster.

For the second toaster you might do all the same calculations about features and value for money. But behavioural economics tells us the discount will provoke a more complex emotional reaction than the first toaster.

Research shows most of us will tend to “segregate” the price from the discount; we will feel separately the emotion from the loss of spending $99 and the gain of “saving” $11.

Bayer is describing the idea of transaction utility (which I have blogged about before in this context). When we buy an item, we get utility (satisfaction or happiness) from receiving the item (which we call consumption utility), plus we get utility from the transaction itself (transaction utility). If we feel like we are getting a good deal, that makes us happier about our purchase. It doesn't make us any more satisfied with the item itself, but it increases our transaction utility. Higher total utility (consumption utility plus transaction utility) makes us more likely to buy the item.

Retailers can exploit this, and often do. By posting a high 'regular price' or 'recommended price' and showing a deep discount, they increase the consumer's perception of getting a good deal, and increase their transaction utility. This makes them more likely to make the purchase, because it increases their total utility.

Transaction utility can wear off pretty quickly though. You know that feeling of buyer's remorse, when you've bought something and you felt really good about it at the time, but soon after you think it wasn't worth it and maybe you want to change your mind? That's the transaction utility wearing off, and you're realising that the consumption utility alone is not enough to make the item worthwhile. But it's too late! Bayer's conclusion is relevant here:

The bottom line: beware the emotional appeal of the discount. Whether real or fake, the human tendency is to overrate them.

Read more:

• Why we are sucked in by good deals for things we don't need

Why we are sucked in by good deals for things we don't need

Back in April, news.com.au had an interesting article:

IF you spent the weekend spending up you’re certainly not alone...

Speaking to news.com.au, Dr Brockis, who specialises in brain health said retailers were cashing in on our buying habits.

The Future Brain author said most people got excited buying things with many feeling a great sense of control when they handed their wallet over.

“Our brain reacts to buying things,” she said.

“We either feel a sense of satisfaction we have something we want or reward if we’re buying for other people.”

Dr Brockis also said sales were an effective tool for retailers because shoppers were far more likely to buy something they didn’t need.

“That thinking we got such a bargain is what retailers have really honed in on,” she said.

“If something is significantly discounted shoppers are far more likely to buy it whereas if it’s small discount they’re not as drawn to it. Big discounts pique our curiosity.”

She said discounts made buying irresistible for some.

“The problem is our shopping bias to pay less for a given item can blind us to the fact we actually don’t need the item at all or it doesn’t suit us or might be the wrong size,” she said.

Of course, if a good becomes less expensive, consumers will buy more of it. That is the simple Law of Demand, which underlies the downward-sloping demand curve. However, even if a good is less expensive than before, it makes little sense for consumers to buy it if they have no use for it, i.e. if "we actually don’t need the item at all or it doesn’t suit us or might be the wrong size". So what is going on?

In behavioural economics, we recognise that consumers not only derive utility from the good or service they purchase, but also from the act of purchasing itself. We call this transaction utility. If a consumer feels that they are 'getting a good deal', this makes them happier (higher utility), and makes them more likely to purchase.

The consumer might feel like they are getting a good deal because the price is below some reference price, e.g. $10, marked down from $15. This feels like a good deal. Or perhaps the good is bundled with other things, such that the bundle feels like a good deal. This explains why we buy combo meals when we don't really want a drink or fries, or why we buy-two-get-one-free when we really only wanted one item.

Now, marketers know about transaction utility and use this to influence our purchasing behaviour. That's why they emphasise the original price whenever a discount is offered. Or even worse, why they may initial offer goods at a crazy high price, in order to maximise the discount that is subsequently offered. Taking advantage of our quasi-rational behaviour increases their profits.

Fortunately, we can somewhat protect ourselves against falling victim to such 'false' transaction utility, but only if we're aware of it. Always ask yourself: "Am I only buying this because it seems like a good deal, or do I really need this?" It may not work all the time, but at least it might save us from our worst excesses.