Category: Behavioral Economics

The corporate world is well-known by many as a “battleground” where firms compete for market power, higher profits and better public opinion.The search for the competitive edge has led companies to specialize and improve every aspect of their organizations, striving for differentiation in every front.As ideas start to run out and specialization reaches sky-high levels, firms are starting to realise that there is one area in particular that has both much room for improvement and the capability of providing the advantage they look for: the consumer approach.This phenomena is not only embraced by firms simply because they enjoy helping the community. Even though consumers benefit from it, these measures also allow firms to increase their profits. In fact, the consumer service has improved a lot over the years and the saying “The client is always right” has gained special attention from companies. Ever since trades started to occur, the idea of a consumer and a producer being two separate identities only linked by the currency exchanged has been rooted in our minds. However, as stated, firms are now shifting their focus towards the people who are the reason why they exist in the first place. More and more, organizations are trying to end this notion of separation and starting to approach customers with the goal of breaking barriers and gaining trust.One way to do so lies in customization. The development of the trend where buyers customize their own product according to their tastes and preferences has increasingly brought gains for firms. On the one hand, consumers become emotionally attached to the products as they feel like, by being responsible for part of the creative process, the resulting product becomes part of themselves, boosting positivity towards the merchandise and the brand. On the other hand, firms also have the opportunity to receive massive feedback about consumer taste, transforming the otherwise “passive customer” into an “active customer”, transforming the whole decision process – a win-win situation one could say.

The head of the Center for International Manufacturing at the University of Cambridge, Jagjit Singh Srai, even said that he believed most major companies would have customization operations in place within the next 5 years.

Another way to build consumer trust relies on brand development. Through jingles, logos, catch phrases and multiple initiates firms’ main goal is not only capturing a bigger audience, but also promoting brand loyalty among the regular consumers.It is with no shame that everyone can remember at least a handful of commercials or jingles from their favourite brands, even if they don’t want to. It is actually not our fault that the themes are so catchy that our brains cannot detach from them, or that we are exposed to the same commercial so many times that it sticks. It is a great investment of time and money on the behalf of firms to improve our perception of their reality.

Moreover, brand image is also boosted by campaigns related to events occurring in the world where brands decide to take a stand and defend a certain point of view in order to send a message to their customers, showing what ideals they support. As an example, multiple brands like Nike, Netflix, Ben & Jerry´s and Amazon, decided to make a stand against racism in light of the recent protests “Black Lives Matter” through financial contributions, social media posts and advertisements.

With all these measures the firm´s main goal is to be seen as much more than a company that trades a specific product or provides a service and more as an entity  linked with ways of living and thinking, wanting to sell an experience which their customers can identify themselves with and embrace. It is of great importance to feel part of a family that shares their same interests as it drives loyalty and brings security while promoting and expanding companies’ perception within the market.However, it is also very important to notice that by doing so, firms are now starting to interact more and more with social norms and less with market norms. That is, firms, by trying to reach an emotional attachment with consumers, start to fill an enlarged pool of expectations that if they are not able to fulfil, might generate disappointment among the loyal customers that saw them as more than a brand.

Picture this situation:

For years, you only buy shoes of a certain brand, either because you like the design better or simply because you really like the brand’s message. Imagine that you like it so much that you even have posters on your bedroom wall and stickers on your laptop of commercials and slogans by that specific brand. Well, it’s safe to say you have an emotional connection with this brand.

Suppose now, that you made your first order online and the product is nothing like what you expected and so you complain, calling and sending emails to the “Consumer  Help Service”. After hours waiting on the phone and a couple of sent emails, you receive no answer by the company you liked so much.

Now, you have a strong dislike towards this brand, you have been personally disappointed and it is very likely that you will not shop there again and will persuade your friends to do the same by telling them all about your experience. This feeling of betrayal would not exist if the emotional connection had never been established. Firms should have this in mind when they decide the type of image they want to send to the public.

To sum up, building an emotional connection with customers has numerous advantages and is a very prosperous way to gain market power and brand loyalty, but it is also a potentially dangerous measure that has the possibility of backfiring and having the opposite effect if the expectations are not met. This being said, emotional connections are a significant way to achieve consumer loyalty, but building an image that cannot be achieved can also greatly damage a firm’s reputation.

