About 10 to 15 years ago “everyone” was talking about Behavioral Economics. (Obviously by “everyone” I mean a select few people in marketing and business circles, but it was a big thing).
Dan Ariely published “Predictably Irrational” in 2008, which was the first book I read on the subject, in the same year as Martin Lindstrom published “Buy-ology”. These books referenced the founder of Behavioural Economics, Nobel-Prize-Winner, Daniel Kahneman, who published “Thinking Fast and Slow” in 2011. Daniel Kahneman was even the subject of a book by Michael Lewis, the author of “Moneyball” and “The Big Short” published in 2017.
I mentioned Behavioural Economics in a team meeting recently and, although it is something that influences my decision making to a great degree, I was met with blank (Zoom) faces, so I thought it would be good to write something about it.
What is Behavioural Economics?
The best starting point to answer this question is to look at traditional economics. In traditional economics, economists work on the basis that everyone is rational and makes predictable decisions based on the data that they are presented with. Economics is based on people behaving like robots. The problem with this is that it is not how people actually behave. People are not rational, but they are, as the title of Dan Ariely’s book suggests, “Predictably Irrational”.
The study of Behavioural Economics involves setting up experiments, using real-life people (who tend to be US college undergrads) to see how they behave in specific situations and identifying the trends in their behaviour, which are referred to as “heuristics”.
What are some examples of studies?
There are a lot of examples to choose from, but these are the ones that I often refer to in conversations with people. Apologies in advance if they are not 100% accurate and are not referenced properly, but I don’t see my job here as being a perfect academic or journalist, these are simply things I have remembered that I think may help other people.
The Music Player:
This is probably the example that I use most. A key theme of Behavioural Economics is that you don’t trust what people tell you that they will do, you trust what you can see or measure people doing. This is one of the reasons that I don’t value traditional market research (surveys, interviews, focus groups etc) very highly. People tell you what they think you want to hear, or what they think makes them look smart. That doesn’t help you make the right decisions. A great example to prove this was an experiment where the experimenters got a load of people in to do traditional market research, in the form of in-person interviews and focus groups about a music player. I think it was a Microsoft Zune, but I am not 100% sure (I can’t find the reference, but the story is still valid).
The market research was a ruse. Each participant in the research was offered $50 for their time. The majority of the people interviewed loved the product and said that they would consider buying it. They said lots of positive things about the products. However, the real goal of the study was the final question. The participants were told the value of the product, over $100 and asked if they’d like one instead of their $50 fee. The majority of people, I think it may even have been 100%, refused the offer. They refused something that they said that they wanted, with a value of over $100 and instead took $50. This wouldn’t make sense in traditional economics, or any rational, logical view, but it is how people act in real life. The lesson is to trust what people do, not what they say.
(NB. This does not mean that you shouldn’t do any market research. You should just avoid market research based on what people say, not what they do. There are a lot of far better ways to do market research than the traditional options, but even better than that you are best to just launch a product (potentially an MVP) and see what happens. Done properly this can be cheaper than market research. And don’t worry about the product failing. People worry too much about failure. No one remembers Apple’s attempt at launching a games console, and that failure doesn’t seem to have hurt them!
The IKEA effect:
The Ikea Effect has it’s own Wikipedia page and Harward Business School paper. The premise is extremely simple, that people value something more that they have had a hand in creating. The experiments showed that people were willing to pay an additional 63% for their own poorly built Ikea furniture Vs pre-assembled furniture. This makes no sense if we look at the world solely rationally, but makes perfect sense if we look at it emotionally. There is a similar example (that I can’t find a reference to) of a pancake mix where you added water to the mix and whose sales weren’t good, who changed the recipe and got customers to add an egg. Suddenly the sales increased because customers felt more involved in the product. They felt that they were “cooking” now they were adding an egg as well as water, not water alone.
This example is mentioned in Dan Ariely’s Ted talk, and somewhat ironically covered by The Economist themselves in their article ‘The importance of irrelevant alternatives’. On the Economist’s website they offered a digital subscription for $59, a print subscription for $125 and a combined print and digital subscription for $125. You would think it made no sense to offer the print only. No one would ever go for it when you could get both print and digital for the same price. And that was almost right, when Dan ran an experiment, 84% opted for the combined deal, 16% for the digital, none for print only. He then re-ran the experiment taking out the option that no one chose. This time around only 32% went for the $125 print and digital option and 68% went $59 for the digital option. This would translate into far lower income for The Economist. The “useless” alternative, actually had a very good use, it made the $125 print and digital option look like a far better deal.
The Jam experiment by Sheena Iyengar and Mark Lepper is one of the most famous examples of “The Paradox of Choice”, a subject also covered by Barry Schwartz’s Ted talk. In the experiment, Sheena and Mark went to a local food market and displayed either 6 or 24 jams. We would think that they would make more sales on the days they had more products, this is what classical economics tells us. Choice is good. Customers want choice. However the experiment showed that even though the bigger choice led to more interest in the jams, it did not lead to more sales. When only 6 jams were displayed, customers were almost 10x more likely to make a purchase.
This isn’t a study, more of a commentary, from Rory Sutherland’s great book ‘Alchemy’. He points out that when Red Bull launched Coke was the dominant canned soft drink. To compete with Coke traditionally you would think you needed a better tasting/ cheaper/ better value product. Red Bull came out with a worse tasting (verified by taste tests at the time), more expensive product in a smaller can. Very few people that tried it liked it, no one wanted to invest in it. Red Bull now sold 7.9bn cans in 2020. A very clear example that you should value what people do, not what people say that they will do.