Stocks versus other products: different consumer decision processes?
A literature exploration
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A.O.I. Hoffmann
December 2003
Stocks versus other products: different consumer decision processes?
A literature exploration
Author: A.O.I. Hoffmann
Place: University of Groningen, faculty of Management and Organization Date: December 2003
Student number: 1141503
Supervisor 1: Dr. W. Jager Supervisor 2: Dr. J.H. von Eije
‘The author is responsible for the content of the master’s thesis, the copyright of the master’s thesis rests with the author.’
© 2003
Preface
This document is a master’s thesis written for the faculty of Management and Organization at the University of Groningen. It is written for both the main subject Marketing and the main subject Financial Management (‘Financieel Waardemanagement’). These two subjects have much in common, but also display many opposing views. Combining insights from these two different subjects therefore was a real challenge.
It all started in autumn 2002. At that time, I followed the class ‘Applied marketing research’
of Wander Jager and the fire that was smoldering for years suddenly ignited. I was seduced by doing research and knew this was what I wanted to do after graduating. At that time I contacted Wander Jager and Henk von Eije and after some discussion we agreed that I would write my final thesis as an internal assignment. I soon found the topic: stocks.
Since that day in autumn 2002, I have been preparing my literature research and this report is the result. This report is only the beginning, however, as I will start my PhD project here in Groningen in January 2004. Wander and Henk: thanks for all the support! I would not have come this far without you two.
Arvid Hoffmann
Groningen, December 2003
Contact
Please feel free to contact me if you are also interested in this topic, if you have comments and/or if you would like to participate in the discussion. I am very interested in your opinion and will be pleased to discuss with you about this topic.
E-mail: a.o.i.hoffmann@volvo-tuning.nl
Index
Summary 5
1. Introduction and research outlay 9
2. Stocks, stock markets and the people active on it 12
2.1 Stocks 12
2.2 Stock markets 12
2.3 The people 14
2.4 Conclusion 15
3. The consumer decision process 16
3.1 The EBM model: the basics 16
3.1.1 Stage 1: need recognition 18
3.1.2 Stage 2: search for information 19
3.1.3 Stage 3: pre-purchase evaluation of alternatives 20
3.1.4 Stage 4: purchase 20
3.1.5 Stage 5: consumption 20
3.1.6 Stage 6: post-consumption evaluation 20
3.1.7 Stage 7: divestment 21
3.2 Factors that influence the decision process 21
3.3 Conclusion 23
4. Differences in product characteristics between stocks and other products 24
4.1 Core, augmented and total product 24
4.2 Instrumental, rational and emotional product values 25
4.3 Search-, experience- and credence-attributes 26
4.4 Conclusion 27
5. Differences in the characteristics of sellers and buyers of stocks and sellers and buyers of
other products 28
5.1 The seller: stocks versus other products 28
5.2 The buyer: stocks versus other products 29
5.2.1 Different products, different needs? 29
5.2.2 Locus of control 31
5.2.3 Consumer decision making as a dynamical process 32
5.3 Conclusion 39
6. Different personal needs, trading frequency and trading volume; different consumer
decision process? 41
6.1 The influence of (the dominance of certain) different personal needs 41
6.2 The influence of the buying frequency 45
6.3 The influence of the buying volume 45
6.4 Conclusion 46
7. Conclusion and recommendations 48
7.1 First research question 48
7.2 Second research question 50
7.3 Research objectives 51
7.4 Recommendations for further research 52
References 54
Appendix 1: research proposal for PhD project 56
Summary
In this research, which is written as a master’s thesis, two main research questions will be answered by means of literature research.
First research question:
Does the consumer decision process differ when people buy stocks versus when people buy other products? If so, how does it differ?
To answer this question, attention will be paid to differences in product characteristics and characteristics of the seller and the buyer.
The Product
With respect to the product characteristics of stocks versus other products three taxonomies for product characteristics are used.
First, the division in core, augmented and total product is used. The core product is formed by the physical characteristics of the product. The augmented product is the core product plus some additional characteristics. These additional characteristics can be with regard to every P of the four P’s of marketing instruments. Lastly there is the total product. The total product is the augmented product plus some characteristics that the consumer associates with this product (Leeflang, 1995). The core product stock is less tangible than other products. With respect to the augmented product, stocks do not know such things as warranties in a literal sense, although it’s possible for the consumer to create this him- or herself by using for example stock options. The distribution of stocks takes place in an environment that is not easy accessible for all consumers. There are many rules to adhere to when promoting financial products in general and stocks in particular. Organizations like the SEC in the USA and the AFM in The Netherlands have set up an intensive scheme of rules and regulations.
Second, the division in instrumental, rational and emotional product values was discussed.
Instrumental product values are characteristics of the product that are measurable, tangible and technical. Rational product values are product values that consumers appreciate in a rational way. These values are given to the instrumental product values. Emotional product values are the emotional meanings of the rational product values (Leeflang, 1995). For stocks, it is harder to identify the instrumental and rational product values than for other products. For example, while all relevant information of a can of milk is printed on the label, with stocks it takes more than a quick look at a label to identify for example the risk and returns. A great amount of knowledge and time has to be invested by the private investor to do this in a proper way.
