Why Do People Pay More Money for the Top of the Line Model? Incremental Value Analysis

by Darwin on November 9, 2009

Incremental value analysis confronts us all in everyday expenses from sales at the lunch line at work to replacing routine household items that your wife destroys. The other day, my wife broke the glass coffee carafe for the last time.  I said, “I’m sick of you and the kids breaking these damn things, let’s just get a stainless one”.  Of course, that then led to the discussion of how we might as well buy a nice one since we drink coffee routinely and when we entertain, need to make a large pot now and then, etc.  I told my wife to just pick out something reasonable and buy it.  Of course, she couldn’t make a decision (I love her dearly but she can never make that executive decision!) so she whittled it down to two models and asked which one she should buy.  That simple discussion got me thinking about the buying habits of people in general and why they tend to pay significant premiums for things they clearly don’t need or will never utilize.

The Coffee Pot

After deciding which brand and look she wanted, my wife presented me with two options:
1) 10 Cup coffee Maker for $79.99
2) 12 Cup coffee Maker for $99.99

Both models were the same brand, looked similar, had SS carafes, etc.  The only differentiation I could find was that one made 2 additional cups of coffee.  Now, the fact that my wife even posed the 12-cupper to me indicates she was perfectly willing to buy it had I agreed.  After all, it’s only 20 bucks, right?  I asked her why she thought we should pick the 12 over the 10.  She replied that sometimes if we have a large party and make coffee, it makes the 2 extra cups.  I was thinking about the added utility of 2 extra cups for a $20 difference (25% markup) and I just couldn’t justify it.

1) Most days, it’s just me drinking coffee and occasionally my wife.  So, that would be like a 5 cup setting max.
2) On the rare occasion where we have a large party (couple times a year), if 15 people are drinking coffee for the ride home, neither the 10 cup nor the 12 would cut it on a single pot.  We’d have to run it twice with either model.
3) There was absolutely NO scenario I could identify where having a 12 cup capacity would be any more beneficial or provide any extra utility to us than a 10 cup model.

Thus, there was simply NO value proposition whatsoever in buying the 12-cup.

However, so many people I know (and you may be one of them) just instinctively buy the premium model practically every time.  In the back of their mind, there’s something that says “What if I need X just that one time…Wouldn’t it be nice to have Y instead of the base offering”.  I mean, we have friends that bought a snowblower for thousands in an area that rarely gets snow and another friend that bought a top of the line new mower but pays a landscaper to mow the lawn.  I think this is more of a psychological phenomena than anything else.  People just tend to think that a base model is deficient in some way and they are “deserving of” or getting “better value” for a step or two up, even though, in my estimation, the incremental return on investment is terrible.

Here’s my visual representation of how this works.  Bear with me, but I think you’ll relate to the concept:

incremental-analysis

Consider these additional examples:

The New Car

When we bought a new minivan last year (utilizing some neat car negotiation tips I might add), we were confronted with the base model, base + leather (which we opted for due to kids/pets, and some other more premium models.  Now, obviously, if they’re offering them, people are buying them.  But, I was very surprised by the incremental benefits provided versus the high additional cost.  For instance, it was like an additional thousand dollars for an “entertainment package” which was nothing more than a built in DVD player and it was another $800 or something for a built in navigation system.  This made very little sense to me.

Entertainment system – We just ended up buying a portable DVD player that can go in EITHER car for around $100 instead of $1000 for a fancy in-car system.  It has the same utility to us.  On a real long ride, the kids can watch a movie, this thing plays all video formats (which many models like in-car systems don’t), we can take it with us, watch on a plane, etc. and if it breaks, it can be replaced for $100 or less.
Navigation system – With technology evolving the way it does, I don’t get the point of spending close to $1000 for an in car navigation system when you can get a decent GPS for $150 and now, many smartphones come with free systems built right in.  I mean, some of the early in car navigation systems are now so obsolete and outdated that while they seemed cool and cutting edge at the time, people don’t even use them because they stink.  They’d rather just use a newer GPS or their iPhone.

Again, the “incremental value” you’re getting seems really low to me.

High End Technology

Finally, while I love gadgets and technology as much as the next guy, I just don’t get early adopters and the people that ALWAYS have to have the fastest computer chip and the highest resolution TV or whatever the latest advance is.  With decades of history and the proverbial Moore’s law, within 18-24 months, whatever you just bought is going to be very much obsolete and you’ll just end up paying top dollar for the cutting edge model in the very near future.

By waiting a couple months for a faster Intel chip and buying the 4-month old version or by waiting for LCD TV prices to drop by 50 each year, you’re saving tens of thousands of dollars over a lifetime for virtually the same experience and utility, just delayed by a couple months.  I’m not kidding when I tell you I know a guy who paid $6,000 for a Sharp Aquos when it first came out.  Within a year, it was less than half that.  He completely threw away over $3,000 in my opinion.

I get that people have hobbies and passions and sometimes they justify it to themselves by perhaps cutting costs elsewhere, being disciplined in other facets of their financial management, etc. – or money just is no object to them.  But, for most of us, these decisions can have a pretty high impact.  You could probably call me a hypocrite.  I bought a new iPhone this year.  But, I’ve justified it to myself in that I waited until the 3rd generation to finally jump on the smartphone bandwagon, I needed a new phone anyway since my kid destroyed my cell, I can deduct a portion of the expenses due to my LLC, plus I haven’t really bought anything for myself in over a year.  I can sleep OK at night with my iPhone purchase, but just thought I’d admit that I’m not a bare bones frugalist all the time either.

What’s my point? Just think about purchases a little differently when you remember that silly coffee-pot article.  Think about my goofy picture.  Consider whether you can really justify the incremental cost you’re paying for the measly (perhaps zero) gain in utility that you’re deriving.  Does it make sense?  If so, then go for it!  If not, then maybe that base or middle model is actually your best purchase.

Any other examples come to mind?

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{ 4 comments… read them below or add one }

1 Travis November 9, 2009 at 2:28 pm

Technology is one of the worst in regards to price markup in my opinion… you can easily wait a few months and that “next-gen” tech becomes 2/3 of its current cost. Wait a year or so, and usually you’re down to 40-50% of its current markup….

Interesting article though, as sadly, most people have a hard time understanding the mindset behind price markup and all too often seem to get fooled by it.

[Reply]

2 JoeTaxpayer November 9, 2009 at 10:35 pm

Interesting.
I can look at it this way; I have a nice size cup, so it’s really about 5 cups or 6. I make a full pot every time and the rest gets put in a pitcher in the fridge which I microwave in the morning a cup at a time. I’d need to measure and make 1/6 fewer pots, and over the life of the pot, years I’d guess, that 20 bucks would turn into many hours of time saved. For the fact that I’m drinking 10 cent a cup coffee, and not $4 per cup, I’d likely get the larger one and pay the $20.

[Reply]

3 The Zen Capitalist November 14, 2009 at 3:53 am

This is too good of a post to have 2 comments! (3 now with me)

I love how you put marginal value (easily one of the most boring microecon concepts) in Layman’s terms that everyone can understand. It was a fun read too!

Sadly, to answer your question: Why Do People Pay More Money for the Top of the Line Model? Answer: Keeping up with the Joneses.

Zen

[Reply]

4 Monevator November 16, 2009 at 6:02 am

Great post. More worryingly, I think we may be separated at birth — I did exactly the same thing with the iPhone, and yet I would have gone for the better coffee maker, too.

More mundanely, there’s probably a ‘target market demographic’ with our name on it!

[Reply]

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