Last week the Republican health care bill seemed doomed to fail, and was thus pulled prior to a vote. It was a setback for the Republican Congress, as well as President Trump. Wired magazine wrote about the situation in an article called, “How Trump’s Ultimatum Gambit Sank His Health Care Bill” which posited that the President overplayed his hand by issuing an ultimatum to Republican holdouts who apparently determined that they had more to gain (or nothing to lose) by rejecting it.
About the Ultimatum Game
The Ultimatum Game is a simple exercise. In the purest example, it is played one time by two anonymous people—who do not know, see, or hear each other. Player 1 (the Proposer) defines how a pot (typically of money—but it can be anything both players see as having value from gold to gummy bears) is divided, and Player 2 (the Responder) can accept the offer or reject it. If accepted both players share the pot as proposed by Player 1, if rejected nether player gets anything. Game over, no take backs, no repeats.
Economic theory would suggest that any offer greater than 0 should be accepted by the Responder, as it would leave him in a more economically advantageous place than does rejecting it. In practice, this almost never occurs, and study after study has found that offers under 20% of the pot are typically rejected. Why? Explanations vary with some attributing it to a desire for fairness, an emotional response to being treated unjustly or even a desire for revenge, with the end result being that the Responder values punishing the Proposer more than he values the share of the pot allocated to him. Essentially, as the Wired article quotes University of Chicago Professor Richard Thaler saying, “If you offer me $1 out of $10, that doesn’t seem fair, and I’m willing to pay a dollar to say f— you.”
This example from the Numb3rs TV show is a short and clear illustration of the Ultimatum Game:
Variations on the Ultimatum Game
In studies of pure Ultimatum Games, the most common offer was a 50-50 split, while the mean offer was a 60/40 split favoring the Proposer. (Interestingly, the total value of the “pot” did not have a strong effect on the outcome—with Responders almost as likely to reject 10% whether it was 10% of $1 or 10% of $1M—though the “pain” of the loss does come into play.) But, as the video clip demonstrates, things change when anonymity is removed from the equation. In the video the Proposer tells the Responder that she lost money in her 401k retirement account as a justification for offering a 70/30 split.
In the video that justification is insufficient to persuade the Responder to abandon his desire to punish unfairness. But, consider other examples where a social context (as opposed to a one-shot anonymous deal) might make a difference:
- Knowledge that the game may be repeated with roles reversed.
- Perceptions regarding the other player’s motives, trustworthiness, or character.
- How a player wants to be perceived socially (magnanimous, stingy, spiteful, etc.)
- Cultural mores regarding giving and receiving
- How needy the Proposer deems the Responder in relation to the Proposer’s own need
Those are just a few of the types of variations studies have examined, with the ultimate conclusion that the decision of both Proposer and Responder are typically made to maximize total utility—economic, emotional, and social.
The Ultimatum Game and Small Business Ecommerce
Studies of a pure Ultimatum game are best suited to economists and game theorists. But, when you start examining variations of the game that remove anonymity and add social economics, human biases and pre-conceptions to the equation, the potential for putting the data to use for practical and actionable purposes becomes apparent.
Comparing politics to the Ultimatum Game is nothing new. It has been applied to Brexit, and in this interesting (2016 pre-election) read, to US Politics in general. But, lessons from the Ultimatum Game are also useful in an ecommerce context, where (unlike a give and take sales negotiation) you essentially have a take-it or leave-it offer that can be accepted or rejected to the advantage or detriment of both parties.
Think for a moment about how ecommerce sales take place. A merchant describes a product or service on its website, includes a price for it, and enables a customer to purchase it or go away. Assuming the merchant has not priced the item to its own detriment, and assuming that the customer really wants/needs the item and cannot get it elsewhere, both parties win if the sale goes through and both lose if it does not. In this scenario, there is no room for negotiation, no back and forth “best offer” option, or any other way for the Proposer (the merchant) to sweeten the offer, or for the Responder (the customer) to ask for a better deal.
For generic goods this analogy is a big shaky because the customer can always go somewhere else to find a better offer, but if you are selling specialized services or unique goods that cannot be easily obtained elsewhere, then the take-it or leave-it scenario fits rather well. And, even in the more tenuous generic goods case, understanding how customers evaluate and make the buy (take it) or walk away (leave it) decision can be extremely useful for making not only pricing, but also design and other creative decisions for your small business ecommerce site.
In a typical ecommerce implementation the merchant is faced with an Ultimatum Game type decision– how to price a product/service in order to maximize his own utility—i.e. to generate the greatest possible profit without losing the sale. If the merchant can determine the 50-50 split scenario of perfect Ultimatum Game fairness, he can be reasonably certain of closing deals with a modest utility upside for himself. If he can find the lowest possible split (somewhere between 79-21 and 51-49) that the customer will accept, he will maximize his utility for the sale.
Thus the critical question for an ecommerce merchant is how to create a website that moves a customer to pay the highest possible price while still perceiving positive utility for the transaction.
Leveraging Ultimatum Game Study Findings for Ecommerce Websites
Creating an effective ecommerce website goes far beyond pricing decisions, just as decisions in an Ultimatum Game go beyond simple economic utility. However, the following studies provide findings that can be applied directly to your small business ecommerce website to help maximize sales.