Sources: NY Times, The Guardian, Forbes Magazine

Scientific revision: Ana Clara Malta (Behavioral Economics Team Leader)

Have you ever regretted eating that hamburger or that pizza some days later? Probably you have, and you are not the only one. How can this possibly be explained? Well, we are humans, it all lies in the way we perceive our own self-control.

Self-control is the concept of sacrificing short-term pleasure for an important long-term benefit. All existing theories are based on this idea of conflict of preferences between the “now” self and the “future” self. The “now” will seek (and consume) a tempting good, but the “future” one would regret such consumption.

Following this idea, preferences are a key element to have present. It is crucial to understand the reflection of individual taste as it explains one’s choice of consumption. Therefore, to address this opposing conflict we have to explore various properties of preferences and relate them with time.

Firstly, it must be recognized that the conflict between the present and the future implies that preferences actually change over time. This is what behavioural economists and scientists like to call time-inconsistent preferences.  Similarly, preferences are usually ranked, meaning that one is more important than the other. So, as the importance of immediate gratification fades quickly as time passes, long-term preferences end up being superior to the short-term ones, forming a hierarchy which consequently characterizes all forms of self-control conflicts. Considering the previously mentioned characteristics, talking about anticipated regret seems pretty logical. Smoking a cigarette provides pleasure to the smoker, but brings with it a sore throat immediately after smoking and potentially cancer in the long term. Knowing this, the smoker who anticipates that he may regret giving into the temptation of smoking a cigarette is experiencing a self-control conflict.

Where does this bring us? Around 96% of the papers that explore the concept of self-control and present it use this idea that self-control lies where there is a given sacrifice of pleasure. More recently this idea is being presented as flawed mainly because of its assumptions. On one hand, it assumes that all consumers trade-off short-term goals with long-term ones and that the absence of a self-control conflict would inevitably result in the choice of the long-term goal (while the short-term goal always represents a breakdown in self-control).

Nevertheless, many elements may change since not all consumers pursue the same superordinate long-term goals. Consider the choice between pizza and grilled chicken salad. A consumer may choose the former but not necessarily experience a self-control failure because he/she does not care about restraining her calorie intake, or because she is a vegetarian, or because she likes pizza more than salad. (Actually, even though American consumers, in general, believe the better a food tastes the less healthy it is, in a recent cross-national survey conducted in the US, UK, France and Belgium, consumers associated ‘unhealthy’ only weakly with ‘tasty’).

Why is this relevant? This is a powerful insight into consumer behaviour that is even relevant in policymaking. A good example of this is the food industry. Behavioural economists cannot substitute nutritionists but they can find a way to help consumers align their goals and actual behaviour with objective criteria. Consumer behaviour researchers can devise interventions that motivate consumers to consider the long-term consequences of their actions. Based on this “theorizing”, it should also be easier to exert self-control when abandoning the idea that pleasurable and beneficial consumption (hedonic consumption) represents a self-control failure. Rather than categorizing foods into good and bad, consumers could train themselves to use relative quantities as a benchmark for harmful consumption. Rationing portion sizes and consumption frequency are indeed powerful strategies to limit food-intake since how much we eat is as much governed by a food’s tastiness as by serving size.

Beyond food and bad habits, self-control is present in our day to day and regret is inherent to human nature. The more we sacrifice short-term pleasure for an important long-term benefit, the more we become aware and the less probable we are to be disappointed over something that we did or failed to do. Regardless, not everything in life is to be regretted and some things are meant to be done today.

In this era of social networks, communication has reached new levels of virality. The Network of Networks – the Internet – has facilitated the creation of a new status quo: from governments and businesses to common citizens, each piece of information inserted and shared in the Web has the potential (given some very small probability factors) to become viral. If that happens, it cannot be stopped. No matter how far you are from the formal location where the original information fluctuates you will know about it. And it only needs a fraction of seconds.

How should people be in such an environment?  At the current speed at which media spread, even words have tremendous impact when misused. Likewise, silences also have a tragic impact when speech is needed. There is a need to be fast and ready to process information. In the case of politicians, words mean actions, words mean decisions, and these decisions impact much more than themselves: they affect millions of lives.

