The Budget Contraction Effect

THE PROBLEM

Over the course of consumers’ lives, they experience many significant changes in their incomes and budgets. In addition to life events and personal circumstances, consumer budgets respond to fluctuating economic conditions. When a consumer experiences a contraction in their income, their spending declines; of significant interest is how they will implement the reduction in spending. In other words, what choices do consumers make to accommodate budget cuts?

To examine this question Kurt Carlson and his colleagues (Jared Wolfe, Dan Ariely, and Joel Huber) examined consumer choices under contracting and expanding budgets. To do this, they ran a series of studies in which consumers were asked to allocate budgets across a variety of items; in some conditions budgets increased, while in others they decreased.

FINDINGS

In one study, consumers allocated budgets to four different financial investments. One group of participants was asked to allocate three sequentially increasing budgets ($500, $1000, $1500); the other group allocated the same three budgets, but in a sequentially decreasing order ($1500, $1000, $500). When Carlson and colleagues compared how the two groups allocated the middle budget (i.e. $1000), they found that consumers facing the declining budgets allocated the money differently than those who faced increasing budgets. Specifically, consumers in the decreasing budget condition allocated their $1000 investment budget to fewer different investments than did consumers who allocated the same budget in the expanding budget condition. This pattern was observed for both novice and expert investors (see the figure).

Carlson and colleagues observed that consumers exhibit the same tendency in other domains: for example, when allocating money for groceries those facing decreasing budgets reduced the variety in their shopping carts. They also found the effect when consumers allotted time to be spent at various European cities while planning a vacation; when the length of a planned trip was shortened, consumers preferred to reduce the number of cities to be visited rather than reduce the amount of time spent in each city. Regardless of medium (investments, groceries, or travel time), consumers facing a decreasing budget allocated the middle budget level to fewer different items than consumers facing an expanding budget.

Carlson and colleagues argue that this budget contraction effect occurs because consumers faced with declining budgets prefer to avoid the psychological costs associated with making small reductions to many items. To avoid these costs, they tend to focus their cuts more narrowly and therefor completely eliminate some items from their basket.

To test this assertion, Carlson and colleagues examined the budget contraction effect under two different conditions. In both conditions they were shown three budgets, either in expanding ($40, $80, $120) or contracting ($120, $80, $40) order. In one condition, consumers actually allocated all three budgets to groceries. In the other condition, consumers did not actually make the initial allocation — they examined the items, but they did not select them. If the budget contraction effect is caused by the feeling of loss, then it should not occur under conditions in which consumers do not actually make allocation choices (in their initial budget).

Accordingly, when consumers allocated their initial budget and subsequently faced psychological costs of reducing their expenditures on certain items, the budget contraction effect occurred. However, when they did not actually allocate the initial budget, the budget contraction effect was not observed.

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IMPLICATIONS & CONCLUSIONS

Marketing managers should be aware that consumers tend to reduce the variety of their purchases when faced with decreasing budgets. It is important for managers of brands that depend on discretionary spending to invest in research that determines the vulnerability that their product or service will be a victim of the budget contraction effect. Brands that find themselves especially vulnerable should work to deeply engage their consumers and by doing so can hedge the likelihood that a given product is abandoned when budgets are contracting.

This process is especially important because consumer choices made during budget contractions may have long lasting effects. For example, a young couple faced with a contracting budget will be tempted to either eliminate dining out or going to baseball games, rather than cutting back a bit on both. Once the choice to eliminate either expenditure is made, the couple will likely see themselves as either ‘baseball fans’ or ‘foodies’. The brand that better integrates itself with consumers’ lives, and thus avoids elimination, will then benefit by initiating a potential long-term relationship.

Kurt Carlson

Researcher at the Georgetown Institute for Consumer Research and Professor of Marketing, McDonough School of Business

Kurt Carlson is the Associate Dean at the Raymond A. Mason Business School. He received his bachelor’s and master’s degrees from the University of Wisconsin and his Ph.D. in marketing from Cornell University. Prior to joining William and Mary, Carlson was on the faculty of the Fuqua School of Business at Duke University from 2001 to 2009 and the faculty of McDonough School of Business at Georgetown University from 2009-2017.

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