Economic Fallacies and Netflix

by Henry on July 23, 2004

Experimental psychologists are fond of pointing to examples of economic irrationality in every day life – for example, people respond in very different ways if an article is priced at $9.99 and if it’s priced at $10. Through detailed examination of my own and my wife’s behaviour, I think I’ve identified another such example – the “Netflix fallacy.” Netflix, for those of you who aren’t familiar with it, is a subscription service where you pay a set amount each month to rent movies. You can have three DVDs out at any one time – when you are finished with one, you send it back, and receive a new DVD from your list of picks by return post. In theory, it’s an ideal way to make sure that you have the movies you want, when you want, and an excellent deal if you rent more than 3-4 DVDs a month.

In practice, it’s different – at least in my experience. Movies that we’ve rented sometimes sit there for two or three months before we watch them, or eventually, reluctantly, decide to send them back without seeing them. To my shame, this happens most often with the interesting, difficult films with sub-titles. I suspect that this is because we’re accustomed to thinking of DVDs as stocks rather than flows. Because we have physical possession of the DVD, we’re disinclined to give it back until we’ve actually watched it. Of course, this means that we face substantial costs – we may very easily end up paying more money to rent the damn movie than we would have to pay to buy it and keep it forever. Meanwhile, Netflix is laughing all the way to the bank. It’s much smarter to think of the rental service as a flow – you’re likely to be happier if you keep the movies coming along in a steady stream, even if you don’t watch them (the latter may be useful information about your actual preferences, as opposed to the preferences that you would like to have). I suspect that virtually any reasonable decision rule along the lines of ‘send the movie back if you haven’t watched it within two weeks’ is likely to produce better results than our current policy of watching the movies whenever we get around to it. Or, more typically, don’t get around to it.

{ 32 comments }

1

dsquared 07.23.04 at 10:53 pm

I’m not so sure about the $9.99 effect. Historically, the pricing convention dates back to the early days of the cash register. The idea is that if an item is priced at $9.99, then the assistant has to make change. This means that she has to open the till, which creates an audit record of the transaction. If the item is priced at a round $10, then it’s pretty easy to just pocket the banknote.

2

laura 07.23.04 at 10:55 pm

Interesting…just this week I’ve been debating whether to get Netflix or not. My problem is that there are months when I watch many videos and DVDs and it would make a lot of sense for me to have it, and months when I watch none at all, or am out of town for several weeks, and I’d lose money.

I hadn’t thought of the scenario of having something, not watching it, and sending it back after a long time. Of course, I’m unlikely to imagine that it would be a good idea to get anything difficult, let alone subtitled.

3

q 07.23.04 at 10:56 pm

False economy? I have this problem with takeaway indian food. I always order an extra “bombay potatoes” in order to have save some to heat up for tomorrow’s lunch – then I just eat the lot anyway.

Which brings up the topic of obesity! :)

4

Henry 07.23.04 at 11:04 pm

>I’m not so sure about the $9.99 effect

Yeah, I’ve read that take too, but why has it persisted? In my take, path dependence not only has to have some historically rooted explanation, but also some explanation of the mechanism that is reproducing the phenomenon in question. Not sure what could be reproducing it here.

John Huston and Nipoli Kamdar have a piece in the “Eastern Economic Review” (22:2 1996) suggest that it’s all about rational consumers who don’t want to read to the end of the price (reading the final digits to the right impose a cost), and merchants taking advantage of that fact to up the price to the maximum possible. Sounds a bit absurd to me – but then, many articles written by economists trying to explain everyday consumer behaviour as economically rational strike me as absurd – efforts in creating epicycles.

5

John Quiggin 07.23.04 at 11:05 pm

I was cured of the $9.99 fallacy when I lived in the US. This is because US price tags are almost invariably pretax, unlike Australia.

So I’d fall for the “less than $10” trick, produce my picture of Alexander Hamilton (IIRC) and be told “That’s $10.67”, or whatever, resulting in an embarrassing search of my pockets for quarters and pennies.

The end result for me, was the feeling that, whatever was on the price-tag, I should have at least twice as much ready, which is not conducive to happy shopping.

6

eudoxis 07.23.04 at 11:26 pm

We’ve had a Netflix membership for about 2 years. We recently downloaded our rental history and calculated we paid an average of $1.69 per movie. That compares to the local video store rental fee of $4.00 plus tax and frequent late fees.

We’ve gotten out of the habit of feeling compelled to watch a movie as soon as it arrives. I think this is created by the local store format. That’s really one of the advantages of Netflix. We’re also more inclined to return a movie that sucks. When we travel, we return all the present unwatched movies, load the queue with kid flix and have the babysitter mail them back before we return. Even better, my husband and I don’t feel compelled to watch the same movies, we each have the freedom to rent our own. When renting from the store, we tended to agree on a movie, but our tastes are varied.

