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A Behavioural Scientific Case for Prepayment



Although the world may be filled with AfterPays, credit cards and other payment postponing methods, my behavioural science heart lies with what is known as prepaying. Let me tell you why.

 

Pre-paying is the paying upfront, either complete or partially, for a good or service. It means that the transaction occurs before the good/service is received, and when the good/service is being received there is no, or only partial, payment left. From a behavioural scientific perspective, we have the pain of paying (Zelermayer, 1996) to explain why this is a good idea. Prelec and Loewenstein (1998) wrote a paper about different aspects of the pain of paying, especially in regards to payment timing. They found that people had a strong preference for paying holidays upfront, yet a lot of people put their holiday on their credit cards, meaning that once the holiday was over, it still had to be repaid in full. This scenario may give the clue away as it is: if you prepay you incur the cost now, and the enjoyment later, if you postpay you incur the enjoyment now, but the cost later. Having it spelled out like that it is hardly surprising that most people prefer spending on credit cards, we are present-biased animals after all. Meaning, everything positive we can incur now is worth more than everything positive we can incur later. Everything negative we can incur now is more negative than everything negative we can incur later. It’s because we discount things in the future.


This notion of the pain of paying, and its difference with regards to timing, has an interesting appearance in the brain as well, although in terms of timing I will be extrapolating the findings. Research by Knutson et al. (2007) had participants go through an online shopping task whilst measuring their brain activity (fMRI). There were two particular brain areas of interest: the insular cortex and the striatum. Now the former is associated with experiencing physical pain, and the latter is associated with (anticipated) reward. Knutson and colleagues found that through studying the activation in these two brain areas, they could predict whether a purchase was going to occur, or not. When activity in the insular cortex was higher than the activity in the striatum there was no purchase. It was too painful to purchase. However, when activity in the insular cortex was lower than the activity in the striatum, a purchase was made. As it was too pleasant not to purchase. When you add timing into the mix you essentially separate the two occurrences just mentioned. With postpayment (BNPL, credit card), what we see is that the pleasure is front loaded (striatum) and that the experience of pain due to the cost/payment is discounted much into the future, and therefore experienced to a lesser extent at the time of purchase. So insular cortex activity decreases, whereas striatum activity goes through the roof. Our animal brain is experiencing a lot of (anticipated) reward. This purchase is likely to happen. This is why we find that a lot of people overspend when using credit cards. For prepayments this scenario is flipped. The cost, and therefore the whole pain of paying is endured upfront, whereas the pleasure is moved to the future. So our insular activity increases, whereas the activity in our striatum decreases. Now in terms of activity in the striatum this is a bit trickier, as the striatum doesn’t simply “light up” when there’s an immediate reward; it also functions on reward anticipation. However, we should not forget about our friend discounting: pleasure experienced now is worth more than pleasure experienced later. So although activity in the striatum is likely to decrease when faced with future rewards, as compared to immediate reward, this decrease might not be as big as expected. The real kicker here is the increase in insular cortex activity. Well, what does this look like at the scene of the crime (or purchase, if you will)? Prepayment is a really good test to see whether you actually want to make, or continue to make, a purchase. Rather than being led by our animal brain seeking out immediate reward, we’re faced with the deliberative process first: “I have to pay now – do I really want it later?” This type of reasoning just doesn’t allow for impulse purchases, because no impulse is triggered.

From a budgeting and money management perspective prepaying is also an excellent tool; it wipes out temptation through restriction. If I plan on taking a holiday, yet I put it on my credit card now and deal with the cost later, I do not have to change my current spending pattern. I will only have to change my spending pattern later to be able to repay the cost of the holiday (+ interest costs). However, if I prepay the holiday (either in full or in installments) I have to change my spending habits now. I need to make sure this money is available. And when paid, the money I left is for me to live off (pay the bills, hopefully some savings and only some splurging if there’s any left). This is People do actively apply these types of restrictions in their day to day lives. If you’ve read the US Financial Diaries this example should be familiar to you: every single time a male participant of the USFD received a higher than expected paycheck, he went to the grocery store immediately to buy long shelf life items, such as canned goods and toothpaste. This ensured him of two things: 1. He’d always have something to eat and clean teeth; and 2. He wouldn’t waste the “additional” money on something else like gambling. This form of prepayment was used to constrain the rest of his money. And this is very clever if you don’t trust your own ability to deal with the temptation of splurging.

Now the example I keep mentioning is prepaying for a holiday, which has the advantage of giving us anticipatory utility: even though the cost happens now, we’ve got something amazing to look forward to. Unfortunately, most expenses aren’t like this at all. What about prepaying your car needing to be fixed, your tuition fees, or something else that just “has to be done?” Sure, you might argue that a lot of the prepaying I’m describing and purchase preparation is already known as savings. And that is a very fair point. But when it comes to saving for something specific, the anticipated reward from owning that good or experiencing that service may not necessarily be salient enough to make a good case for prepayment. Whereas nothing could be more salient than being presented with the good/service when paying with a credit card. Whether we derive any reward from the purchase (holiday) or none at all (car repairs).

 

Postpayment has proven to be very popular, however, it has led a lot of consumers into financial troubles, if not completely into a debt trap. It’s time prepayment steps up its game and becomes a threat to the postpayment sphere.

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