Insights into Consumer Use of Financial Products: Payoffs from the New Behavioral Economics

I talked about behavioral economics in my last blog. Some of the top minds in that field are studying how consumers use financial products. They aren’t doing this to provide any business advice. Instead, financial products provides them with neat laboratory for testing some of their theories on how consumers make decisions about complicated products that involve some discounting of future costs and benefits. But some of the studies are interesting for those of us in the payment biz. All of them are based on conducting real-world experiments where people are offered financial products under different terms. Then the authors compare a test group with a control group.

Here’s a summary.

Suppose you are running a bank and you are curious how offering gifts to customers will affect deposits. George Loewenstein from Carnegie Mellon, who is one of the giants in this area, and Emily Haisley from Yale have looked into the effect of gifts on deposits. They worked with a bank and tried several different combinations of gifts. No surprise: giving people gifts increased balances and the effects persisted for some time after the gifts. The returns outweighed the value of the gifts. They conclude that gift programs might even beat reward programs:


“The boost in deposit balances in the gift treatment conditions compared to the no-gift control suggests that surprise gift programs may be effective alternatives to transactional loyalty programs that rely on point schemes. Though a direct comparison is not possible with data in the current experiment, these gift programs show promise in their ability to produce revenue generating results. Further, surprise gift programs require less administrative costs since there is no need to sign-up customers, track points, deliver rewards, and address questions or complaints.”


One interesting result from the study concerns repeating gifts over time. People don’t take well to reducing the value of the gifts. So starting with a high value program and then reducing it is worse than not having a gift overall.

Another interesting study by Loewenstein, this time with Elif Hafalir (also of Carnegie Mellon), looked at whether credit cards increased spending. They did an experiment at an insurance company cafeteria. They gave some diners’ a credit card along with an incentive to pay by card rather than cash. What they found for buying cafeteria food was that credit card users didn’t spend any more money on average than cash spenders. This is related to my recent blog on taxi cabs in New York which reached the opposite conclusion. My guess is that whether cards increase spending or not depends on whether they help lower some transactions cost — either in getting cash, recording receipts, and financing a purchase. Maybe none of those things were important in the cafeteria. Nevertheless, this is important stuff for card networks to care about since their bread and butter is convincing merchants that plastic increases spend. We need more controlled studies on that to figure out what’s going on.

Another interesting study is by Agarwal, Driscoll, Gabaix, and Laibson. These are all well respected authors, but Laibson is one of the superstars in behavioral economics (we’ll see in my next blog why he, like many in this area, is so hostile to credit cards that he would like to ban them — seriously). These authors documented that — surprise! — late fees work. Here is a summary from them:


“Agents with more experience make better choices. We measure learning dynamics using a panel with four million monthly credit card statements. We study add-on fees, specifically cash advance, late payment, and overlimit fees. New credit card accounts generate fee payments of $15 per month. Through negative feedback — i.e. paying a fee — consumers learn to avoid triggering future fees. Paying a fee last month reduces the likelihood of paying a fee in the current month by about 40%. Controlling for account fixed effects, monthly fee payments fall by 75% during the first three years of account life. We find that learning is not monotonic. Knowledge effectively depreciates about 10% per month, implying that learning displays a strong recency effect.”


Short story — If the purpose of these fees is to discourage people from doing bad risky stuff, they work. This is, of course, why issuers are facing serious problems from the limitations imposed by the CARD Act.

There’s a lot more in this literature including work on how consumers use different kinds of tender types (debit vs. credit for example) for mental accounting. That’s why most people don’t finance the groceries even though they could get rewards and some float.

Behavioral economics has also been used to bash the credit card industry and in fact is the intellectual foundations of the dangerous Consumer Financial Protection Agency Act of 2009. That’s the subject of the next blog on behavioral economics.

Related Content


The New Economics of Consumer Behavior and Why You Need to Know About It

The Effect of Card Acceptance on Sales: The Case of Taxicabs in New York

The Consumer Financial Protection Agency: Sorting the Critiques