Even with the inevitable battle over the movie queue and the occasional delay with new releases, our experience with Netflix, for our lifestyle, has been far better than with the local rental store.

7

tom 07.23.04 at 11:46 pm

>I’m not so sure about the $9.99 effect

Tell me how you feel about this line of argument – it might feel a little circular:

If you’re thinking about the $9.99 then you’re not going to be fooled (of course you aren’t, no deliberate form of reasoning is going to be swayed more that 1 part in 1000 by a cent difference).

So that takes in all of us, right now, as we discuss the matter. And maybe anyone (like John) who’s had the awareness of it trained into him.

Of course, if you’re not really thinking about the $9.99 – like most people most of the time – then there’ll be a small bias into experiencing $9.99 as significantly cheaper than $10.

Because most of us most of the time don’t have the intellectual or temporal resources to reason deliberately about most things (including prices) $9.99 is worthwhile for people setting prices. Why else would it be so ubiquitous?

8

tom 07.24.04 at 12:03 am

And thinking more about the ‘Netflix fallacy’ – it could just be an example of our general difficulty thinking about statistics, averages and base-rates.

There’s a tendency to over-estimate low probability events (in this case, maybe that’s getting more than your money’s worth from the Netflix arragement) and under-estimate less recent events (which could be the weeks you don’t use the service, from the perspective of the week when you signed up, which was probably a high-salience high-DVD watching week).

Add these biases, and a few others, together and you get our general inability to take base rates into account when reasoning with probabilities (in this case a neglect of the base rate of weeks when you watch a good number of DVDs). It’s a great deal some weeks, but not most weeks – but the frequency of these bad-deal weeks has a hard time influencing decision-making.

Possibility?

9

bleh 07.24.04 at 12:25 am

Re Netflix, I think this discussion overlooks the way many (most?) people typically rent movies, i.e., on the spur of the moment, with a choice made after browsing. “Let’s go get a movie.” My guess would be that Netflix makes more money from people UNDER-using the service (following an initial burst of enthusiasm) than from late fees.

Re the “99” phenomenon, aka the “grocery store trick,” the opening-the-till story sounds like apocryphal myth to me. I think the truth is much more basic: people respond better EMOTIONALLY to lower dollar figures, even if their more rational sides are fully aware that the difference is only a penny. That’s why you see the same effect even when the numbers are in whole dollars, e.g., $699 or $1599.

10

Mark 07.24.04 at 12:37 am

I’ve had Netflix for a little while and I split it with my roommate, so it costs me about $10/month. I spend so much money in a month, there’s no way in hell I’m missing that $10.

Netflix offers me a savings that nobody here has mentioned: no more roundtrips to the video store. This alone is well worht the $10. Also, browsing movies on the Internet, with the searching capability and all of the accompanying links, is far superior to a video store.

11

Mark 07.24.04 at 12:37 am

I’ve had Netflix for a little while and I split it with my roommate, so it costs me about $10/month. I spend so much money in a month, there’s no way in hell I’m missing that $10.

Netflix offers me a savings that nobody here has mentioned: no more roundtrips to the video store. This alone is well worht the $10. Also, browsing movies on the Internet, with the searching capability and all of the accompanying links, is far superior to a video store.

12

abb1 07.24.04 at 12:39 am

Yes, $9.99 is stupid, I agree, but what about $199.99 vs. $200.00? Not so stupid.

When my wife buys a new watch or something and I notice it and ask: how much did you pay for this? She can say: oh, a hundred something.

Otherwise she would have to say: 200. Then she may have listen to a lecture and, eventually, we may start yelling at each other and saying things we’ll later regret.

So, she may buy something for $199.99 but not for $200.00. How ’bout that, folks?

13

sidereal 07.24.04 at 1:09 am

Wife and I have used Netflix for about 2 years and came up with the 1 week rule fairly early on. If it’s on the shelf for a week, it goes back and we stick it back on the bottom of the rental queue.

Our problem isn’t so much keeping dud movies. It’s having to keep Ice Age or Monsters, Inc for 3 months because our son won’t let us send them back.

14

Tom T. 07.24.04 at 1:47 am

Isn’t the deal with Netflix that you only pay the flat fee per month, and there are no late fees? My recollection is that the flat fee was priced such that Netflix would be cheaper than Blockbuster or Hollywood if I watched maybe six DVDs in a month.

Won’t they keep sending new movies to you, though, as long as you’re returning at least one of the three in your possession? Thus, as long as one of the three DVDs in your possession is turning over at least six times in a month, you’re not losing money on the deal no matter how long you keep movies 2 and 3, right?