Third, a distinction is made between search-, experience- and credence-attributes. Search attributes are aspects of a product that a consumer is able to identify before purchase. The characteristics of the augmented product may be part of these search attributes. Experience attributes are characteristics of a product that can only be identified and experienced after purchase and consumption of the product. Lastly, credence attributes are characteristics of
characteristics that can be identified before purchase, just like other products have. But characteristics like the real risk and return of a stock often only becomes evident after buying it and/or selling it again. Stocks seem to have relatively more experience- and credence- attributes in contrast to other products, which display more search-attributes. So for stocks it is harder to know in advance exactly what is coming at you.
The seller
With respect to the characteristics of the seller, a distinction between three different situations is made.
First, the seller of the stock can be the previous owner of the stock. In this case, the seller is tangible and clear. It is easy to switch from this kind of seller if that is necessary.
Second, the seller of the stock can be the bank/broker that an investor uses. In this case the seller is also tangible and clear. For this type of seller there are enough alternatives as well.
Third, the actual (electronic) stock exchange can be seller. In this case, the seller is less tangible and clear to the investors. The disadvantage of this is that investors have no opportunity to get loyal to a stock exchange. However, often the (private) investor can only use his or her national stock exchange. Though there are some possible advantages of today’s stock market as well. For example the opportunity to buy stocks anywhere and anytime by using the Internet. With electronic exchanges it is also harder to get fooled by ‘blue eyes’.
Finally, stock exchanges are regulated and have requirements for stocks to be liquid. The last is not necessary with stocks (e.g. shares of ownership) bought from others.
The buyer
Regarding the buyer, a distinction is made between differences in needs, locus of control, social processing and cognitive effort.
It is not possible to state sec that stocks satisfy other needs than other products do. A distinction should be made between durable goods and commodities. Then it is reasonable to state that stocks, in contrast to commodities, satisfy more the needs of affection, understanding, participation and identity and that commodities satisfy more the needs of subsistence and protection. On the other hand, it is plausible that consumer durables like for example cars can roughly satisfy the same needs that stocks can.
To what extent people take personal responsibility for their behavior and its consequences is called someone’s locus of control (Kreitner, Kinicki and Buelens, 1999). In short, when you see yourself as master of your own fate, you have an internal locus of control, while blaming the environment for the (negative) results of your decisions is typical for someone with an external locus of control. With stocks, there are many possibilities to ascribe the results of a person’s actions to ‘the market’ or the ‘recession’. This is less the case with other products. It is difficult to blame someone or something else for buying for example the wrong brand of margarine. So, with stocks there is more opportunity for displaying an external locus of control in comparison to other products.
Much social processing can be expected in the decision process of stocks. Buying stocks is socially relevant, as is discussed by for example Brealey and Meyers (2000), Welch (2001) and Butot (2003). Also, a high level of cognitive effort seems necessary for this decision process, as there is a high level of uncertainty, time pressure and possible cognitive
constraints to deal with. However, the levels of social processing and cognitive effort can be expected to differ from person to person and from one situation to another.
Second research question:
In what way is there a relation between the characteristics of private investors with regard to their (dominance of certain) personal needs, their buying frequency and their buying volume and the way these people move through their consumer decision process? What is the effect on the quantity and type of information that is being used in making a decision?
Personal needs
With regard to the dominance of personal needs and the effect on the decision process and the information processing, a distinction is made between extended problem solving and limited problem solving and internal and external information search.
A high involvement makes it more likely that a consumer will display extended problem solving (EPS) in contrast to limited problem solving (LPS) (Engel e.a., 2001). When a decision process is especially detailed and rigorous, EPS often occurs. This happens when the costs and risks of a wrong decision are high. EPS can be fueled by doubts, fears or lack of experience and information about an expensive, significant or high-involvement purchase. In the case of EPS, all seven (in chapter 3 identified) stages of the decision process will be followed (Engel e.a., 2001). It is in this case realistic to assume that a consumer will search extensively for much information. This information can be either external or internal information. External information is what you receive while searching the environment, while internal information is what you already know (Engel e.a., 2001). The reliance of consumers on internal information will depend on both the adequacy and/or quality of their existing knowledge as well as their ability to retrieve this knowledge from their memory.
It can be expected that the dominance of the needs for subsistence, protection, understanding, leisure, creation and freedom are more likely to lead to extended problem solving than to limited problem solving. This needs can be regarded as very important for someone’s life.
Therefore, it is expected that someone is very involved when he or she tries to satisfy these needs. This high involvement makes it more likely that someone will invest a great amount of time and cognitive effort in making this decision. However, there can be personal differences and this can differ from one situation to another.
The needs for affection, participation and identity can lead to either extended problem solving or limited problem solving. When the need for affection, participation and identity can be satisfied by trading stocks in general, a private investor still has to decide on his or her own which stocks to buy and when. So, to make a wise decision (i.e. to increase the probability of positive financial returns), he or she probably has to follow all seven stages of the consumer decision process (extended problem solving). When these needs can be satisfied by buying a specific kind of stock, the private investor faces a fairly easy decision process; just buy what the members of the relevant reference group are buying. It is therefore not necessary to follow all stages of the consumer decision process. This is an example of limited problem solving.
