Prices Roundness and Price Rigidity

1. Prices Roundness and Price Rigidity Presenter: Haipeng (Allan) Chen Texas A&M University Avichai Snir Bar-Ilan University Daniel Levy Bar-Ilan University, Emory University, and RCEA National Tsing Hua University Hsinchu, Taiwan, April 22 2014

2. Frequency Distribution of the Last Digit, Dominick’s, Regular Prices, Stores #8, #12, #122 and #133 Source: Levy, Lee, Chen, Kauffman and Bergen (2011)

3. Frequency Distribution of the Last Two Digits in the Internet Data Source: Levy et al. (2011)

4. Why 9-ending? • “Change-making” story • Truncation (Manning and Sprott 2009; Thomas and Morwitz 2005; Schindler and Kirby 1997; Schindler and Kibarian 1993; Schindler and Wiman 1989; Lambert 1975; Gabor and Granger 1964) • Left-digit effect • Signaling (Schindler 2006, 1991; Anderson and Simester 2003; Stiving 2000; Stiving and Winer 1997; Schindler and Warren 1988) • Right-digit effect

5. Price Points => Rigidity Source: Levy et al. (2011) • Price points: One of leading theories of price rigidity (Blinder et al. 1998) • Price points contributes more to price rigidity than menu costs. • Once the effect of price points is accounted for, “menu costs are largely irrelevant as a source of price rigidity ” (Knotek 2010).

6. Convenient Pricing • Knotek (2008, 2011): • Convenient prices • In convenience stores, automatic vending machines, kiosks, … • Prevalence of round prices and other prices that minimize transaction costs • Transaction costs = minimum # of coins required to complete a transaction • Convenient prices are more rigid than other prices • We offer another explanation • Perceptual convenience (vs. “transaction convenience”) • Price roundness

7. Unique pricing regulation in Israel • The legal tender in Israel is the New Israeli Shekel (NIS), introduced in 1985. • The current denominations include NIS 0.10, NIS 0.50, NIS 1, NIS 2, NIS 5 and NIS 10 coins and NIS 20, NIS 50, NIS 100 and NIS 200 notes. • The NIS 0.01 (1 agora) and the NIS 0.05 (5 agora) coins ceased to be legal tender in 1991 and 2008, respectively. • Although the NIS 0.01 and NIS 0.05 coins are no longer in use, until very recently (Dec. 2013) retailers were free to set any prices and use any price ending. • When a consumer used an electronic payment device, such as a credit-card, she paid the exact amount. • When a consumer paid with cash, the total transaction price was rounded to the nearest NIS 0.10. • For example, in all cash transactions priced between 4.45 NIS and 4.54 NIS, the consumer paid the rounded price of 4.50 NIS.

8. Note: The legal tender in Israel is the New Israeli Shekel (NIS), introduced in 1985. The current denominations include 0.10, 0.50, 1, 2, 5 and 10 NIS coins and 20, 50, 100 and 200 NIS notes. The 0.01 NIS coin ceased to be a legal tender in 1991 and the 0.05 NIS coin ceased to be a legal tender in 2008.

9. Note: The legal tender in Israel is the New Israeli Shekel (NIS), introduced in 1985. The current denominations include 0.10, 0.50, 1, 2, 5 and 10 NIS coins and 20, 50, 100 and 200 NIS notes. The 0.01 NIS coin ceased to be a legal tender in 1991 and the 0.05 NIS coin ceased to be a legal tender in 2008.

10. What we see in Israel … • 9-ending prices in large stores • 0-ending prices in convenience outlets • The same patterns as in the U.S. supermarkets and convenience stores, respectively • And, the changes in popularity of 9-ending and 0-ending prices do not coincide with the elimination of 0.01 and the 0.05 coins • Is this expected?

11. Puzzle • Recall: • 9-ending prices may be perceived as much lower than what they are. • 9-ending prices may signal “something is on sale!” • In the meantime, in Israel a 9-ending price (e.g., 4.99) would be almost the same as the next round price (i.e., 5.00) • Especially in convenience stores where most consumers may pay with cash. • Israeli convenience outlets should use 9-ending prices to leverage these perceptual advantages of 9-ending prices, without sacrificing (much) profit. • In other words, since a nine-ending price (e.g., 4.99) requires the same number of coins as the approximate round price (i.e., 5.00), the popularity of 0-ending prices in Israeli convenience stores cannot be explained by “transaction convenience” (# of coins).