15

s_bethy 07.24.04 at 3:30 am

I’m surprised that nobody has mentioned that gasoline is always priced at (something) and 9/10ths of a cent per gallon.

It’s an outrage that Big Oiul has been raking off the rounding error in millions of transactions over the years.

I’m outraged, I tell you.

16

P.D. 07.24.04 at 5:58 am

If I’ve got this right, then the general form of the Netflix Fallacy is failing to ignore sunk costs. Since you’ve gone to the trouble of getting the movie, you hang on to it. Returning the movie would be better for you, but you irrationally insist on getting some return on your sunk cost.

17

Persimmon 07.24.04 at 6:22 am

Tom asked “Isn’t the deal with Netflix that you only pay the flat fee per month, and there are no late fees?”

Yes, that’s true — and if you know you have a movie hoarder in the house you can pay a somewhat larger fee and up the number of movies you can have out. (I just looked at their site, which offers a cheapie deal for only 2 movies at a time, all the way to 8 movies at a time.)

But no matter how long you keep the movies out, no late fees.

I love it, because it means that I can have a couple of movies I’m interested in sitting on the shelf until I’m ready – and when I’m done, the next movie on my list is on the way. It’s so easy, no trips to the store — I always think of Netflix as a successful business because it really makes it easier for me to have what I want as a viewer — a good, constantly updated set of movies, ready and waiting when I have time for them.

18

Bernard Yomtov 07.24.04 at 5:57 pm

The $9.99 effect works on me, much as I hate to admit to irrational economic behavior.

When I pick up an item with a $10 price tag I find I am always pleasantly surprised to learn that it in fact costs $10, and not $10.99. This suggests to me that however the practice originated it is so common that we now instinctively take it into account when shopping.

So for a merchant to stop it would be irrational.

19

Adam Kotsko 07.24.04 at 6:14 pm

What about local video stores who offer a Netflix-like scheme? That type of arrangement seems to exaggerate both the benefits and the drawbacks of Netflix. On the one hand, you still get the video-store experience, with the spontenaity that implies. On the other hand, I’d wager that you’re even more likely to hold onto movies too long, since you have to physically carry them back to the video store, keeping your failure to watch it in mind for much longer than if you had simply dropped it in the mailbox.

Another thing to consider in cost-effectiveness is that if you’re going to have a long list of movies to watch, chances are most of them will no longer be new releases, so the individual rental will be cheap — and factor into that the fact that my local video store doesn’t make you pay off your late fees until it’s like $40.

20

h. e. baber 07.24.04 at 6:23 pm

I tried Netflix for a few months. I couldn’t ascertain my tastes by introspection. When I discovered that I didn’t want to watch enough movies to make it worthwhile I quit. If I’d decided to adopt a rule to return each movie within 2 weeks, whether I watched it or not, in order to make Netflix worthwhile–undertaking the self-discipline to carry it through, keeping track of how long the movies were out, etc. it wouldn’t have been worth my while even if I could lower the cost of the movies below Blockbuster prices because the costs of the hassle and self-discipline figure in.

My ex-colleague, L., who was quite mad, rented from Blockbuster. When deadlines for returning movies pressed he would watch them fast forward to get them watched before returning them. One year he bought a Christmas tree after Christmas–he got a guy who was loading leftover trees onto a truck to sell him one for $5 and was pleased no end to have gotten a bargain.

21

Shelly Rae 07.24.04 at 7:38 pm

I love the way Netflix allows me to be slothful about returning a movie. If you’ve ever run up late fees at your video/dvd store then Netflix is definitely a bargain. Plus, I live in a small Pacific Northwest town where the best rental selection is at Safeway–not exactly a rich collection. Netflix has so many films to choose from that my queue is regularly maxed out at 500 movies. It may be years before I get to the movie currently at 500 (unless I change its place in the list) but at least I get to finally see those films that Safeway will never carry.
Netflix is definitely a bargain for me.
Anon.

22

Shelly Rae 07.24.04 at 7:40 pm

I love the way Netflix allows me to be slothful about returning a movie. If you’ve ever run up late fees at your video/dvd store then Netflix is definitely a bargain. Plus, I live in a small Pacific Northwest town where the best rental selection is at Safeway–not exactly a rich collection. Netflix has so many films to choose from that my queue is regularly maxed out at 500 movies. It may be years before I get to the movie currently at 500 (unless I change its place in the list) but at least I get to finally see those films that Safeway will never carry.
Netflix is definitely a bargain for me.
Anon.