Whether consumers mainly use internal or external knowledge depends on their knowledge
Buying frequency
With buying frequency is meant the frequency of buying/selling stocks. With regard to the effect of buying frequency, the following can be concluded. When a consumer has made a decision often, he or she has a lot of experience regarding this decision. Because of this, it is not necessary for the consumer to follow all seven stages of the decision model. Also, when someone has made a decision very often already, the perceived uncertainty of this person can be assumed to be lower than when this is the first time this person makes this decision. When uncertainty is low, there is less need for social processing. First time buyers often have no adequate internal information to make a correct decision. Even regular buyers have to use external information as there is the possibility of important changes in the environment (for example developments on the stock markets) between the different purchases. So, it is hypothesized that frequent buyers of stock use more internal information and less external information and infrequent buyers use more external information and less internal information.
Buying volume
Buying volume is in this research the monetary value of the stocks that are bought. The influence of the buying volume is less clear than the influence of the buying frequency, as there are some contradicting influences here. On the one hand, higher volumes assume higher involvement and therefore the consumer decision process will be moved through completely.
On the other hand, a higher volume makes it more likely that the consumer is more experienced, possibly leading to the skipping of some stages of the consumer decision process. With regard to the quantity and type of information that is processed, a same type of contradiction can be discovered. On the one hand, higher volumes make it more worthwhile to invest in acquiring more information. On the other hand, higher volume assumes more experience and less need for information. The final effect is not clear and more research is needed to determine the exact relationship.
Concluding, this interesting topic needs further research before it is clear how the decision process really differs when people buy stocks versus when they buy other products. Also, to find out the exact relationship between (the dominance of certain) personal needs, buying frequency and buying volume and the consumer decision process when people buy stocks, more research is needed. The author of this thesis will contribute to the discussion by devoting his PhD project to this topic (although in an adjusted form).
1. Introduction and research outlay
The stock markets sometimes seem to be like a casino; a smoky atmosphere swarming with gamblers. Big profits, dramatic losses, the stock market has also seen it all. But why do people perceive the stock market as something special? In principle (assuming perfect markets), the stock market should function in exactly the same way as the vegetables market on Wednesday morning. Nevertheless, a lot of people seem to perceive stocks as something very different than a bunch of carrots. Also, stock traders seem to be a special kind of people.
One often speaks about the great uncertainty and emotions a stock trader has to deal with. But are these factors only relevant when buying stocks or are they a common appearance in every consumer decision process? And to keep pushing: aren’t there differences within the stock market with respect to the consumer decision processes of each stock trader caused by different needs and different stock characteristics? Both stock traders and stocks are not homogenous. There can be large differences between stock traders in the needs they try to satisfy by buying stocks, their buying volume and their buying frequency. Stocks can vary in their risk, returns, image, etc. The effects of these differences on for example the decision processes of investors are by no means clear. These are all probing questions that need to be answered. In this master’s thesis I will try to answer them by looking systematically for differences between the consumer decision processes for stocks versus the buying process of other kinds of products. There will also be attention for differences within the stock market itself with regard to the consumer decision process caused by factors as different buyer needs, buying frequency and buying volume.
In this research, two different, but related main research questions will be answered by means of literature research.
The first main research question is:
1. Does the consumer decision process differ when people buy stocks versus when people buy other products? If so, how does it differ?
The corresponding research objective is:
To gain further insight in the possible differences between the consumer decision process for buying stocks and buying other products.
With the help of this research question, a first overview will be provided on possible differences between the decision processes for stocks versus other products. Only private stock traders will be taken into account. Stock traders who trade by profession or large institutional stock traders are excluded, as they have stringent rules to obey to and are not free to trade as they want to themselves. From now on, the term ‘private investors’ will be used when this group of people is meant.
With ‘decision process’, the consumer decision process is meant. This seven-stage process starts with the identification of needs and ends with an evaluation of the decision that has been made to satisfy this need. In this thesis, when the term ‘buying’ is mentioned, the consumer decision process in general is meant, which can be buying, selling or holding either
simplicity, I will make no forced distinction in this thesis between buying, selling and/or holding. These different processes will be kept in mind, however.
With regard to the terms ‘consumption’ and ‘consumer decision process’ there are some contradictions between the marketing approach and the (classical) finance approach.
In marketing, consuming behavior is the behavior consumers display when they are searching for, buying, using, evaluating and divesting products, services and ideas, of which they expect that they will satisfy their needs (Leeflang, 1995). So, both buying stocks and bonds is consuming, as is buying an ice cream.
In finance however, consuming and saving/investing are two different, opposing things.
Consuming means buying consumer goods, while saving and/or investing is delaying the consumption to a later period. The money not consumed can be invested in stocks or invested in a savings account. In a later period, more can be consumed, because of the interest or stock returns. These rewards are a compensation for delaying consumption and/or for taking a risk.
When consumption and consuming are discussed in this thesis, the broader, marketing term of consumption/consuming is meant. This because I will use marketing concepts to investigate the decision processes of private investors. So, in this thesis, both buying groceries and buying stocks is consuming.
Before going on with the identification of differences between these decision processes, it is necessary to mark our boundaries and give some definitions. The first two sub-questions therefore are:
1.1 What is a stock and what is the stock market and what boundaries do we take into account?
1.2 What is a consumer decision process, what factors affect it in which way and what boundaries do we take into account?
These two questions are being dealt with in the second and third chapter in the above- mentioned order.
Every buying process involves at least three parties: the buyer, the seller and the product.