12. Perceptual Convenience • Knotek (2011) • Suspected that “psychologically convenient prices may yield convenient transactions as well.” • But claims that “it may be impossible or unnecessary to completely separate convenient transaction prices from convenient psychological prices.” • Called for more research on this issue. “The fact that round, convenient prices are more likely to be recalled than price points … raises the possibility that customer recall and memory may play an important role in explaining price rigidity and flexibility at the microeconomic level.” • Also called for studies of convenient price in “countries with distinct monetary systems.” • We study the role of perceptual convenience • That is, price roundness • In the prevalence and rigidity of convenient prices • Using data from the U.S. and Israel (i.e., two countries with distinct monetary systems).

13. 0 is Special • Its special role as a number (Schindler and Kirby 1997). • Its shape satisfies the Gestalt principles of roundness or completeness (Treisman and Gelade, 1980). • It is processed differently by consumers (Heyman and Ariely 2004). • People use zero-ending numbers as cognitive references points (Rosch 1975) • Professional baseball players more likely to walk if their batting average is just below .300, but more likely to have substitutes play for them when their batting average is just above .300 (Pope and Simonsohn 2011). • SAT test takers are more likely to retake the test if their score is just below a round number, especially for high school juniors (vs. seniors; Pope and Simonsohn 2011). • 57% of the transactions made at the self-service gas station pumps has final prices that end with .00 (Lynn et al. 2013).

14. The Current Paper … • Focus on 0-ending prices • Demonstrate • Prevalence of 0-ending prices • Rigidity associated with 0-ending prices • Reasons for rigidity of 0-ending prices • Use data from • A lab experiment • A survey of adult consumers • Two secondary datasets • From the U.S. and Israel

15. Three Types of Evidence • Lab Experiment: U.S. College Students • Demonstrate the perceptual advantage of 0-ending prices • Survey: Consumers at Israeli Supermarkets • Demonstrate how roundness of 0-ending prices contributes to perceived convenience • Secondary Data Sets: • Israeli Central Bureau of Statistics (CBS) • Dominick’s Finer Food from the U.S. • Demonstrate the effect of 0-ending on price rigidity

16. Lab Study • Design: 2x2x2x4 • 2 (numbers of digits: three, four), between subjects • 2 (stimuli types: number, price), between subjects • 2 (task type: find small, find large), between subjects • 4 (locations for the different digit: none, left-most, middle, right-most digit), within-subject • N=206 undergraduate business students at TAMU • Could receive up to $10 for performance • If they used 1 second or less per comparison (5 cents penalty for each additional second) • AND made no mistakes (10 cents penalty for each mistake) • A trial run and 4 experimental blocks • 75 comparisons in each block • Press A for left, L for right and the space bar if the two numbers/prices are the same • Key measures: • Accuracy • Response time

18. +

19. 5.47 5.49

21. +

22. 5.47 5.49

23. Lab Results

24. Survey of Adult Consumers • 393 consumers at large shopping centers in Israel (May – July 2012) • Average age=32 • 26% women • 33% usually pay with cash • Compared 68 pairs of prices and indicated preference • 0.10 ~ 15 New Israeli Shekel (NIS; 1 USD=3.70 NIS as of June 6, 2013) • These prices are usually paid with coins because their value is smaller than the smallest banknote (20 NIS). • The average price in the sample was 4.83 NIS. • The minimum difference between any pair of prices was 0.01 NIS. • The maximum difference was 5 NIS. • The average difference was 1 NIS. • If there were significant differences between two prices, participants were told that the difference in the prices was due to differences in quantity. • Then ranked the six existing coin denominations (10, 5, 2, 1, 0.50 and 0.10 NIS) from the most convenient to the least convenient. • Used to construct another index of “coin convenience” (= # of coins weighted by their perceived inconvenience).

