Alchian–Allen effect
The "Alchian-Allen effect" goes by the definition of "ship all the good apples out"!
Although there could be a section of the world who don’t really pay too much of heed to the price of a product, a really large sample space deeply cares about pricing whilst a pretty sizeable subset of them also tend to base their final BUY / PASS decision on that parameter alone.
Take a good look at this visual here from the month of MARCH 2024 at a local supermarket.
It shows 3 cans of the same product bearing the same weight. But observe the price & the manufacturing date against each of those cans. As for the choice & which one of those cans got added to the cart is just so plain & simple for most given how all retail products (at least in India as geography) mandatorily carry the “per gram” cost over those pricing labels making comparison more straight-forward.
That more than proves how customers / users could be picky in terms of tying the value to the price and comparing a few tradeoffs prior to arriving at that BUY decision (if anyone did have any sort of a doubt or an argument concerning it).
But consider another scenario where there could be multiple products competing for shelf space in a retail store like say Coffee Powder which obviously comes in a host of varieties sorted on quality, consistency & taste, not to mention the price range.
When the rarest of coffee varieties like the Black Ivory Coffee (coffee aficionados may identify with the iconic black elephant logo) produced in Thailand could carry a price tag of US $2,000 per kg and upwards some other popular ones that are listed atop the “Best coffees in the world” like say, the Jamaican Blue Mountain could come approximately at US $150 per kg, or the Hawaiian Kona Coffee which could be around US $124.
Now, let’s assume both these are available and ready to order over an online site that is home to some exclusive coffee brands from across the world.
With those prices listed there, supposing someone not residing in the USA chooses the Hawaiian coffee and adds it to the cart which would obviously bump the price up taking it closer to $150 inclusive of all taxes, shipping charges and the like.
That would then leave the users with these prominent coffee choices: –
JAMAICAN = US $150
HAWAIIAN = US $148.5
This reduces the margin of difference between the options drastically making the Jamaican option more attractive all of a sudden. Remember how just a few minutes back that option looked costly compared to the Hawaiian option that was picked?
And that’s precisely what the Alchian–Allen effect suggests.
It was first brought to light by Armen Alchian & William R Allen over their book “University Economics” later called “Exchange and Production”.
Definition:
Alchian Allen effect suggests how the prices of products (like say coffee in our example) would increase by a significant proportion after the addition of all taxes & shipping costs forcing users to shift their focus towards a higher-grade product.
Alternately this theory is also described as “SHIP ALL THE GOOD APPLES OUT” which is justified in the way the finer commodities / richer produce hit international markets first on priority & more bang for the buck landing everyone involved in the supply chain additional revenues.
Application to Product Management
Let’s consider product that offers digital camera on rent targeting photographers / hobbyists who are actively into photography but can’t really afford high end equipment owing to the cost factor.
It is very possible that they may have many variants allowing extensive storage space on their servers combined with a few e-mail ids given that it may be an agency.
And that could be offered over a TIER pricing model as shown in the figure below.
As you can see it has 3 options each coming with their own value & benefits:
BASIC – 19.99
STANDARD – 29.99
EXTENDED – 39.99
Although it goes without saying, let’s suppose that the “EXTENDED” package would be the one the organization would be looking to target given their goal of maximization of revenues.
On the face of it, although each of those options are $10 apart, that could still turn out to be a very significant factor for the users when they are looking to pick one for themselves (considering it’s a PLG growth model the org. is employing).
Now, if the Alchian Allen effect ought to be any testimony here, the choices could get severely influenced by the final prices when added to the cart with the inclusion of taxes (given that shipping costs don’t apply here).
A small tweak in design (refer fig. below) could help the users overturn their decision to settle for something less. And one way to do that could be to add all the other extra / hidden costs as applicable, providing enough clarity by displaying it as a part of the pricing slabs there influencing users towards picking a higher option.
Like so:
FEW ASSUMPTIONS:
The user’s geography / location information has been obtained with their permission
A flat tax amount representing “local taxes” has been before the final price of the product is arrived at
If you look at the pricing slabs now, the STANDARD pricing model is adding up to $37.99 which is just about $2 shy off the EXTENDED model which stands at $39.99. This could force users to rethink their purchase and drift over to pick a higher slab.