Melberg, Hans O., Investments and Psychology

_{[Note for bibliographic reference: Melberg, Hans O. (1996), Investments and
Psychology: Why not all profitable investments are exploited right away, http://www.oocities.org/hmelberg/papers/960823.htm]

Investments and Psychology

Why not all profitable investments are exploited right away

by Hans O. Melberg

The paradox

Three years ago I gave the owner of a campground (where I had worked every summer since I
was 15), a list of suggested improvements. Many of these improvements were small
adjustments such as larger garbage cans and improved information. The next year I was
surprised to see that only a few of the things had been done. If I had asked for big
investments I would not have been surprised, but these were small adjustments - sometimes
with large gains in terms of the service for the tourists. I asked him why he had only
done a few (in addition to a major improvement which I had not asked for). His answer
taught me something about the relationship between investment and psychology.

The solution

Basically the owner replied that he did not want to exhaust all the possible improvements
in one year because he would then be left with no (or few) improvements next year. Well -
I asked - does that matter. Is it not better to give the best possible service to the
tourists right now? No - he said - we raise the price a little every year and because of
this increase the tourists want to see a few visible improvements every year. They would
not accept a large rise in prices, even if it was accompanied by many small changes.
Hence, the best strategy was to do only a few improvements every year - not to exhaust all
the possibilities and receive complaints (and fewer guests) when you rise the price
without changing the service.

The generalization

The answer struck me as valid. In some cases it really is optimal not to give the
customers the best possible product in a single year since it would mean disappointing
them next year which in turn would means loosing future customers. (Expressed a bit more
complicated: What was statically optimal was not dynamically optimal). Here we have one
example of how investment-decisions are governed by the psychology of the customers.
First, the fact that they want to see yearly improvements. Second, that they are not
willing to accept a short term price increase and many small improvements, but
(irrationally) that they are willing to accept the same price and the same level of
services if the change is brought about gradually. It seems to me that the same kind of
reasoning could apply to other products. (Please, feel free to send me concrete examples
if you know any).

Conclusion

There are, of course, many other reasons why all profitable investments are not exploited
right away (such as the fact that there is limited capital). The reason given in this
observation might be exceptional, but at least I know from personal experience that it is
real mechanism, not just a possible story.

_{[Note for bibliographic reference: Melberg, Hans O. (1996), Investments and
Psychology: Why not all profitable investments are exploited right away, http://www.oocities.org/hmelberg/papers/960823.htm]}}