ILLUSTRATION BY Gordon Studer

By Priya Raghubir and Joydeep Srivastava

t has become exceedingly apparent of late that credit, rather than money, makes the world go ’round – all the way up the line, from micro- to macro-economics. With great interest, we set out to investigate the connection between paying in cash and paying with credit. We wanted to understand how buying with credit – which typically entails a time lapse between the purchase and the need to pay for it – affects how people think about and spend money. We also wanted to see if other factors influence purchase decisions similarly, such as using a gift certificate rather than cash or a credit card, and whether treating a gift certificate like cash and holding onto it for a period of time makes any difference.

Pick a Card, Any Card

With the proliferation of different payment modes in recent years, consumers have a wide array of payment options to choose from in making their purchases. Typically, consumers have the option to purchase with cash, a check, a credit card, or a debit card. However, other payment modes such as bank drafts, money orders, traveler’s checks, gift certificates, gift cards, coupons at fairs, chips at gaming houses, and stored value cards such as those used in mass transit and tolls, etc., are quite common in the marketplace. Some types of gift cards are almost identical to debit cards, such as the American Express or Visa gift cards. Further, the advent of Internet commerce has spurred the growth of new payment modes such as PayPal.

Relatively few studies have investigated differences in spending behavior as a function of the mode of payment. The few existing studies demonstrate that consumers tend to spend more when paying with a credit card than when paying by cash or check, after controlling for other factors. A review of the previous research on the effect of payment mode on spending behavior suggests that the focus has been primarily on the difference between credit card and cash payments. The phenomenon of higher spending when paying with a credit card than with cash has been attributed to the separation in time of the purchase decision from the actual payment – referred to as payment coupling.

Payment form is another aspect of the mode of payment that refers to the differences between two monetary instruments that are identical in temporal coupling and face value but different in terms of physical appearance (e.g., $50 legal tender and a $50 gift certificate that can be used anywhere). Relatively little research has focused on spending as a function of payment form. Noting that a credit card differs from cash in coupling as well as form, we set up a series of experimental studies that examined consumer spending as a function of payment mode both when the mode differs in coupling and form (e.g., credit card versus cash) and when the mode differs only in form, holding payment coupling constant (e.g., gift certificate and cash of equivalent value).

Ignorance is Bliss

The conceptual underpinning of our research was that payment modes differ in transparency – which we characterize as the vividness with which individuals can feel the outflow of money – with cash being the most transparent payment mode. We argued that the more transparent the payment outflow, the greater the aversion to spending, leading to less transparent payment modes such as credit cards and gift cards (versus cash) being more easily spent or treated as play or “Monopoly money.” Further, to the extent that the transparency of paying affects spending behavior, we tested whether altering the salience, or significance, of parting with money would lessen any behavioral difference across payment modes.

Research on the cognitive psychology of financial behavior suggests that people organize their finances around mental accounts, which have been described as the set of cognitive operations used by individuals and households to organize, evaluate, and keep track of financial activities. Analogous to accounting and budgeting systems used by companies, individuals create separate source-based expense and income ledgers in their mind. For example, people group and label expense accounts separately, such as food and entertainment, and spending is driven by the available surplus or deficit in each account. Since people treat money differently depending on how it is labeled, money in one mental account is not a perfect substitute for money in another account – hence it is not perfectly fungible. In general, mental accounts serve to simplify financial decision-making and aid in making tradeoffs among different types of spending.

At the specific transaction level, it has been shown that a mental account is opened and the decision to purchase is based on an evaluation of the perceived benefits of consumption and the costs of payment in this particular account. As discussed above, there is an immediate pain of paying that can reduce or even prevent the pleasure of consumption. In balancing the pleasure derived from a purchase and the pain of paying for it, making the cost salient undermines the pleasure one can derive, whereas making the benefits salient may blunt the pain of paying. In this case, coupling – the extent to which the consumption and payment are psychologically linked together due to their proximity in time – tends to enhance the pleasure of consumption and reduce the pain of paying.

It makes sense, then, that, as previous research has shown, consumers tend to spend more when using a credit card than when using cash, as the purchase is fully decoupled from the payment. By contrast, in the case of cash purchases, there is a tight coupling of the consumption and the payment, accentuating the pain of paying. Further, in balancing the immediate gratification against the expectation of the pain of paying in the future, people are likely to underestimate the pain and thus spend more with a credit card than cash.

