z on life

California Golden Cookies is an amazing gyro place and bakery on Kearny St. in downtown SF and is a frequent lunch spot of mine. The food is amazing, prices are reasonable, service is given with a smile, but far and away the best part is that you sometimes get a free cookie that is amazingly tasty. The interesting facet is that you never know when you’re going to get a free cookie. I have gone about 20 times now and gotten, I’d roughly estimate, 10 free cookies. The problem is I can’t seem to figure out what variables the guy uses to determine if you get one or not. I have thought about everything and watched carefully, but to no avail, I cannot figure it out. This prompted me to think about the pyschology of giving out free stuff.

Consider three cases in which I am going to buy a gyro and may or may not get a free cookie.

1. Every other time I get lunch there, the guy gives me a free cookie.
2. Every time I go there, I get to flip a coin and if I call it right I get a cookie.
3. It is seemingly random whether he gives me a cookie or not, but so far it has worked out to roughly 1 out of 2 times I go I get a free cookie.

Notice that the expected value for all three of these is that, per lunch session at the restaurant, I expect to earn half a free cookie. So does this mean that the affect on the consumer is actually equal for all three stratgies? I say no, and here’s why.

In the first case, you have a game of perfect information and you know exactly what you’re getting. The problem with this approach is that, while people generally get excited about free stuff, you are reducing the experience down to its raw economics. The customers know exactly how much they are saving per lunch visit. Plus or minus a little added excitement, they know that if the cookie is $1.75, they are really just being given 87.5 cents back each time. This feels like a coupon. Coupons work, but it comes down to economics.

Pros

• After an odd number of visits, people will be thinking about coming back to get the next one free.
• For the store owner, this is predictable and easy to work into his financial models of sales and profitability per customer.
• If people get a cookie every other time free, they’ll probably get used to eating them and actually buy one every time they don’t get a free one.

Cons

• Some people will see it purely as a coupon and the free cookie will not have any intangible or emotional value.

In the second case, you have a game of chance where you expected value tells you you’ll earn 87.5 cents back each time, but really it is either 0 or $1.75. Some customers would probably prefer the fun and allure of this more so than just having a ‘coupon’ as in case 1, but some would also probably not like it. Some people prefer to save every penny, some prefer to buy lottery tickets. This might be a fun idea to try, and may cause the restaurant to turn into a really fun environment as the tension builds for each coin-flip and there will be excitement after wins.

Pros

• This will really be fun to some percentage of people (risk-takers).
• The coin-flips will create excitement and hooplah.

Cons

• For small sample sizes, the number of free cookies needed to be given out is highly variable so there could be inconsistencies in profit day-to-day caused by this.
• Risk-averse people would probably just prefer the coupon style.

In the third case, you as the consumer really have no idea what is going on. All you know is that sometimes you are excited about your bonus, and other times, not. The key here is that you can’t prove the restaurant owner has a systematic method for giving out the free cookies, and thus you must (or at least it is human nature to) conclude that he is actually giving you one out of kindness. When you make the decision to go to the restaurant, you will not only consider the empirical chance that you’ll get a free cookie, but also the emotional aspect of ‘wow that guy is nice, we should go back there’.

Pros

• You get the human factor of emotion and personal connection involved.
• If the owner is being secretly systematic, he can tweak the algorithm to his daily needs (ie: if there’s only a few cookies left and still many more potentially paying cookie customers to come in later, he can simply not give any more out free that day).
• Because there is no set expectation of something free, you can never be disappointed on non-free days (ie: it is easy to be mad at someone for not keeping their word, but really hard to be mad at someone for not being overly nice).

Cons

• In the case of the customer who is the utmost consistency seeker, they may react negatively to this mysterious process (highly unlikely though).

It is so interesting to see how these three economically equivalent schemes are so psychologically different and complex. Of the cases, I think case 1 is the most popular (think those little things restaurants stamp when you come in, and every 10th free or something). Case 2 is the most fun and would be interesting (I have never seen it done). But I think very strongly of case 3 above and beyond the first two.

There is something about selling the ‘hope’ of a free cookie and genuine kindness that is awesome and resonates very well with me. Of course, in case 3, the guy could really be deeply manipulative and have this complex algorithm for which he is maximizing my expenditures in his restaurant. And if that is true, kudos to him, he should be an econ PhD (or maybe he is). But, in my book, he is innocent until proven guilty and until I or anyone else can prove that he has a system, I have to believe he is genuinely just a nice guy and that means a lot. It keeps me coming back.

