Behavioral Economics – How Your Customers Make Decisions
Understanding and Leveraging Customer Decision-Making.
The relationship between man and business is complex. In the business world, rational decision-making and compelling argumentation are valued and the goal is to make numbers bigger and bigger. But there is more to human beings than the rational side. How can companies and brands benefit from consumer irrationality?
Some people smoke themselves into the grave, despite knowing better and having been warned. Big projects regularly fail despite having optimal resources. Populations choose leaders who bring chaos and destruction to the world. People should really know better. The good news is that even irrational behavior operates according to a certain system. And that is something brands and companies can make use of.
Behavioral Economics is a discipline which for some years now has been seen as holding great potential. The leading figures in the field include Daniel Kahneman and Richard Thaler, both recipients of a Nobel prize in recent years for their work, which has been more than enthusiastically received.
The two have developed models based on psychological insights which render human irrationality predictable. Man makes mistakes, and that’s good news for corporate number crunchers working in top management and R&D because he (she) makes them systematically!
Thinking, Fast and Slow
In his bestselling book Thinking, Fast and Slow, Daniel Kahneman outlines a theory that our way of thinking in comprised of two fundamentally different systems:
System 1 is fast, unconscious and automatic. It requires virtually no effort, and is often triggered by emotional reflex. For example, System 1 knows what 2 + 2 is. It can recognize anger in a person’s voice. It makes us grimace when we see something disgusting.
System 2 performs conscious thinking in which one’s full attention is required and multi-tasking is impossible. In contrast to System 1, it is strenuous to use, controlled, slow and deliberate. System 2 is deployed when we try to calculate 14 × 21, when we regulate our behavior in social situations and when are filling out our tax return. It’s what we generally call our ‘conscious’, ‘rational’ thinking.
Why considering things is not always practical
One complicating factor in this scheme is that the two systems are often mutually influencing. Interestingly, System 1 generally has the upper hand, because our bodies try to save energy by employing the automatic System 1 whenever possible. This sensible approach usually works out quite well. We would not have come far as a species if we first had to make a PowerPoint presentation of the options at hand when faced with a saber-toothed tiger. You might think the world would be a better place if we weighed every word, but it’s just not practical.
Most of our thoughts flow automatically, and our actions are in fact often ‘justified’ by our conscious System 2 after the fact. A classic example is making a spontaneous, compulsive purchase that we later rationalize. How many SUV drivers are there, for example, who go around explaining to their friends how safe, useful and simply indispensable their vehicle is. Rarely are status, luxury or psychological compensation cited in such conversations.
Nudging the buyer
What are the implications for brands and marketeers? Put simply, people can be ‘nudged’ into making certain decisions and engaging in certain behaviors that are in the interest of specific parties.
There are three well-known marketing tactics based on behavioral economics that have found their culmination in the age of e-commerce: urgency, scarcity and free samples/trial periods. These kinds of offers emphasize potential losses rather than potential gains, exploiting people’s innate risk aversion, the risk in this case being the possibility of missing out on something (aka ‘loss aversion’). Amazon, for example, displays a countdown clock (“ends in x minutes”) on Prime Day, and other online retailers call attention to product availability (“only x left”). These moves trigger loss aversion among customers by setting a time frame for action in a way that makes the consequences of inaction more motivating than if the benefits were simply communicated. The customer can also be nudged to buy by offering a free trial period, a frequent practice employed by Spotify, Netflix and Sky. What starts with a way to avoid missing out turns prospects into future buyers. This has to do with the endowment effect—a behavioral economics concept according to which people tend to value things more simply by virtue of owning them. Once you own a service (which you may have used a lot in anticipation of the trial period running out), you are more likely to not want to go without it.
The decoy tactic
Another example of behavioral economics theory in practical use in marketing is the British weekly magazine The Economist. Potential subscribers originally were given two options (‘online only’ for $56 and ‘online and print’ for $125). The broad majority were taking for the first option so the publisher introduced a ‘decoy’ option (Bateman, Munro, & Poe, 2008): ‘print only’ for $125. All of a sudden the $125 ‘online and print’ option looked more attractive, as customers now thought they were getting the online version for free. Introducing a similar but less attractive third option enhanced the proposition for the formerly less popular option. This works because consumers have an incredibly faulty understanding of the actual worth of goods and services, and thus often make choices based on what is offered rather than strictly on their own preferences.
Behavioral economics: The occasional suspension of reason
The examples discussed above show how behavioral economics insights can be used to nudge consumers in a particular direction. But behavioral economics is not magic, obviously, for despite all the heuristics and cognitive bias talked about in the discipline, it must not be forgotten that we sometimes do act and decide rationally, so human behavior and decision-making are extremely complex. It is thus unlikely that a single little nudge is all it takes to get the desired result. The growing interest in behavioral economics however is due to an increasing fascination with mankind being revealed to be less rational at times than we would like to admit. And possibly in part because it injects jazzy pop psychology into the dismal science of economics.
If you haven’t get enough of the subject yet, here are two classic books by Nobel Prize-winning behavioral economists:
Nudge: Improving Decisions About Health, Wealth, and Happiness (2009)
by Richard H. Thaler and Cass R. Sunstein
Citing numerous examples, the work presents the idea of ‘Libertarian Paternalism’—how it not only possible but also legitimate for private and public institutions to affect behavior through psychology in the interest of better decision-making. A noble ideal, but the book and author are not uncontroversial because the line between well-intentioned nudging and manipulation is such a fine one. Some of the case studies like the one on retirement planning are a bit dry, but overall it’s an interesting read.
Thinking, Fast And Slow (2012)
by Daniel Kahneman
This book has been an international bestseller for years, and for good reason. It’s title succinctly and cleverly characterizes a simple yet important insight of the psychologist Kahneman into the mind of man. While not always light reading, readers will get enriching insights into their own minds—and the work even concludes with a description of how to die happy.
Sina was an Innovation Strategist at STURM and DRANG. Her interdisciplinary academic background, drawing on perspectives from computer science and psychology, is the source of her broad competency in new media and man-machine interaction. She approaches problems in a structured, analytical fashion blended with intuition and creativity.