Paying the Piper

In addition to the difference in payment coupling across payment modes, we argued that payment modes may also differ in terms of form. Consider an individual who receives $50 either in the form of cash or a gift card that can be used almost universally. Although there is no difference in coupling or the face value of the amount of money given (i.e., $50), the two payment modes are different in physical appearance and thus differ in terms of payment form. In the case of credit cards versus cash, the two payment modes differ in terms of coupling as well as form, whereas in the case of gift card versus cash, the two modes differ only in terms of form. We argued that the physical form of the payment mode is likely to affect payment transparency, or the vividness with which the outflow of money is felt. Thus, extending the reasoning to different payment forms, the more transparent the payment form, the higher the pain of parting with money, the greater the aversion to paying, and the lower the likelihood and level of spending.

We investigated our hypotheses with four groups of students. The first two studies examined whether consumers were willing to spend more when the payment mode was a credit card versus cash. Holding payment coupling constant, the second two studies examined spending decisions when an equivalent amount was given either in the form of a gift certificate or cash, so that the payment mode differed only in form. Exploring conditions under which payment modes led to differences in spending decisions, we were also able to examine the extent to which the spending differences across payment modes were eliminated or reduced by altering the significance of parting with money in the case of credit cards and gift certificates, respectively.

Our findings lent support to previous theories that paying for goods and services leads to an immediate pain of paying, which is balanced against the anticipated benefits of the goods and services. While making the benefits significant may somewhat blunt the pain of paying, our results suggested that payment modes that are even less transparent dull the pain of paying, thus increasing the likelihood of spending. The outflow of money is very vivid, and thus painful, when individuals use cash. We found, in contrast, that any payment mode that makes the outflow of money less vivid, and thus less painful, reduces the psychological barrier to spend. Importantly, the results also suggested that contextual variables that make the pain of paying salient serve to reduce the propensity to spend more, even when using a less transparent payment mode such as a credit card. Thus, participants in one of our studies were made to feel the full extent of the future pain of paying, which attenuated the tendency to overspend when using a credit card as compared to cash.

Substantively, this research contributes to our understanding of individuals’ propensity to spend as a function of payment mode and thus the increase in the variety of different payment modes in the marketplace. For example, American Express in 2004 began focusing on increasing sales of American Express gift cards, the sales of which tripled from the previous year. The Incentive Federation Study of Merchandise and Travel Incentive Users found that gift cards are commonly offered as incentives for salespeople (78 percent), resellers (57 percent), consumers (77 percent), and employees (67 percent).

Park Place or Boardwalk?

From a consumer welfare perspective, our results suggested that individuals are prone to biases in spending when they use non-legal tender. Treating non-legal tender as play money leads to overspending that authorities can warn consumers about. It has been reported that people recall their cash payments better than their credit card expenses, indicating that the full extent of the pain of paying in the future is not felt at the time of purchase. To the extent people can be made to anticipate the future pain of paying at the point of purchase, the difference in spending behavior as a function of payment mode is likely to diminish. In the case of gift cards relative to cash, frivolous spending is more likely to occur with a gift card than with cash. Although equivalent in face value, the intrinsic difference in physical form and appearance serves to anaesthetize the pain of paying.

There are several promising areas for future research around this subject. One is the extent to which people may choose to use cash for justifiable necessities but credit or gift cards for frivolous luxuries. Another relates to disentangling the transparency versus matching effects of credit card spending for utilitarian and hedonic goods – the extent to which people may consciously match more transparent payment forms to necessities or utilitarian consumption and less transparent payment forms to frivolous luxuries. Identifying the learned cognitive structures, or schemas, associated with different payment modes is another fruitful area for research. In our context, people may learn and develop schemas about different payment modes and how these may aid in balancing consumption pleasure and the pain of paying.

Future investigation of these issues could examine differences in spending behavior with larger sums of money and non-student populations under more naturalistic conditions than the laboratory environment allowed. Further, future research could investigate whether the differences due to the transparency of the money also affect differences in the likelihood of spending and amount of spending for new payment mechanisms such as prepaid stored value cards, like those offered by American Express, Visa, phone companies, and many retailers.

PRIYA RAGHUBIR is professor of marketing and Mary C. Jacoby Faculty Fellow at NYU Stern.

JOYDEEP SRIVASTAVA is associate professor of marketing at the Robert H. Smith School of Business, University of Maryland, College Park.