With buyer an individual investor is meant. There are a number of options for the seller. The seller can be the stock exchange, the bank/broker or the previous owner of the stock. The product is the stock that is bought, hold or sold by the individual investor. The buyer, the seller or the product can cause differences in the consumer decision process. The next three sub-questions therefore are:
1.3 In what way do stocks differ from other products with regard to their product characteristics?
1.4 In what way do stocks differ from other products with respect to the characteristics of the seller?
1.5 In what way do stocks differ from other products with respect to the characteristics of the buyer?
Question 1.3 is discussed in chapter 4. The questions 1.4 and 1.5 are dealt with in chapter 5.
In the stock market, people seem to follow each other’s behavior quite often. Is this an example of some irrational herding behavior, is this rational behavior or is this an example of smart timesaving by using (social) heuristics? This behavior could also be a way to satisfy a social human need, like the need for participation (Max-Neef, 1992). It is probable that by following someone’s behavior it is possible to satisfy a social need like participation and at the same time saving time due to using this heuristic.
The following is also important. It is a fact that stock buyers differ with regard to their trading volume and frequency. There are low volume and high volume buyers and one investor trades more frequently than the other. But do low-volume and high volume investors display differences in the way they buy their stocks? And does the trading frequency influence the way these people make their investment decisions? For example, some investors may follow all seven stages of the consumer decision process, while other investors may skip a number of stages. These questions are the topic of investigation in the second main research question.
The second main research question is:
2. In what way is there a relation between the characteristics of private investors with regard to their (dominance of certain) personal needs, their buying frequency and their buying volume and the way these people move through their consumer decision process? What is the effect on the quantity and type of information that is being used in making a decision?
The corresponding research objective is:
To gain further insight in the possible influence of different personal needs, trading frequency and trading volume on the way private investors move through their consumer decision process.
This research question will be dealt with in chapter six. After this chapter, a conclusion will follow (chapter 7) which will answer both research questions. Also, recommendations for further research will be given in this last chapter.
2. Stocks, stock markets and the people active on it
In this chapter, a first look at stocks, stock markets and the people active on this market will be taken. The sub-question that will be dealt with here is: What is a stock and what is the stock market and what boundaries do we take into account? It’s important to get a clear view of these themes, to prevent any misunderstanding. First, some characteristics of a stock will be discussed. Then, the stock markets will be examined. Lastly, attention will be paid to the people active on these markets. Research boundaries will be mentioned as well.
2.1 Stocks
Before defining stocks, some basics of finance will be discussed. A firm’s capital can be sliced up in different parts. There can be a part debt, which is money borrowed which has to be paid back to the creditors one day. Also, there can be equity, this is the other part of the firm’s capital base. This capital is brought in by the shareholders of a firm, which are the owners of the firm. They own shares in the firm, called stock. Every dollar of profit remaining after paying of all the debt and paying all other stakeholders, like the government, the employees, the suppliers etc, belongs to the stockholders. So, they have a so-called residual claim on the firm’s capital. When someone owns a piece of stock, he or she owns part of a company (Ross, Westerfield and Jaffe, 2002).
According to the dictionary, a stock is:
• The part someone contributes to the capital base of a firm, and/or
• The written proof of someone’s share in the capital base of a firm.
(Van Dale, Handwoordenboek hedendaags Nederlands)
In this research, I will discuss stocks in general, making no division between common stock and preferred stock.
2.2 Stock markets
With regard to the stock market, a number of basic characteristics seem relevant. These are whether the market is private or public, whether the market is primary or secondary and whether the market is efficient or not. These characteristics will be discussed in the mentioned order.
Private markets
Stock markets can be private or public (Ross, Westerfield and Jaffe, 2002). On the private market, firms contact other firms, wealthy individuals and governments to inform if they are interested in buying their stock. With a private placement, a firm has a minimum of costs and it does not need to disclose all kind of information to the registration authority, in the US this is the Securities and Exchanges Commission. In the Netherlands there is a special law that makes sure that the stock markets adhere to a set of rules and regulations. This law is the ‘Wet Toezicht Effectenverkeer’ (WTE). These private parties then negotiate which price will be paid for each share of stock and what number of shares of stock will be issued. This whole
process is invisible to anyone other than the involved parties. As this market is not open for the general public and there often is no active trade in the stocks once they are issued, I will not take this market into account in my research.
Public markets
The public market again can be divided in a primary market and a secondary market (Ross, Westerfield and Jaffe, 2002). The primary market is used when firms and governments sell securities (here: stocks) for the first time to the public. Often, in this primary market, an underwriting syndicate is used. This is a group of large investment banks that buys the stocks from the issuing firm and tries to sell them to the general public for a higher price. These syndicates often give a guarantee of a minimum volume of stock being sold, buying on their own account if necessary. For this service they often get a fee and the already mentioned spread between the price they pay to the issuing firm and the price they collect from the investing public.
The secondary market is the market on which stocks are traded once they have been sold for the first time. In the Netherlands, this is for example the AEX, and in the U.S.A. the New York Stock Exchange. These markets can be either auction markets or dealer markets (Ross, Westerfield and Jaffe, 2002). In auction markets, the highest bidder can buy the stock. In dealer markets, parties can contact a dealer, stating which stock they wish to buy or sell, and the dealer will bring the buyers and sellers together. In this research, I am interested in the behavior of investors in general and not in possible differences between the different kinds of markets. Also, most people talk about the stock market in general and do not make a distinction between primary and secondary markets and dealer or auction markets. This division is mainly a theoretical one and does not have much practical value for this thesis. For these reasons, no distinction between these markets will be made in my research.
