The Four Ways to Spend Money

I like best the wine drunk at the cost of others.

— Ascribed to Diogenes the Cynic, c. 380 B.C.

According to Milton and Rose Friedman in Free to Choose, in any economy there are four ways people can spend money (Friedman and Friedman 1980: 116–17):

On Whom Spent

Whose Money

You

Someone Else

Yours

I

II

Someone else's

III

IV

Category I: When you spend your money on yourself, you will do everything in your power to maximize your utility. For example, if you are in the market for a car, you will download information from the Internet, talk to friends, visit dealerships, take test drives, read consumer reports, and so on. You will try to get the biggest bang for your buck.

Category II: Perhaps you're buying a gift for a spouse, friend, or colleague. You will still want to maximize your utility and theirs and to shop around and try to get the biggest bang for your buck. If you doubted your ability to maximize utility for the recipients, you might simply give them money and put them into Category I.

Category III: When you spend someone else's money on yourself, this is the greatest luxury of all. A corporate expense account is a perfect example. There is very little incentive to economize. You might fly first class, upgrade your rental car, not eat all of your dinner, even eat the cashews in the mini bar. This is why airlines, hotels, and rental car agencies discriminate in their pricing against business travelers, since they know these people are not paying their own bills. They are, by definition, less price sensitive. Businesses serving travelers would be missing an enormous opportunity if they did not charge these customers higher prices.

Category IV: When you spend someone else's money on strangers there is very little incentive to economize. Government programs are a perfect example, and are why government spending is out of control. Health-care spending has moved from Categories I and II to Categories III (private health insurance) and IV (government spending on health care, such as Medicaid and Medicare). If groceries were purchased in these categories, prices would most definitely skyrocket, and Fido would dine on top sirloin every night. There is no incentive for the spending party to make value/price tradeoffs, nor is there an incentive for the party providing the money to insure they are meeting the expectations and utility of the receiving party. At least with a corporate expense account, my employer has the satisfaction of knowing I received a direct benefit from the more expensive rental car and upgraded hotel suite, but a government employee has little incentive to follow up with a recipient of a government sinecure.

These four categories hold many lessons about how businesses price their goods and services, and we will continue to refer to them throughout the rest of the book.

Understanding exactly what customers buy — expectations — will enable your firm to exceed those expectations and thus be able to charge premium prices for your services. Understanding how customers buy helps to focus on the decision-making process of the customer, enabling you to better manage the entire customer experience. Let us now put it all together by providing a value proposition to the customer.

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