bottom-dollar-effect

What Is The Bottom-Dollar Effect And Why It Matters In Business

The bottom-dollar effect describes a tendency among consumers to dislike purchases that exhaust their remaining budget. If a consumer spends the last $50 in their bank account on dinner at a restaurant with friends, they may enjoy good food and good company. But after the meal, they feel dissatisfied because the meal has exhausted the last of their funds. Here, the negative emotions associated with running out of money have been applied to the meal itself. This is known as the bottom-dollar effect.

Understanding the bottom-dollar effect

Money management is a vast subject, but in a perfect world, purchasing decisions should be made with rational logic. However, consumers experience the bottom-dollar effect because they tie emotions to money. They feel temporarily elated when purchasing something they want and then despondent when the money has left their account. Despondency, as we have seen, is most pronounced when bank account balances run close to zero.

Three types of mental accounting in the bottom-dollar effect

Consumers maintain three mental “accounts” when considering or managing purchases:

  1. Current income income or cash in a bank account.
  2. Current assets – including homes, investments, emergency funds, and other less liquid assets.
  3. Future income – including retirement income, promotions, and expected windfalls such as inheritance.

It’s important to note that exposure to the bottom dollar effect is highest in the current income model and lowest in the future income model. This is because consumers facing fund exhaustion will use funds from their current income and in some circumstances, will also sell assets.

Future income is the least affected for reasons which will be explained in the following sections.

The bottom-dollar effect in marketing

Marketing teams who understand the bottom-dollar effect can use it to their advantage.

With an understanding that people associate negativity with fund exhaustion, they can time marketing messages to coincide with periods where consumers have greater access to funds. 

For businesses endeavoring to attract new customers, this is particularly salient. They do not want the first interaction a consumer has with their brand to be a negative one.

Periods that businesses should target include:

  • Friday and Saturday, before consumers have had a chance to exhaust discretionary weekend funds.
  • Payday.
  • End of financial year, where many receive tax refunds.

Research published in the Journal of Consumer Research has validated these spending periods by linking them with the mental accounting mentioned in the previous section. The study found that the bottom-dollar effect increases as the effort required to earn money increases. 

Importantly, the bottom-dollar effect decreases as the gap between budget exhaustion and replenishment decreases. In other words, consumers experience less pain when spending their last few dollars if they know replenishment is imminent.

How can businesses use these insights? It begins with deep research into buyer personas. The most successful marketers will segment their target audience according to specific characteristics such as earning capacity, frequency, and spending habits.

Key takeaways:

  • The bottom-dollar effect involves consumers associating negative experiences with purchases that exhaust their funds.
  • The bottom-dollar effect is an emotional response to money management. It has no basis in rational, logical decision-making.
  • Businesses can use the bottom-dollar effect in marketing campaigns to target buyers at different stages of the buying journey. Ultimately, this will be determined by the recency or availability of funds in their bank account.

Connected Business Concepts

Heuristics

heuristic
As highlighted by German psychologist Gerd Gigerenzer in the paper “Heuristic Decision Making,” the term heuristic is of Greek origin, meaning “serving to find out or discover.” More precisely, a heuristic is a fast and accurate way to make decisions in the real world, which is driven by uncertainty.

Bounded Rationality

bounded-rationality
Bounded rationality is a concept attributed to Herbert Simon, an economist and political scientist interested in decision-making and how we make decisions in the real world. In fact, he believed that rather than optimizing (which was the mainstream view in the past decades) humans follow what he called satisficing.

Second-Order Thinking

second-order-thinking
Second-order thinking is a means of assessing the implications of our decisions by considering future consequences. Second-order thinking is a mental model that considers all future possibilities. It encourages individuals to think outside of the box so that they can prepare for every and eventuality. It also discourages the tendency for individuals to default to the most obvious choice.

Lateral Thinking

lateral-thinking
Lateral thinking is a business strategy that involves approaching a problem from a different direction. The strategy attempts to remove traditionally formulaic and routine approaches to problem-solving by advocating creative thinking, therefore finding unconventional ways to solve a known problem. This sort of non-linear approach to problem-solving, can at times, create a big impact.

Moonshot Thinking

moonshot-thinking
Moonshot thinking is an approach to innovation, and it can be applied to business or any other discipline where you target at least 10X goals. That shifts the mindset, and it empowers a team of people to look for unconventional solutions, thus starting from first principles, by leveraging on fast-paced experimentation.

Biases

biases
The concept of cognitive biases was introduced and popularized by the work of Amos Tversky and Daniel Kahneman in 1972. Biases are seen as systematic errors and flaws that make humans deviate from the standards of rationality, thus making us inept at making good decisions under uncertainty.

Dunning-Kruger Effect

dunning-kruger-effect
The Dunning-Kruger effect describes a cognitive bias where people with low ability in a task overestimate their ability to perform that task well. Consumers or businesses that do not possess the requisite knowledge make bad decisions. What’s more, knowledge gaps prevent the person or business from seeing their mistakes.

Occam’s Razor

occams-razor
Occam’s Razor states that one should not increase (beyond reason) the number of entities required to explain anything. All things being equal, the simplest solution is often the best one. The principle is attributed to 14th-century English theologian William of Ockham.

Mandela Effect

mandela-effect
The Mandela effect is a phenomenon where a large group of people remembers an event differently from how it occurred. The Mandela effect was first described in relation to Fiona Broome, who believed that former South African President Nelson Mandela died in prison during the 1980s. While Mandela was released from prison in 1990 and died 23 years later, Broome remembered news coverage of his death in prison and even a speech from his widow. Of course, neither event occurred in reality. But Broome was later to discover that she was not the only one with the same recollection of events.

Crowding-Out Effect

crowding-out-effect
The crowding-out effect occurs when public sector spending reduces spending in the private sector.

Bandwagon Effect

bandwagon-effect
The bandwagon effect tells us that the more a belief or idea has been adopted by more people within a group, the more the individual adoption of that idea might increase within the same group. This is the psychological effect that leads to herd mentality. What is marketing can be associated with social proof.

Read Next: BiasesBounded RationalityMandela EffectDunning-Kruger

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