The Study: Framing the Ultimatum Game: The contribution of simulation
This study looked at whether the way a Proposer’s offer was framed affected the likelihood that the Receiver would accept less than equitable offers. Offers were framed using the language of either “I give you” (which focused on what the Responder would get) or “I take” (which focused on what the Responder was losing). The study used brain imaging to conclude that there is a different neural reaction to the “I give” offer than there is for the “I take” offer, and found that while profoundly unfair offers were universally rejected regardless of language framing, fair offers of equal value were viewed more “pleasantly” with the “I give” language and more “unpleasantly” with the “I take” language.
Put it to use: When crafting your ecommerce product listings and other website content, be cognizant of your customer’s desire to “gain” and leverage it to help close a sale. This can be as simple as crafting a sale using the language “Get 40% off” and showing the original price and a reduced price instead of simply listing the sale price (which is equivalent to what you as the merchant will “Take” for the item). You can also employ this technique more subtly in your product descriptions by emphasizing what the customer will gain by completing the purchase—which includes not just the item itself, but other intangibles such as more free time, envy of peers, satisfaction, wellbeing, pride, etc.
The Study: The undermining effect of facial attractiveness on brain responses to fairness in the Ultimatum Game: an ERP study
This study provided Chinese male Responders with a head-shot of female Proposers along with their offers. It found that male Responders were more likely to accept “unfair” offers from female Proposers rated as “attractive” than from those rated as “unattractive.” It also found that while all offers from “unattractive” Proposers had a similar reaction time, “unfair” offers from “attractive” Proposers resulted in long consideration periods while “fair” offers were quickly accepted. And, it found that “unfair” offers from “unattractive” Proposers were viewed more negatively than the equivalent offers from “attractive” Proposers. The authors conclude that, “Based on this evidence, the enjoyment of the perceived beauty could relieve the subjects’ dissatisfaction with an unequal money distribution and attenuate their intention to decline unequal offers to punish the selfish proposers.”
Put it to Use: After discarding the initial inclination to classify all men as pigs, and noting that this study may not translate to the US male population, and certainly does not directly translate to female subjects, it can still provide some useful tips for ecommerce design. Most notably it emphasizes that if there is nothing of value to offset what appears to be an “unfair” price, the decision to walk away will be a quick and easy one. However, if ecommerce offerings can highlight intangibles (such as the prospect of gaining the favors of an attractive Proposer by accepting a low-ball offer) at the very least it can extend the time customers spend considering the purchase, and in the best case the value-adds will help to close the sale. For example, if $10 is a high price for Item A, but a merchant can offer additional items along with it that have a high perceived value to customers but cost the merchant little, that may be enough to persuade a customer to accept the offer. (Think of all those “But wait, there’s more…” infomercials.) Similarly, merchants may be able to charge a premium for a service, if they donate a portion of profits to charity. And, the best and most common example is free shipping. Study after study has shown that people are more likely to pay more for a product that includes free shipping than they are for the identical product with paid shipping—even if the total cost for each item is identical. (On a more shallow level, the study suggests that merchants may see better results when including pictures of attractive people using and offering products/services on their ecommerce sites than they would with product pictures alone.)
The Study: Emotions and Strategic Behaviour: The Case of the Ultimatum Game
This paper uses the Ultimatum Game as a case study to explain how emotions affect determinations of utility in decision making. It posits that in the Ultimatum Game when an offer is less than equitable (anything less than a 50-50 split), the Responder will experience negative emotions (“valence”) that enter into the decision making process, and that the strength of these emotions (“arousal”) will dictate the “total utility” decision such that stronger negative feelings will result in the willingness to give money away to compensate for those feelings. The study even provides equations that can be used to determine an optimal offer, once values for “valence” and “arousal” are determined. The catch is that it is almost impossible for the Proposer to divine the Responder’s “valence” and “arousal.” Thus, the study suggests that Proposers typically will substitute their own values (i.e. make an offer that they themselves would accept). As the game is repeated, the Proposer will gain more experience and thus be able to adjust her offer to replace her own values with those she is likely to encounter in other players.
Put it to Use: If there was ever an argument for knowing your customer, this is it. Further, it emphasizes how important it is that merchants track not only purchase behavior, but also cart abandonment on ecommerce websites. The more merchants know about their customers’ pain levels, the prices customers are willing to accept, and those that will send customers running, the more profitable the ecommerce site will be. One other important point this study highlights is the importance of making it easy for customers to assess the fairness of an offer (whether that is just price or price in combination with other factors). That fairness assessment, not the offer itself, is the starting point for the decision process. For example, a study found that consumers are willing to pay more for an item from Merchant B than Merchant A, if they know it cost Merchant B more. While this may be due to a perception of value (Merchant B’s Item is of higher quality), it may also be a function of simple fairness. This highlights the importance of educating customers, so that they fully understand the value of an offer and can accurately begin their purchase decision with a positive feeling of fairness. Further, if merchants can craft an offer such that the customer’s immediate perception is of “unfairness” to the merchant (a “great deal” or “steal”), even if that is not actually the case, the sale is more likely to occur, and to occur quickly.
If you’re interested in learning more about the Ultimatum Game and Game Theory in General, it is not too late to sign up for the free introductory Coursera Game Theory course, given by professors from Stanford University and The University of British Columbia. (It started yesterday, but you’re not behind yet!)
Get Small Business Tips like this one by signing up for our Small Business Smarts newsletter.