23

Shelly Rae Clift 07.24.04 at 7:43 pm

I love the way Netflix allows me to be slothful about returning a movie. If you’ve ever run up late fees at your video/dvd store then Netflix is definitely a bargain. Plus, I live in a small Pacific Northwest town where the best rental selection is at Safeway–not exactly a rich collection. Netflix has so many films to choose from that my queue is regularly maxed out at 500 movies. It may be years before I get to the movie currently at 500 (unless I change its place in the list) but at least I get to finally see those films that Safeway will never carry.
Netflix is definitely a bargain for me.
Anon.

24

Chris 07.24.04 at 7:54 pm

For the past several summers, we drop cable for 3 months (June, July, August) and then reup (for a $10 reconnect fee) when football season starts in September. This summer, we signed up with Netflix to replace the need to have something to watch when nothing else is going on.

So, Cable costs $40 bucks a month, so by canceling it we come out $110 ahead (minus the $10 dollar reup fee in September). Netflix costs us $20 bucks a month for the 3 months we are keeping our membership, so we are still $50 bucks ahead.

Even with netflix, the family budget is $50 richer for 3 months. Which may not sound like much, but does make a difference.

25

david 07.24.04 at 10:55 pm

Why not burn a copy before sending them back?

26

harry 07.25.04 at 1:33 am

We pay nothing for the videos/dvds we watch because we get them form the local public library. We keep them a week. We can queue for popular movies — and this is a problem for very high demand non-blockbuster type movies. Sometimes we have to wait 3 whole months!! Big deal. The selection is better than the local video store, though. You can check progress online. And NOBODY ELSE EVER RENTS H.R. PUFNSTUFF! So the kids are in clover.

27

nick 07.25.04 at 7:45 am

Just an addendum to the .99 thing: I’ve noticed the tendency to read out big-ticket prices as single numbers (‘six-nine-nine-five’) or even in two-digit groups, as if they were small-ticket prices (‘sixtynine-ninetyfive’). Definitely designed to cushion the blow, since you don’t hear a ‘thousand’ or a ‘hundred’…

But as John Quiggin notes, the small-ticket thing is rendered somewhat meaningless when sales tax is added on later and you instinctively add 10% on to the bill. Perhaps that’s also why Americans are so prone to tip, because all bills are designed to be supplemented?

Oh, and Netflix? Especially good for watching box-sets of TV series. Order the lot, and there’s your flow.

Why not burn a copy before sending them back?

Because it’s illegal? And pragmatically, because we’re talking about a product that’s primarily consumed, rather than collected. You don’t really want a pile of DVDs to sort through. With the hassle and cost ($1/blank), it’s easier just to send the unwatched DVDs back and re-order.

Does anyone use the on-demand services offered by cable companies? In theory, they should be the real replacement for the local video rental store (especially in combination with a TiVo or video recorder), but I’ve never found the on-demand stuff compelling…

28

david 07.25.04 at 4:44 pm

OK don’t burn a copy. Copy it to HD and delete it after you watch it. I know its illegal. So this spliff I’m smoking.

29

Lindsay Beyerstein 07.25.04 at 6:13 pm

I considered Netflicks money well spent even in months when I didn’t make my 4 DVD quota.

1) No late fees.
2) Much better selection than your average video store.
3) Convenient returns. You just drop the DVD in the mailbox instead of having to go all the way back to the video store.

30

Dan McEnroe 07.26.04 at 4:32 pm

My wife and I got caught up in what we called the “tyranny of Netflix.” We’d make our list, and then in the time it took for the movies come, we’d change our minds about what we wanted to see. So, the movies we got would sit there for about three weeks until we got in the mood to see them, at which point we were simply getting them “out of the way” in order to get to the stuff on the list we really wanted. Why didn’t we just send them right back, re-queue them, and get the movies we wanted? Good question. Never said we were sane.

31

Willy Sutton 07.26.04 at 4:47 pm

When I buy a pot of milk, and then throw it away after few weeks, is that irrationality?

We all make ‘mistakes’ in our consumtion, and we all modify our future consumtion based on our past experience. ‘Mistake’, is not the same thing as irrationality.

It seems to me that it can take some time before someone decides that signing up for Netflix is a mistake, since the benefits could come in few months, for example when the annual ‘video season’ starts in December.

Also, this Netflix-thin is a new thing for most people, and as such, the customer has no past experience that is quite the same (although many other experiences that he can draw on).

Now I personally don´t buy milk at all, and Netflix is now a continent away.

32

Matt Weiner 07.26.04 at 6:38 pm

S Bethy–
That’s true (though I don’t think anyone thinks that the .9 cent effect is morally wrong)–and note that this can’t be explained away by Daniel’s opening-the-till effect.
OTOH, I think the Huston-Kamdar effect sounds better for gas prices since there is a much higher cost to reading to the end of the price when you’re whizzing down the road looking for a gas station than in an ordinary shopping situation. Of course now you get no extra information by reading to the end of the price, since the last digit is always 9.

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