Why would someone choose a credit card with a one percent interest rate over another with a zero percent rate? The answer, says a new study, lies in the fact that consumers are often flummoxed when it comes to zero.
"A reasonable assumption is that a product will be more attractive when it offers more of a good thing, such as free pictures (with a digital camera purchase), or less of a bad thing, like interest rates on a credit card," says Mauricio Palmeira of Monash University, Australia. Palmeira's research found that consumer comparison methods tend to get confused when one of the comparison terms has a zero value.
For example, a consumer interested in a new credit card may need to choose between one with a $45 annual fee and a one per cent interest rate and another with a $15 fee and a 20 per cent interest rate. "One could view this decision as a choice between an extra $30 annually for a 19 per cent reduction in interest rate. It can also be viewed in relative terms. In this sense, a $30 difference between $15 and $45 appears much bigger than the same difference between $115 and $145," argues Palmeira. Consumers tend to be more sensitive to relative rather than absolute differences, which is why a one per cent interest rate looks good, since its interest rate is 20 times less than 20 per cent.
But what if consumers compare a 20 per cent interest rate to a zero percent one? "I argue that whereas a 20 per cent interest rate may look very large compared to one per cent (it is 20 times larger!), it may not look as large compared to zero per cent. Zero eliminates the reference point we use to assess the size of things," Palmeira explains. His study has been published in a recent issue of Journal of Consumer Research.
"This leads to a counterintuitive situation, in which a credit card can increase its likelihood of being selected when it has a small but non-zero interest rate," says Palmeira. The same is true of other attributes that consumers want to minimise, like interest rates and fat content.
The inverse is true when consumers desire an attribute. For example, if a digital camera offers a promotion that adds 200 free pictures to a purchase, a competitor may be better off offering nothing rather than just a few free pictures. "This is because 200 will look larger compared to 10 or 20 than compared to zero," Palmeira writes.