The moral of the story is that if you are slick about it, you can connect with your customers on a personal level in a way that doesn’t cost you anything extra. Good feelings and good relationships are huge in business, and even matter down to the level of this small restaurant. If you take a little time to think about the psychology of such techniques, you can get something for nothing, and that’s always a good thing.

Think of it this way. Consider that each of those cookies probably costs the guy, let’s say, 30 cents to make. He’s given me about 10 free. He’s lost $3 to such a business practice but just got me to blog about it. If even one reader buys one more gyro at his restaurant, he’s made that back in raw profit. Interestingly, he’s created economics that make sense for him (not even including the probably 30 people I have told about his place in conversation), but I as the customer never even thought about the economics. All I thought about was how nice the guy was.

PS: I did not get a free cookie yesterday, but I’m still happy.

Let’s say you’re a brilliant hacker or any other breed of wild intelligence. You’re young, maybe high school, college, or shortly after, and show the potential to achieve enormous success and to make huge sums of money. You haven’t made it yet, though, so you haven’t hit a state of financial security and would obviously like to have more money than you do. You may need money to pay off college, or to quit worrying about paying the bills so you can focus on being entrepreneurial, or just want a bit more of a comfortable life now and pay it off later. So, if you’re in this scenario, would you sell life equity?

What exactly I mean by life equity is the following:

1. You find someone interested in your potential.
2. They give you X dollars up front.
3. You give them in return Y% of your earnings every year for life.

There’s lots of ways to do this like allocated the money in tranches subject to performance, a variable percentage of future earnings, etc. But let’s keep it simple. If a benefactor wanted to give you $1MM right now for 10% of all future money you made, would you do it? If not, what if it was 5% or even 2%? If yes, what if it was 20% or even 50%?

The pros:

1. You can stop worrying about baseline finances.
2. You can earn interest on the money you now have in the bank.
3. You can engage in ventures without seeking early external funding.
4. You can spend money to alleviate stress and increase professional performance.
5. You can get career help from your benefactor who has a vested interest in your success.
6. You can do things, go places, and help people you couldn’t before.

The cons:

1. If you’re really successful, you actually end up losing money on the deal.
2. Every year you have to think about how you traded a one-time gain for an annual loss.
3. If structured wrong, you may have incentive to do nothing after getting the money.
4. Being able to do anything you want is hugely distracting and a career detriment.
5. You are accountable to your benefactor for returning good money to him or her.
6. You now have a much weakened sense of urgency to go far in your career.

So would I do it? The truth is it depends on the numbers. A good deal is a good deal, and certainly money at different points in life has a different value, and for most people that utility curve is monotonically decreasing so money up front can be a rational choice. On the other hand, there is something special about making it on your own, not having things given to you, and having complete control. It should be the process of building success, not the financial reward itself, that is valuable in life. If you’re confident in yourself and have the basic necessities to live, I think the answer has to be no. So would I do it? Probably not, unless the deal was really good.

Cases where I think it does make sense:

1. The person is in abject poverty but shows huge potential. Even if it is just to pay for college, the money could make a huge difference.
2. The cash infusion can raise the expected career value of the person more than the annual percentage payment. This is like the minor league baseball player that recently wanted to do this very thing so he could practice instead of working two side jobs.
3. The person has a valid time-sensitive reason for needing money. Maybe it concerns the health or wellness of a family member or something else where the money loses its value sharply as time goes on.

But before the notion of ‘life equity’ could ever became a common financial product, there’s a couple things that need to be worked out:

1. How do you price such a risky and variable future cash flow?
2. Does equity lead to ‘voting rights’ for life decisions?
3. Is this purely financial? If not, how would intangible achievements (ie: Nobel Prizes) be split up?
4. What are the ramifications of people holding stock in others? Suddenly there can be a quantifiable benefit to favors and business relationships. Would this corrupt the flow of business dealings?

I am not sure this concept of life equity will ever exist above and beyond a few one-off cases. I have been told it has been tried in the past for very special scenarios and has not worked out (I don’t know when and where, but I am looking into that now). If it did, though, would you sell part of yourself? For how much and with what terms? It’s very interesting to think about. I’d love to hear some thoughts.

Great thought experiment: how would you sell water*? This is much like one of the stereotypical Microsoft interview questions of “how would you sell ice to an eskimo?” and is a cool exercise to go through just for fun.

