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

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.
recognition-heuristic
The recognition heuristic is a psychological model of judgment and decision making. It is part of a suite of simple and economical heuristics proposed by psychologists Daniel Goldstein and Gerd Gigerenzer. The recognition heuristic argues that inferences are made about an object based on whether it is recognized or not.
representativeness-heuristic
The representativeness heuristic was first described by psychologists Daniel Kahneman and Amos Tversky. The representativeness heuristic judges the probability of an event according to the degree to which that event resembles a broader class. When queried, most will choose the first option because the description of John matches the stereotype we may hold for an archaeologist.
take-the-best-heuristic
The take-the-best heuristic is a decision-making shortcut that helps an individual choose between several alternatives. The take-the-best (TTB) heuristic decides between two or more alternatives based on a single good attribute, otherwise known as a cue. In the process, less desirable attributes are ignored.
biases
The concept of cognitive biases was introduced and popularized by the work of Amos Tversky and Daniel Kahneman since 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.
bundling-bias
The bundling bias is a cognitive bias in e-commerce where a consumer tends not to use all of the products bought as a group, or bundle. Bundling occurs when individual products or services are sold together as a bundle. Common examples are tickets and experiences. The bundling bias dictates that consumers are less likely to use each item in the bundle. This means that the value of the bundle and indeed the value of each item in the bundle is decreased.
barnum-effect
The Barnum Effect is a cognitive bias where individuals believe that generic information – which applies to most people – is specifically tailored for themselves.
first-principles-thinking
First-principles thinking – sometimes called reasoning from first principles – is used to reverse-engineer complex problems and encourage creativity. It involves breaking down problems into basic elements and reassembling them from the ground up. Elon Musk is among the strongest proponents of this way of thinking.
ladder-of-inference
The ladder of inference is a conscious or subconscious thinking process where an individual moves from a fact to a decision or action. The ladder of inference was created by academic Chris Argyris to illustrate how people form and then use mental models to make decisions.
six-thinking-hats-model
The Six Thinking Hats model was created by psychologist Edward de Bono in 1986, who noted that personality type was a key driver of how people approached problem-solving. For example, optimists view situations differently from pessimists. Analytical individuals may generate ideas that a more emotional person would not, and vice versa.
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 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 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.
design-thinking
Tim Brown, Executive Chair of IDEO, defined design thinking as “a human-centered approach to innovation that draws from the designer’s toolkit to integrate the needs of people, the possibilities of technology, and the requirements for business success.” Therefore, desirability, feasibility, and viability are balanced to solve critical problems.
catwoe-analysis
The CATWOE analysis is a problem-solving strategy that asks businesses to look at an issue from six different perspectives. The CATWOE analysis is an in-depth and holistic approach to problem-solving because it enables businesses to consider all perspectives. This often forces management out of habitual ways of thinking that would otherwise hinder growth and profitability. Most importantly, the CATWOE analysis allows businesses to combine multiple perspectives into a single, unifying solution.

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Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which reached over a million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get The FourWeekMBA Flagship Book "100+ Business Models"