One lesson that Behavioral Science has taught well is how it is human nature to systematically make mistakes in evaluating circumstances. This comes with no shame: our ancestors needed to make decisions quite fast, and that led us to develop mechanisms to quickly judge whether a shadow was one of a rock or say, a lion. This is no different at this time, as we are still required to make these fast decisions. Politicians, corporate top management, governmental bodies’ leaders, some people’s job is to make decisions better than others for others. Yet, very often is forgotten how even our leaders are human. As so, they are equally prone to the same heuristics of anybody else. Yes, they may be more aware, and yes, they are skilled decision makers (usually), but emergency situations require quick reactions.

Our brain is programmed to follow a more rational, logic system (lets call it system 2) when decisions are complicated and require abstraction. However, most is processed by a quick, instinctive mechanism (that we call system 1). The latter, is the one responsible for both convenient intellectual shortcuts as well as for all of our biases and heuristics.

Availability is the name for the heuristics that describes how we evaluate situations based on examples that come up to our mind. This is among the main reasons why people are more scared about a plane crash when the news has reported one unlucky case, ignoring how many flights are done daily, yearly, with virtually no accident.

For the same reason, when something has never happened (or, to better put it, has never happened while we were conscious and alive…), we fail to capture the potential consequences of that event dramatically. We human beings are simply very bad at evaluating probabilities. Again, this is true even for the most capable, skilled leaders! (see our article on Nudging for more insights)

The work of behavioral economists has helped highlight this condition. Starting from the first inception with the research of psychologists and Nobel prize recipient Daniel Kahneman and his fellow Amos Tversky, the more recent work of economists such as Richard Thaler and Dan Ariely (author of the acclaimed Nudge and Misbehaving, among others), helped spreading awareness about the potential benefits of the behavioral science among various high ranks. President Obama himself has been a perpetrator of the nudging theories in his second mandate; yet, it is a case rather than the norm.

Availability heuristics, Groupthink (the tendency of believing something just because others believe it), Inertia and many other cognitive and emotional biases, help us explain why governments failed to evaluate the Covid-19 threat on a systematic, large scale. Why did this happen, despite early warnings and examples by the first victims, from China to South Korea? No simple answer is the right answer: many actors from different contexts with different interests likely lead to an environment where cooperation and mission alignment is tough to achieve. But one thing we can be sure: we are all humans, and as such, as scientific research has demonstrated, we are all prone to biased decision making. Through this, perhaps we could find a common denominator, a common ground for global discussion, from individual to country level.

The current situation shows how the role of behavioral science is still unclear. As an example, the UK has indeed a behavioral insights team operating. In the last days, the debate is around the decision of prime minister Boris Johnson not to enforce quarantine measures but rather “nudge around” the situation. Is it the right choice? Is it the right time to act like this? Is behavioral science going to be blamed in case the decision doesn’t have the hoped results? Still, the ultimate decision power doesn’t lie in behavioral units, but in politicians. Takes unbiased foresight for a leader to understand when a threat has to be taken seriously despite no direct consequence can be observed in his/her community. In this case, we should keep in mind that it is the prime minister’s decision on when to take action and who to ask for collaboration from.

Should perhaps behavioral science be first a way to improve decisions at a widespread individual level, before becoming a toy at disposal of biased leaders? Behavioral units are still scarce, with a bunch of countries actively using them. We shall see how events unfold…

Take this little quiz to test which system you’re naturally relying on to read a piece:

1-A bat and a ball cost 1.10€ in total. The bat costs 1.00€ more than the ball. How much does the ball cost? … cents

2-If it takes 5 machines 5 minutes to make 5 widgets, how long would it take 100 machines to make 100 widgets? …Minutes

3-In a lake, there is a patch of lily pads. Every day, the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long would it take for the patch to cover half of the lake? …days

To check your answers go to our instagram/web page. Did you get them? Maybe just some? If you’re interested in exploring more of the research behind “clever formulations” and its applications, consider the read of “Nudge”, by Richard Thaler and Cass Sunstein.

Sources: The Guardian, Politico, Apolitical, The conversation, Behavioural Economics.com, Springer

QUIZZ SOLUTIONS:
1- (5 cents)
2-(5 minutes)
3-(47 days)

Nudging has been the start point of many economic studies, in particular in the area of behavioral economics as it explores the way people´s decisions could significantly change in a predictable way by modifying the context of such decisions in a very subtle form. The concept was first introduced by the Nobel Prize winner Richard Thaler and Professor Cass Sunstein. Thaler, however, stressed the point that nudging should be used for good, with the goal of improving society’s welfare, but has his wish become a reality?