Here’s how I would do it. Put the water in an interesting bottle. This bottle has 5 different openings from which to drink. Maybe one on the top, one on the bottom, and three on the sides at different angles. At this point, ergonomists, environmentalists, and production managers alike are probably freaking out at how user-unfriendly, plastic-heavy, and expensive this product would be, but just bare with me.

Now, let’s include a marketing spin on the consumption of the water. Not only is this a ‘premium’, ‘hot’, and ‘blinged out’ product, but we will push the idea that the opening you drink out of ’says something about you’. For instance, those who drink from the top are traditional, those who drink from the bottom are rebellious, and those who drink from each of the side openings are wild, cool, and bad-ass respectively.

What’s the goal of this? It’s to get people to self-identify with one of the methods. If you can successfully pull it off, you’ll have created an interesting dynamic between the product users where they argue over the best way to drink. Soon you’ll have trash-talk dialogues going about how “top-drinkers are un-cool” or “left-side-drinkers are the $&!^”. This is exactly what you want. Not only do you have to put thought into which way you drink as an image statement, the choice of buying another brand of water will become a huge social detriment. If you buy a different brand, you lose the ability to express yourself. You become a generic person. Yuck! Who wants to be generic? No one does. And that’s the beauty of it.

Take this a step further. Let’s get 50-cent to have the water in his video. Maybe he can even throw in a line like “The realest playaz drink from the right. Damn this water is tight.” Next thing you know, hardcore 50 followers everywhere are buying up bottles like crazy, eager to show off their loyalty and get some street cred. Things only get better when Kanye raps about “I only drink from the top, cause it gets me goin and I just can’t stop”. Kanye fans rush to grab some bottles and drink from the top to show how he’s the man and Fifty is uncool. Now you’re golden**. Everyone who chimes into the debate further boosts the sales numbers. The more controversy you can raise, the stronger the dedication will be, the more water will move off of the shelves.

Now in all reality, pulling something like this off is far-fetched. There’s a number of serious problems with this strategy above and beyond the less-than-serious issue that Fifty was an equity holder in Vitamin Water and thus has a conflict of interest. Joking aside, we see similar things in the consumer world every day. It’s like wearing the Yankees hat with a perfectly flat brim and the sticker still on. Surely it’s not more comfortable, and it’s not as if the sticker has utility value. It’s really an image thing. How about paying 5 times more for something because it has Gucci tags? At the end of the day it just makes the wearer ‘feel’ good. How about shooting out T-shirts into the crowd at a baseball game? You don’t pay for an expensive ticket to catch t-shirts, you pay to watch baseball, but fans love the t-shirt toss and often remember it more than the game nonetheless. How many people wear Tag Heuer because Tiger Woods does? How many people bought a LiveStrong bracelet, not for charity, but because it was the ‘cool’ thing to do?

The learning lesson here is that you shouldn’t always just think about the actual product you’re working with as the thing you’re selling. You could be better of selling an image, a feeling, a status symbol, supplementary activities, or personal meaning. If you can surround the most boring of products, ie: water, with a really super-cool context and get people riled up about it, then almost any other product should give you way more leeway. Instead of getting caught up on the idea of creating the perfect product, settle for an okay one. Instead think about all the little things you can do to get people feeling excited to use your product, either directly or indirectly. Sometimes its the subtle mini-emotions evoked by products that make the difference, not the shear utilitarian value. The more you can get people to use your product because of what it means or how it makes them feel and not because of what it is, the better. If you get to this point, you’ve created personal value for the user, and you have created an arbitrage. Personal value is free to you as the product creator, but worth lots to the customer. And when you’ve made some, it’s like you have a license to print money because what makes you money costs you none.

So, how would you sell a teenage girl MySpace? Would you talk about social networking features and news updates and friend lists? No, of course not. This is like selling water “because it hydrates you”. The magic isn’t in the utility, it’s in the soft experience. The sell for MySpace is in the ‘wow’ moment when she is done customizing her profile with glitter, blinking text, a custom sunrise background, 4 YouTube embeds, 3 celebrity photos, a blog post, a music player bumping, and an ‘about me’ where she answers 100 personal questions. The sell is when she takes a step back and says, “yes, that’s me, and I love it!”. Again, it’s not about utility. It’s about what it means.

How would you sell water? How do you plan to sell your web 2.0 idea to users? If it’s just great features or great technology, you’re probably still leaving something on the table.

* - Credit for this great hypothetical goes to Andrew Chen.

** - If you’re not familiar, Kanye and Fifty have had a bitter on-going rap battle for a long time and fans of each side usually take vary strong stances and are never hesitant to show support.