Behavioral Economics

Your customers don't think the way you think they think

They don't even think the way they think they think.

Do you remember Spring 2020, when the first lockdown for Covid-19 was imminent, and we were all surprised that to survive the pandemic and the lockdown, the thing people seem to cannot do without the most was... toilet paper. We were maybe laughing at videos and memes that circulated the internet, but raise your hand if you did feel a little bit nervous, thinking you maybe should have stockpiled some, too, when you saw the empty shelves in the toilet paper aisle of your supermarket.

In the Micro Economics class of my MBA, I was taught to look at everything through the eyes of the resourceful, evaluating, maximizing individual (short: REMI). This model allowed to make assumptions where you could change one or two factors and explain how that would influence consumer behavior or willingness to pay. Looking at the example in the lead or how investors sometimes behave at the stock market, a consumers behavior is difficult to explain with the above charateristics. Behavioral Economics is relatively new field and combines psychology, judgement, decision making and economics to create a more adaptive and true understanding of human behavior.

«Nothing defines humans better than their willingness to do irrational things in the pursuit of phenomenally unlikely payoffs»

Scott Adams, American cartoonist

Think fast...

You’re buying a new stylish pen. You’re visiting an office supplies store in town, where they offer the pen for 49 Swissfrancs. The shop assistant takes you to the side and tells you, that their chain is opening a second store, 15 minutes away, where they offer the exact same pen at 29 Swissfrancs this weekend. Will you make the trip?

Now, what if you’re buying a new business suit? It’s sold for 1’499 Swissfrancs at your regular store. The shop assistant (not the same one as above, of course) takes you to the side and tells you, that their chain is opening a second store, 15 minutes away, where they offer the exact same suit at 1’479 Swissfrancs this weekend. Will you make the trip?

Economically, the time value of money for both decisions is the same. But if the initial price is our anchor, the 20 Swissfrancs that we can safe by investing 15 minutes looks very different in relative terms.

Rational decision making is a myth

As stated above, traditional micro economics assumes that a consumer makes decisions based on all the available information, trying to maximize personal benefits, independent from everyone else and that this behavior is more or less stable.

In reality, especially the more complex a product becomes, it is very difficult for a consumer to calculate all the costs and benefits correctly. We are influenced by our social networks that influence our independent choices by decisions other people make (e.g. toilet paper). Emotion overtakes logic for immediate satisfaction. Also altruism, making decisions for the benefit of someone else instead of oneself can have an impact on decision making.

Richard Thaler, an economist, Nobel laureate and University of Rochester Graduate, is one of the fathers of modern Behavioral Economics. I am especially interested in his theory of the "Nudge". The theory suggests that there are many opportunities to nudge people's behavior by making subtle changes to the context in which they make decisions.

As with everything, you can use nudges for good and for bad. Good nudges are good, when they benefit both parties involved in the transaction.

Jobs to be done

One of the mega trends of the last decade is "Big Data". With all the information we have, and the possibility to use algorithms to structure even previously unstructured data, we can learn so much more about our customers.

Does this data tell us the entire story? Does the data of the past really allow us to extrapolate the future of customer needs? The data does not tell us for example that the customer picked a specific product, because there was no alternative at the time, or the alternative was too expensive. Data only tells us what was. Of course, there are companies like Palantir, that are very good in recognizing patterns and predicting, where these pattern might lead next. But in the end, it is extrapolation of what was in the past.

If you are looking to grow through innovation, Jobs Theory explains why customers "hire" products and services into their lives to do a job and why some innovations are successful and others are not. Fully understanding a customer's job requires understanding the progress a customer is looking for in specific circumstances and understanding all of its functional, social and emotional dimension - as well as the tradeoffs the customer is willing to make

I recommend the book "Competing Against Luck" for more theory and examples.

Saving in Kenya

Dan Ariely and his colleagues conducted a large-scale experiment with thousands of customers of a mobile money-saving system in Kenya.

In different cohorts of participants, different methods of 'nudging' were tested. From simple reminder messages to personalised ones, that impersonated the participants kids. Other cohorts with different bonus payments if savings targets were reached. Bonus payments with 'loss aversion', by putting the bonus visibly on the account, with the threat that it would taken away again proportionally, if the weekly savings target was not reached. The last cohort of participants received the same text messages plus a coin with the numbers 1–24 engraved on it, for the 24 weeks that the plan lasted. They were asked to place the coin visible in their home and mark the number for each week to indicate if they saved or not. At the end of the experiment, the measure that had performed best was: The coin.

Taken from Ariely, Dan; Kreisler, Jeff. Dollars and Sense (p. 242). Harper. Kindle Edition

The story reminded me of the "coupon" life insurance contracts that were common in Switzerland in the 1950s, 1960s and 1970s, where an insurance inspector would visit you weekly (or monthly) - no electronic messaging services yet - to collect the premium and clip a coupon off your policy, creating a visible proof of your savings efforts.

Books I Have recently read on Behavioral economics and Psychology

Also checkout these authors and YouTube. There are many talks on the content of their research in different lengths.

If this topic moves you as well, then don't hesitate to contact me to find out, how we can learn and make progress together.