Trade-ins, mental accounting, and product replacement decisions

"We'll buy your old suit back for $100 when you order a new suit." "We'll trade you $15 for your old sneakers when you buy a new pair." These offers may seem unusual, but these trade-ins can be an effective pricing tool. When a firm introduces a new and unproved product to the market, consumers who already own a product of lower quality in the same category may not be so willing to upgrade. There may be a mental cost to making a new purchase when they feel that they have not yet gotten their money's worth out of their previous purchase. Pricing tools such as trade-ins can help mitigate this mental cost. Based on the principles of mental accounting (Thaler 1985) and mental depreciation (Heath and Fennema 1996), I provide a theoretical explanation for the mental cost of a replacement purchase, and why a trade-in can be a more effective pricing tool than a straight sale of equivalent cash value. The product replacement model that I present has two unique aspects. First, it describes a replacement product purchase as a decision that involves two criteria: one based on marginal cost benefit analysis, and another based on mental accounting. Each criterion is coded as a gain or loss according to a simplified value function (Kahneman and Tversky 1979), and the net gain associated with a replacement product purchase is the sum of the gain/loss of these two accounts. The second unique aspect is the concept of a product's "mental book value". During ownership of a product, a consumer mentally depreciates the initial purchase price, thus creating a mental book value for the product. This mental book value is written off when a replacement purchase is made, and this write-off is essentially the mental cost associated with the replacement purchase. Through three experiments, I explore trade-ins, gift opportunities, and external reference prices as three different ways to promote the purchase of a new replacement product by mitigating the write-off of the mental book value.