25. Rank order of coin convenience Notes: The average convenience ranking assigned by survey respondents to each coin. The t-test scores are for testing the hypothesis that the average score given to a coin is not different from the score of the next coin. *, **, and *** indicate statistical significance at 10%, 5%, and 1%, respectively.

26. Results on Preferences Note: Results of random-effect probit regressions on the probability that a participant picked a price as the more convenient. Standard errors are reported in parentheses. In Column (2) we add controls for the interaction between coin-inconvenience, roundness and participants’ gender, age and the dummy that equals 1 if a participant mostly uses cash rather than credit cards. In Columns (3) and (4) we restricted the analysis to prices with a difference of less than 0.10 NIS. In Columns (5) and (6) we use a different measure of coin-inconvenience. That is, # of coins weighted by the perceived convenience of each coin. *: p<.10; **: p<.05; ***: p<.01

27. Results – An Illustration • The probability that participants preferred a price of NIS 5.60 over NIS 5.51 was over 71% • NIS 5.51 is rounded to 5.50 • So NIS 5.60 is more expensive than NIS 5.51 by NIS 0.10 • The probability that participants preferred a price of NIS 5.56 over NIS 5.51 was about 36% • NIS 5.56 is rounded to NIS 5.60 • NIS 5.51 is rounded to NIS 5.50 • So the difference between the two prices is also NIS 0.10. • Thus, Israeli consumers prefer a zero-ending price over a slightly lower non-zero-ending price (5.60 vs. 5.51). • But this preference is weakened when the higher price is not zero-ending (e.g., 5.56 vs. 5.51). • Even though the real price difference is the same (NIS 0.10). • And, the difference in the number of coins required is the same.

28. Secondary Data Set (1) • Israeli Central Bureau of Statistics (CBS) for compiling the CPI index • monthly observations on the prices of goods belonging to 18 categories of consumer goods • 1999 – 2011 • bag shops, fruit and vegetable stores, shops in gas station, car repair shops, groceries, kiosks, non-food shops, open market stalls and organic food shops • Data on the following variables: share of female customers, socio-economic status, share of Arab-Israelis customers, size of the population, distance from Tel-Aviv and a periphery index based on the size of the population in the vicinity of the locality, so that a small town in a densely populated area has a lower periphery index than a small town in a low density area. • Total # of observations=127,477 • Average price=39.87 NIS • Median price=7.50 NIS • 81% are 0-ending; 51% are 00-ending

29. Secondary Data Set (2) • Dominick’s • 130 stores; 29 Product Categories; 18,037 SKU’s • 1989–1997, Weekly Prices • Over 98 Million observations • Overall, more than 65% 9-ending prices; less than 5% 0-ending prices (Levy, Lee, Chen, Kauffman and Bergen 2011). • Front-end candies as a “convenient” product • 4,228,852 weekly observations • 12% price changes • Average price=$0.61 • Modal price=$0.50 (11%) • 24% of the prices are 0-ending prices. • 19% of the prices end with a multiply of 25 cents but are not 0-ending (i.e. $0.75 and $1.25). • 43% of the prices are set at “convenient prices” (i.e., 0 and 5). • 39% of the prices are 9 ending.

30. Results from Israel Note: Results of a probit regression on the probability of a price change. The regression also includes a full set of dummies for product category and year fixed effects. * p<.01

31. Results from the U.S. Note: Results of a probit regression on the probability of a price change. The regression also includes a full set of dummies for product category and year fixed effects. * p<.01

32. Conclusions • 0-ending prices are prevalent • in the U.S., and • in Israel where there is no penny or nickel denomination • 0-ending prices have perceptual advantages. • They are processed faster and more accurately. • 0-ending prices are preferred by consumers. • And by retailers (they are more rigid). • In both the U.S. and Israel • Answering Knotek’s (2011) call for studying convenient pricing in “countries with distinct monetary systems.” • These perceptual effects are above and beyond the effects of transaction convenience. • Answering Knotek’s (2011) call for identifying the transaction vs. psychological drivers of the prevalence and rigidity of convenient prices.