Market efficiency
Market efficiency refers to the information content of prices. There are three types of market efficiency. These are the weak form efficiency, the semi strong form efficiency and the strong form efficiency. These three types differ with regard to the type and amount of information that is incorporated in the market prices of stocks (Ross, Westerfield and Jaffe, 2002).
A capital market is said to be weakly efficient or to satisfy a weak form efficiency if it fully incorporates the information in past stock prices. This means that today’s price is equal to the sum of the last observed price plus the expected return on the stock plus a random component.
The random component in one period is unrelated to the random component in any other period. Hence, the random component is not predictable from past prices. The stock follows a so-called ‘random walk’ (Ross, Westerfield and Jaffe, 2002).
A market is semi-strong form efficient if stock prices reflect (incorporate) all publicly available information. This can vary from accounting statements to information about past prices (Ross, Westerfield and Jaffe, 2002).
When stock prices reflect all relevant information there is about a stock, either public information or private information, the capital market is said to be strong form efficient
When a market is efficient, this means that a firm will obtain a fair price when it sells a share of stock, in the sense that the price reflects the value of the stock given the information that is available about it. Investors do not have to worry that they pay too much for a stock with a low dividend or some other characteristics, as this information is already incorporated in the price of the share of stock. However, investors still should worry about their level of risk exposure and their degree of diversification (Ross, Westerfield and Jaffe, 2002). Investors can use portfolio theory to diversify their risk and lower their total risk exposure. Portfolio theory states that due to diversification effects, the total risk of a portfolio of stocks is less than the risk of one single share of stock (Ross, Westerfield and Jaffe, 2002).
There is evidence for the stock market to be weak form efficient and semi-strong form efficient. However, there is no evidence for the stock market to be strong form efficient. But the classical finance theory of perfect markets assumes that markets are strong form efficient.
When markets would be strong form efficient, and an investor would use portfolio theory, the decision process could be very simple: just buy a basket of shares and the perfect market and portfolio theory will make sure you reduce your total risk and have a decent return. This due to the fact that in perfect markets, there are no trading costs, all information is available and incorporated in the stock prices and no single trader can have a significant influence on the stock prices.
Taking the above into account, one could state that there is no need to investigate the decision process of stock traders into detail, as this process is just a simple picking of a number of stocks without deliberating much and without doing a lot of research on the stocks. However, I do not believe the capital markets to be efficient, at least not strong form efficient and I am more interested in the decision process of a private investor with regard to one share of stock at a time instead of a portfolio of stocks. For this reasons, I consider the decision process for private investors to be worth a detailed investigation.
2.3 The people
In the stock markets, a distinction can be made between private investors and professional investors. Private investors are people who buy and sell stocks on their own account in relatively small volumes. These people do not have to obey to any rules of how they make their stock trading decisions. Professional investors are people who trade stocks as a profession; who work with some kind of institutional investor, like a bank or an insurance company. They have to obey to strict rules when they buy stocks and are not completely free to trade as they want themselves.
To give the reader an idea about the distribution between private and professional investors, some statistics on these groups of investors will be discussed. In the Netherlands there are now (2003) 1.370.000 private investors active on the stock market. In recent years there was a large drop in the number of private investors, possibly due to the World Online drama. At the time of the market introduction of World Online the number of private investors in the Netherlands was at an all-time high of 1.900.000 private investors (Centrum voor Marketing Analyses, 2003).
About 35% of all investors active on the Dutch market are private investors (Parool, 11-06- 2001). About half of the total market turnover on the Amsterdam Exchange (AEX) is from private investors (Stockstore, 2003) Concluding, private investors are an important and large group of investors in the Netherlands.
In this research, only private investors are taken into account, as they are free to trade as they like, without any limitations. So their trading behavior is not merely an expression of company rules, like that of the professional investor.
2.4 Conclusion
In this chapter, the basics of stocks, the stock market and the people active on the stock market were discussed. In this research, stocks are seen as a share of ownership in a company, without making a distinction in different kinds of stocks. Only the public stock market will be discussed, making no further distinction in the primary and secondary markets. I regard the stock market as being not efficient, at least not in a strong form. Lastly, only private stock traders are taken into account. In the next chapter, the consumer decision process will be discussed.
3. The consumer decision process
In this chapter, the focus is on the consumer decision process. The following sub-questions will be answered: What is a consumer decision process, what factors affect it in which way and what boundaries do we take into account? To find the answer to these questions, I will use the consumer decision process (CDP) model that was first developed by Engel, Kollat and Blackwell (the so-called EKB model) and was later revised into the EBM model, to acknowledge the work of Miniard (Engel e.a., 2001). This particular model is used as it is a very clear and well-structured representation of the consumer decision process. Also, it takes a great number of related factors like environmental influences, personal differences and psychological factors into account. In this chapter, first the model will be shortly described and graphically displayed. After that, each of the stages of the decision process will be discussed in more detail. Then, factors that affect this decision process are discussed. Special attention will be paid to the influence of psychological factors by discussing the insights of behavioral finance. After this a conclusion will follow. Also, research boundaries will be given.