It all started at Amsterdam’s Schiphol Airport where Thaler´s discoveries were first explored by a simple experience aiming to solve a very real problem: the cleaning manager intended to reduce the “spillage” around urinals in order to reduce the cleaning expenses on the airports´ bathrooms.

Where does Thaler´s nudging theory come into play? Well, to the surprise of many the solution suggested was to “paint” a small fly near the drains of the urinals. Many may (and did) find it ridiculous and childish but actually it was a very credible and simple solution following the reasoning of human (particularly, men’s) behaviour. The goal was to “guide” men in to reducing spillage (without even noticing) and the results were an impressive 80% reduction in spillage and a consequent 8% reduction in cleaning costs. The raw truth is that men can’t help themselves and start aiming at the fly.

This is one of the most famous examples of the nudge theory, as it respects the most important principles that guide its use. Firstly, all nudging should be transparent and never intended to mislead (a common prevented practice – just like with publicity & advertisements since it can in fact be used to manipulate human behaviour). Secondly, it should be really easy to opt-out of the nudge (it is not mandatory for anyone). And thirdly, the behaviour encouraged should aim at improving the welfare of those being nudged (once more, no harm is intended).

Not only relevant for small problems, but also in various other areas, this theory has impacted and been adopted by governments all over the world. Over the last decade, many countries have seen and tested the effects of nudging – aiming at lower costs and better exploitation of long-lasting benefits – and the results have been astonishing. Whether the goal is to promote a healthier lifestyle by displaying healthy food at eye level in supermarkets – the impact of ordering and context framing – or increasing the savings rate of the population by automatically enrolling people in a savings plan, the results have been mostly  positive.

Another example that illustrates the impact of a nudge lies in organ donations: In countries where enrollment is necessary for those who want to donate organs after dying, the percentage of people that go through with the process is very low. On the other hand, in countries where organ donation is an opt-out option (that is, people are automatically enrolled), the acceptance rates are extremely high.

This enormous difference can be explained by what is called the default effect. Socially speaking, people tend to be change averse and avoid anything that poses extra effort and so accept the proposed default option even though they have the ability to reject it at any time.

This being said, one can probably anticipate that Thaler´s wish to use nudge for good, isn’t entirely respected as private entities are also trying to explore human psychology and use the nudge effect for profit purposes, appealing consumers to either buy or to use their products more often.

Think about these two cases in particular, Spotify and Netflix. If you don’t have a premium subscription in Spotify you may be tired of listening to something like “Don’t have premium? Try now a 1-month free trial!”. As you may know, this very tempting offer requires the allured clients to give their credit card information to be saved for the period after the free trial. Surely, after the free month, the consumer is given the choice to give up the premium account and not pay anything, but the statistics prove that many stay immersed in the inertia of the default effect and simply don’t have the energy to quit, leading them to a monthly payment that they wouldn’t otherwise have if Spotify hadn’t given the nudge. In the Netflix case, their nudge is even more camouflaged. By simply having an automatic count down to the next episode, they encourage people to go for the path of least resistance and keep watching.

It is important to highlight that in both cases, consumers weren’t forced to do anything, they were simply guided towards an option. Notwithstanding, this suggested (consumerist) human behaviour falls a bit short on doing good and has been a matter of concern to the authors of the theory.

Whether we notice it, or not, nudging is present in many of our daily lives and its influence can lead us to make choices that we wouldn’t otherwise. One could consider nudging anything like a simple buzz from a phone, a “ding” from a microwave or even a jingle played by the washing machine, warning and leading us to its use. The effects, however, go way beyond mere sounds and as people start realising that they could be being manipulated without even noticing, they start to distrust even the things that lead them to better choices, harming, this way, the true purpose of the theory. Regardless, it will continue to be part of our lives and it is our role as citizens to be aware of its potential but also of its limitations, so that we can make the most of such a powerful tool.

