The discussion about abandoning cash or putting limitations on cash payments is creating quite a stir. Harvard economist Kenneth Rogoff was the first to cause a commotion with his suggestion to get rid of cash. More recently, support for this idea has come from a totally different angle. Deutsche Bank Co-CEO John Cryan described cash as a model worthy of being “phased out.” Related topics such as the connection of cash and freedom, data protection, and the fight against terrorism have so far dominated the discussion. Less well-known are some surprising research results regarding the impact of cash on the behavior of individual consumers.
Cash and the pain center
Modern brain research has revealed that price information activates the brain’s pain center. This is hardly surprising since paying the price is the unpleasant part of making a purchase. Cash payments, however, activate the pain center more strongly than credit card or online payments. Also, the customary presentation of prices in the form of “$16.70” has a stronger impact on the pain center than if a price is presented without the currency symbol as “16.70”. The pain effect is lowest when a price is written simply as “17”. This is why more and more restaurants are communicating their prices in this manner.
Preference for cash payments
Today, card or digital payments are possible almost everywhere. It’s quick and easy. Why then do many people still prefer to pay with cash? Economists used to assume that the transaction costs determine the method of payment. However, from a consumer perspective cash payments have advantages that go beyond this. Prospect theory, for which Daniel Kahneman won the Nobel Prize, provides an answer. This theory distinguishes between the perception of gains and losses. Spending cash produces a higher negative loss perception than paying with a debit or credit card. If you would like to reign in your compulsion to spend money you’re better off paying cash. Economists from Germany’s Bundesbank have discovered a further effect. A study of 25,500 individual transactions showed that consumers who want to have a better overview of their expenditures prefer to pay with cash. Researchers describe this effect as “the reminder function of cash.” You see in your wallet how much you’ve already spent and how much is still there. Particularly people with low financial means should use the cash payment as a control mechanism – and actually do so. They pay for two-thirds of their purchases with cash. The Bundesbank researchers give heavily indebted individuals the following advice: pay cash.
In business and trade, there are some tricks that seem absurd at first glance. Car dealers in the U.S. frequently use a tactic known as “cash back.” You buy a car for $30,000 and then get back $2,000 in cash. What is the purpose of this tactic? An explanation can again be found in the prospect theory. First, the payment of $30,000 generates a loss perception. This is in contrast to the benefit gained from owning the car. Cash back now adds a third positive component to the transaction, the $2,000 obtained in cash. For many Americans the three components (one negative, two positive) seem to generate a higher total perceived benefit than simply paying $28,000 for the car with no cash back. This effect is reinforced by the fact that the actual purchase price is paid by check, bank transfer or credit card, which produces a loss perception that is less intense than the strongly perceived benefit from the repayment in cash.
Business or economy class
When my wife and I were checking in at the business class counter in Boston for a return flight to Frankfurt, a Lufthansa employee informed us that business class was overbooked and offered each of us $1,000 cash to downgrade to economy. I said to my wife: “For a flight of 6.5 hours, that’s not bad.” My wife, however, had a different opinion and replied: “That’s less than the additional amount you were willing to pay when you originally booked the business class tickets. Why didn’t you just book economy tickets to begin with? Then you would have saved more than $2,000.” She was right. Back when I was booking the flight, I couldn’t have imagined spending this overnight flight in economy. So why did I suddenly think of the offer as attractive? Prospect theory provides a plausible explanation: The perceived loss at the original booking, which occurred in an abstract way via my credit card, must have been lower than the perceived gain from the immediate cash amount that the Lufthansa employee offered me.
Cash as tip
Until a couple of years ago, taxi drivers in New York only accepted cash payments for fares. Customers decided on how much to tip – of course also in cash. On average, tips were around ten percent. Then, New York taxi drivers introduced the option of paying by credit card. Passengers simply swipe their credit card through a reader device. Tips can be entered either manually on the keypad or by pressing a button with one of three default options: 20, 25 and 30 percent. After this system was introduced, the average tip jumped to 22 percent; taxi drivers generated additional revenues of 144 million dollars.
- Prof. Dr. Dr. h.c. mult. Hermann Simon is the founder and Chairman of Simon-Kucher & Partners. @hermannsimon