3.1 The EBM model: the basics
The EBM model describes a central decision process that is surrounded with environmental influences, individual differences and psychological factors that influence this central process.
The central process contains of seven major stages that consumers typically go through. These stages are:
1. Need recognition 2. Search for information 3. Pre-purchase evaluation 4. Purchase
5. Consumption
6. Post-consumption evaluation 7. Divestment.
The environmental influences consist of influences of different cultures, social classes, personal influences, family and the situation.
The individual differences consist of consumer resources, motivation and involvement, knowledge, attitudes, personality, values and lifestyle.
The psychological factors are factors as information processing, learning and attitude- and behavior-change.
In this research, I will try to discover, if there are differences in the stages of the consumer decision process when people buy stocks versus buying other products. A close look will be taken at the influence of individual differences between consumers, where the focus is on the needs of consumers. The environmental influences are not discussed into detail, as this would make the research too broad. The psychological factors will be discussed in a section about behavioral finance and also in later sections.
In figure 3.1 the complete CDP is graphically displayed.
1. Need recognition
Satisfaction Dissatisfaction
6. Post- consumption
evaluation 2. Search
3. Pre-purchase evaluation of
alternatives
4. Purchase
5. Consumption
Environmental influences
• Culture
• Social class
• Personal influences
• Family
• Situation
Individual differences
• Consumer resources
• Motivation
• Knowledge
• Attitudes
• Personality, Values and Lifestyle
Exposure
Attention
Comprehen -sion
Retention Acceptance
Memory Internal search
Stimuli
• Marketer dominated
• Nonmarketer dominated
External search
Figure 3.1: The consumer decision process model by Engel e.a (2001).
Stages
Psychological factors
• Information processing
• Learning
• Attitude and behavior change
7. Divestment
3.1.1 Stage 1: need recognition
Every purchase decision starts with a customer need or problem. Need recognition occurs when an individual senses a difference between what he or she perceives to be the ideal state of affairs versus the actual state of affairs ( Engel e.a., 2001: 72). The consumer will only then take any action, if and when this difference is large enough. There has been a lot of research on human needs. For example, by Maslow (1954), Kamenetzky (1992) and Max-Neef (1992).
I choose to use the needs taxonomy of Max-Neef in my research as it has a number of advantages over the other needs taxonomies. First, it is an extensive framework of human needs, consisting of nine different needs. Second, Max-Neef makes a division in needs and satisfiers of that needs, this division is lacking at the other authors. Third, Max-Neef makes a distinction in four different types of satisfiers.
As indicated above, Max-Neef makes a division in needs and satisfiers. The needs will be discussed first. According to Max-Neef, there are nine fundamental human needs. These are:
• Subsistence. This need is a very basic one and in fact means to be, to stay alive.
• Protection. People need protection. This can range from protection from the weather (a house) to protection of their income (by for example social security).
• Affection. People want to be appreciated and loved by others.
• Understanding. People want to learn new things and develop themselves by studying.
• Participation. People want to be a part of something larger than themselves. They want to share and interact.
• Leisure. People want to spend their free time in a meaningful and fulfilling way or want to have fun.
• Creation. People like to make and create new things. They are curious for inventions.
• Identity. People like to integrate oneself and to feel a sense of belonging. With this need there’s a large social element.
• Freedom. People want to have equal rights and to be free to do what they like to do.
Stocks may simultaneously serve different needs. On the one hand, stocks can satisfy rather individual needs like subsistence. For example, some people own stocks and keep them on a separate account, saving money for ‘a rainy day’. On the other hand, stocks may serve their owners by satisfying more social needs, like the need for participation. For example, people who own Ajax stocks may not only do this because they hope to make a profit one day, but they may also do this to participate with other Ajax supporters. By owning Ajax stocks, these people satisfy their need for participation. Not only the rather ‘passive’ owning of stocks may satisfy a social need, also ‘active’ interacting with other people when trading stocks, for example at a stock trading club, may satisfy the need for participation.
Max-Neef has given a definition of satisfiers and made a distinction in different kinds of satisfiers. Satisfiers define the prevailing mode that a culture or society gives to needs.
Satisfiers are not the available economic goods. Instead, they are related to everything which by the virtue of representing forms of Being, Having, Doing and Interacting, contributes to the satisfaction of human needs. For example, the need for subsistence can be satisfied by being physically healthy, by having a shelter, by doing some work and by interacting in a social setting (Max-Neef, 1992).
3.1.2 Stage 2: search for information
After need-recognition, consumers begin to search for information and solutions to satisfy their needs. This search process can be either internal or external. Internal search uses information that is being retrieved from the memory of the consumer. External information uses information from outside the individual. For example information from peers, family and the marketplace in general. Consumers may look passively for information, by just becoming more receptive for new information, or they can search in an active way for new information by looking in research journals, reading product tests or looking on the Internet. Sometimes factors outside the control of the customer cause the consumer to start looking for information, for example when a washing machine breaks down or for stocks, in the event of a stock crash. The length and depth of this search for new information depends on the involvement of he consumer. When a consumer is very involved in making a decision, he or she is more likely to search for a long time and in great depth for information, as this consumer wants to make a wise decision. The involvement of a consumer is dependent on the need that a consumer tries to satisfy by buying a certain product. It is likely, that when a consumer tries to satisfy a basic need for survival, like subsistence, he or she is very involved, as this decision is very important for him or her. When a person perceives a need as less important, it is plausible that he or she is less involved in making this decision. In this process, background variables like personality, social class, income, time constraints etc. also play a role, although they are assumed to be less important than the factor involvement. In a later section, this topic will be dealt with in more detail.