Sources:

• Financial Times

• NY Times

• Washington Post

• Book “Nudge” by Richard Thaler and Cass Sunstein

Scientific Revision: Ana Clara Malta, Behavioral Economics Team Leader

Imagine you were a manager and wanted to improve the performance of your team. What would you do? Let me guess, you would try to minimize the principle-agent problem by aligning the interests of the workers with the ones of the corporation, in a way which fitted all employees. You would take a look around, study the most commonly used sources of extrinsic motivation and finally come with the answer “money”. Why not? Who doesn’t like seeing its salary being increased and wouldn´t work harder for it? Higher salary, more effort, better performance, more profit. Pretty straight forward, right? Wrong!

Motivation is the reason for people’s actions, willingness and goals. It’s the “power” which allows us to wake up in the morning and perform difficult tasks, such as studying or going to work. There are two main types of motivation: intrinsic and extrinsic. Intrinsic motivation is the motivation which comes from “inside”, i.e., we perform a task because we enjoy it or find it interesting. Extrinsic motivation is the motivation which comes from the “outside”, i.e., when you do something for external rewards or to avoid negative consequences. Both intrinsic and extrinsic motivators can be either positive or negative. All intrinsic and extrinsic motivators, positive and negative, have its weaknesses and strengths. Intrinsic motivators differ from person to person, which makes it really difficult to apply them in large teams. However, they are much more long-lasting. Extrinsic motivators are easier to generalize. However, they may be only effective in the short-run or they may worsen the environment inside a team (in the case of negative motivators, such as threats to be fired or demoted).

Money is generally seen as a powerful extrinsic positive motivator, as it can be successfully used for motivating almost everyone. At least that’s what people believe and behave accordingly. However, they couldn’t be more wrong.

The MIT (Massachusetts Institute of Technology) conducted a study in which some of their students had to perform different tasks and received one of three levels of monetary rewards (few money, some money or a lot of money).

The students who received mechanical tasks increased their performance as the monetary rewards increased, i.e., the students who received higher rewards did a better job. However, if the challenge called for rudimentary cognitive skills, larger rewards conducted to poorer performance. In order to eliminate possible wealth variables, the researchers repeated the study in Madurai, rural India, where the purchasing power is way bellow the United States’ . Again, the study showed that, when the challenge involved cognitive skills, higher rewards led to worse performance.

This way, they concluded that the “carrots and sticks” approach (giving punishments and rewards) only works when the tasks that the employees perform are purely mechanical.

“So, the amount of money employees receive is not important?”, you may ask. Of course it is. However, it’s not the most important. If, as a manager, you don’t pay people enough for their effort, they won’t be motivated. However, if you incentivise them with monetary rewards, they may worsen their performance. This way, you should pay them enough to take the issue of money off the table, letting them focus on the work, rather than on receiving their salary.

And the question stands. What is the best way to motivate employees?

According to some scientific studies, there are three factors which lead to better performance and personal satisfaction: autonomy (the desire to be self directed), mastery (the urge to get better at performing a job) and purpose (the aim to do what we do in service of something higher than ourselves). Actually, if we look into some industry benchmarks, such as Google or Atlassian (an Australian software company) we see that these factors are taken into consideration in their management. In Google, engineers can use 20% of their working time to develop their own projects and, on a typical year, about half of the company’s new products are born during that 20% time. In Atlassian, a few times a year, employees have 24 hours to think of some new ideas and present it at a relaxed party at the end of the day. It comes that a whole array of software fixes was created during that period and may never had been created otherwise.

If we think of Wikipedia, for instance, it has a business model that economically makes no sense: it was created by employed and greatly specialised people completely FOR FREE and anyone can use it without paying. Why did the engineers provide it freely instead of profiting with their creation? On one hand, it is the desire for mastery, to overcome obstacles and create something never seen before. On the other hand, the purpose behind the platform and the free access to knowledge and information.

As a summary, people only perform difficult tasks because they are motivated to do so and, as a manager, it is vital that we keep our employees highly motivated. However, it is really difficult to find an effective motivator which fits all workers.

Money is still seen by a lot of corporations as an effective mechanism to motivate people but science proves otherwise. It may be good to incentivise mechanical tasks but, if the work involves some cognitive skills, higher monetary rewards leads to worse performance and destroys creativity. This way, managers should get rid of this extrinsic motivator, based in the “carrot and stick” approach, and replace it by the intrinsic motivator of autonomy, mastery and purpose. Besides being much long-lasting, this type of motivators engage workers and make them much more satisfied with their job, as they are contributing to a better world.