In general, there are two main sources of information, marketer dominated and non-marketer dominated. Marketer dominated information sources refer to anything a supplier does for purposes of providing information and persuasion, like placing advertisements, using salespersons and developing web sites. Non-marketer dominated sources are for example information from friends, colleagues and family. Although these groups may have been exposed to marketing messages, it is still assumed that the messages of these groups are not marketer dominated.
After a consumer has been exposed to information, the information will be processed. This process contains 5 steps. These steps are:
1. Exposure. The first that must happen is that the information or persuasive communication reaches the consumer.
2. Attention. In the second step, a consumer must decide whether to allocate information- processing capacity to the incoming information.
3. Comprehension. If the message gets attention, it is compared in the memory against stored categories of meaning.
4. Acceptance. Before the message can confirm or change existing beliefs of the consumer, the message must be accepted.
5. Retention. The final stage is the storing of the accepted message in the memory.
(Engel e.a., 2001)
However, these 5 steps do not always need to be followed completely. For example, some people will not even be exposed to information. They can refuse to let new information reach them, for example when they are determined to buy a certain product because other people
3.1.3 Stage 3: pre-purchase evaluation of alternatives
In this stage of the consumer decision process, the consumer compares alternatives and decides which one is best. Every consumer hereby uses different evaluative criteria. These are the standards and specifications used to compare different brands and products (Engel e.a., 2001: 76). Consumers can use heuristics to make a pre-purchase evaluation of alternatives.
Heuristics are composed from building blocks that guide search, stop search and make decisions. The distinctive characteristics of heuristics are that they are fast and frugal. Fast refers to the relative ease of computation of these strategies. Frugal refers to the very limited amount of information that these strategies need (Gigerenzer and Selten, 1999). These heuristics can be either individual or social. In section 5.2.3, both individual and social heuristics will be discussed in more detail.
3.1.4 Stage 4: purchase
In this stage of the consumer decision process, the actual purchase is made. After deciding whether to purchase or not, the consumer moves through two phases. The first phase is the choice of the retailer or in the case of stocks, the choice of which stock exchange to use. In this stage of the decision process, the consumer already knows which type of product or type of stock he or she wants to buy. The second phase is the in-store choice. In this phase, the customer decides which particular product or stock to buy. The salespersons and the design of the shop can make a large difference, as do special discounts and coupon actions. It indeed happens often that the consumer leaves the store with a totally different brand than for which it came in for in the first place (Engel e.a., 2001).
3.1.5 Stage 5: consumption
After the consumer has made the purchase and has taken possession of the product, he or she may start using it, or consume it. Consumption can either start immediately or be delayed.
Think for example of people buying more than they normally do during a discount and store the product for later use. The care of the consumer over the product in this phase influences whether and when the consumer has to buy a new product (Engel e.a., 2001). When a consumer for example buys a car but does not change the oil regularly, he or she will soon need a new car (or at least a new engine). Taking good care of products and investing in maintenance will lead to much longer replacement cycles.
3.1.6 Stage 6: post-consumption evaluation
After consumption, a consumer may either experience a sense of satisfaction or dissatisfaction. A consumer is satisfied whenever the experienced performance of the product matches or exceeds the expected performance of the product. Whenever the product falls short of the expectations, the consumer is dissatisfied. This is a particular important stage, as consumers store their evaluations in their memory and use it for later decision making. As can be seen in figure 3.1, a satisfied customer has a much shorter decision process than a dissatisfied customer. A satisfied customer often just buys the same product again in the future, without further search. An unsatisfied customer is open for the messages of competitors, while it is for the latter much harder to reach satisfied customers. Emotions play a large role in the evaluation process (Engel e.a., 2001). Emotions like anger or happiness influence the evaluation process by the consumer.
3.1.7 Stage 7: divestment
Divestment is the last stage in the consumer decision process. A consumer has a number of options for divestment. A product can be sold, given away or recycled, to name a few (Engel e.a., 2001).
3.2 Factors that influence the decision process
In principle, there are three categories of influencing factors on the decision making process;
environmental influences, individual differences and psychological factors (Engel e.a., 2001).
Environmental influences
The environmental influences can be grouped in the following classes:
• Culture. Culture refers to values, ideas, artifacts and other meaningful symbols that help individuals to communicate, interpret and evaluate as members of society.
• Social class. These are divisions within society that comprise individuals sharing similar values, behavior and interests.
• Family. These are close relatives of a person, like someone’s father or mother, brother or sister.
• Personal influence. Those with whom we closely associate often affect our behavior as consumers. We often respond to pressure from people we know to conform to certain norms and expectations.
• Situation. The situations in which we make our decisions change every moment of the day.
In this research we will meet the environmental influences again in the sections about (social) heuristics. Important persons in the environment of a consumer, for example his or her friends or family, can have a major influence on a consumer’s decision behavior. The consumer may observe that these persons are in a very similar situation as he or she is in and may base his or her decision behavior on theirs. This can take the form of social heuristics like for example imitation.
Individual differences
Individual differences between consumers can origin from the following:
• Demographics, psychographics, values and personality.
• Consumer resources. According to Engel (2001) there are three basic consumer resources:
time, money and information reception and processing capabilities (attention). Naturally, there may also be differences between individuals with respect to their physical abilities.
• Motivation.
• Knowledge.
• Attitudes.
In this research, attention will be paid to the factors consumer resources, motivation and knowledge. These factors are important when discussing the influence of social heuristics in
Psychological processes
To the psychological processes we count the following:
• Information processing. The way people process information is important for their decision-making.
• Learning. When you want to influence a customer, in fact you want to teach him or her something; therefore learning theory is also relevant.
• Attitude and behavior change. Changing consumer attitudes and behavior is a major marketing objective.
All the psychological processes mentioned above are important in this research. There even is an academic research field that performs research on the influence of psychological factors on the behavior of stock traders. This academic research is known under the term ‘behavioral finance’. Behavioral finance is the complete entity of views, models and applications, which uses behavioral insights to explain all kind of phenomena with regard to securities, finance and the financial markets (Tempelaar, Overmeer and Bronsema, 1999). The seven parts that together constitute the theoretical insights of behavioral finance will be shortly described in this section (Butot, 2003).
• Loss-aversion. Loss-aversion means, that people seem to think that losses are disproportionately more important than profits are. ‘Losses loom larger than profits’.
People are more agitated with a loss, than that they are happy with a profit of the same size of the loss (Kahneman and Tversky, 1979).
• Mental accounting. The human brain is famous for it’s enormous capacities for information processing. To be able to process all this information, the mind uses some smart short cuts, like mental accounting (Van Zeijl, 2001). With mental accounting, people for example keep making deposits on their savings account, while taking credit on their normal account. This leads to losses, as the interest earned on the savings account is much lower than the interest the customer has to pay on its credit. With stocks we see that people like stocks that pay dividend to get an income, but are reluctant to sell of shares of stock to create income themselves on shares that do not pay dividends (Shefrin and Statman, 1984).
• Hubris. Hubris comes forth from too much self-confidence (Zeijl, 2001). Hubris can cause people to behave in ways that might look irrational for outstanders. For example, people with hubris might buy stocks that are very risky, believing that their decisions will always lead to profit. This may look irrational for outstanders, but from the point of view of the relevant decision maker it can be a rational way to make decisions.
• ‘Embedding’ or ‘Anchoring’. Every day, the human mind gets loads of new information to process. Of these large streams of information, some parts ‘throw out an anchor’, which means that they create a reference in our mind. The mind is happy with this process, as it allows the human to take quick decisions by comparing incoming, new information with the anchor point in our mind (Van Zeijl, 2001). With stocks this happens when people create a reference market price of a certain stock in their mind. In their opinion this reference price is the correct price for this stock and they will use it as a guide for decision making. For example, when KPN performed very well in the (recent) past, investors might have thought 80 Euro to be the correct price for this stock and probably could not believe that the price of a share of KPN would end up below this price. They traded believing that 80 Euro was the correct price for this share of stock. For example, when the price of KPN
fell below 80 Euro, they bought extra shares. They believed that they did a good investment, as the ‘correct’ price for KPN was 80 Euro.
• Cognitive dissonance reduction. Cognitive dissonance reduction is used by the human psyche as a strategy to protect its self-respect. People try to protect their self-respect in every possible way. When people have taken a certain decision, they will exhibit ‘post- decisional closedness’, which means, that they lock out any negative information about their decision. They try to order their cognitive relations in a way that excludes cognitive tension. With stock trading, this means for example, that after a decision to sell is taken, the trader does not follow the market developments of a certain stock anymore, to reduce any possible cognitive dissonance (Jones and Gerard, 1967; Festinger, 1957). Cognitive dissonance occurs whenever the result of a person’s action differs from the desired result.
For example, when someone sells a share of stock, believing that it’s price will fall, and the price of the stock does not fall after selling it, the person becomes dissatisfied and experiences cognitive dissonance. This feeling would be even more severe, if the price of the share of stock rises after selling it. To prevent this feeling of cognitive dissonance to occur, the investor does not follow the developments around the specific share of stock anymore after selling it. ‘What the eye doesn’t see, the heart doesn’t grieve over’.
• Magical thinking. With magical thinking, people assume that two totally independent happenings are connected to each other by some higher power. An example is that people think that the developments of the value of a share in recent years will be the same in the future. When all people think that the value will rise or fall, they will collectively buy and/or sell their shares, thereby making their expectations real. This is called a self- fulfilling prophecy.
• Dilemma of available alternatives. When people have a lot of alternatives, they become uncertain and restless. They do not know which alternative to choose. The more alternatives, the more problematic the decision process becomes. Stock traders have a lot of alternatives to choose from and so exhibit considerable levels of uncertainty (Zeijl, 2001).
3.3 Conclusion
In this chapter, the consumer decision process was discussed. The consumer decision process consists of a central process of seven stages and three sets of influencing factors. The central process stages are:
1. Need recognition 2. Search for information 3. Pre-purchase evaluation 4. Purchase
5. Consumption
6. Post-consumption evaluation 7. Divestment.
The influencing factors are environmental factors, individual differences and psychological processes. Behavioral finance performs research on the influence of these psychological factors. After this chapter, the introductionary part of this research is left. In the next chapter, differences between stocks and other products with regard to their product characteristics will be examined.
