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Behavioural
Economics
What it is and how it can be
harnessed
Introducing Alice
‘Alice loves to listen to New Age music and
faithfully reads her horoscope each day. In
her spare time, she enjoys aromatherapy and
attending a local spirituality group’
Is Alice…
a) An accountant
b) A retail assistant
c) A holistic healer
Traditional economics
“Individuals, groups and organizations are assumed to act rationally, have
multiple desirable ends in sight, limited resources to obtain these ends, a
set of stable preferences, a definite overall guiding objective, and the
capability of making a choice. There exists an economic problem, subject to
study by economic science, when a decision has to be made by one or more
resource-controlling players to attain the best possible outcome under
bounded rational conditions”
Traditional economics
“Individuals, groups and organizations are assumed to act rationally, have
multiple desirable ends in sight, limited resources to obtain these ends, a
set of stable preferences, a definite overall guiding objective, and the
capability of making a choice. There exists an economic problem, subject to
study by economic science, when a decision has to be made by one or more
resource-controlling players to attain the best possible outcome under
bounded rational conditions”
The Reality
It is naive to assume that people always make
informed, rational decisions in an economic and
financial environment. Sometimes we do, sometimes
we don’t.
Traditional economics
People are not influenced by anyone or
anything else
People efficiently and effectively
acquire and process all relevant
information
People figure out and factor in future
consequences of current decisions
People always make smart decisions they
don’t regret
People always make decisions in an ideal
decision-making environment
Wealth and income maximization are all
that matter
Behavioural economics
People are influenced by their peers,
their past and by their circumstances
People are boundedly rational – they do
the best they can given the constraints
they face
People aren’t always able to figure out
the consequences of current decisions
People can and often make decisions they
end up regretting
People often face decision-making
environments that prevent them from
making the best possible choices
Wealth and income maximization are
important, but so is being fair,
maintaining a good reputation and
pleasing friends/partners
Traditional economics compared to
Behavioural economics
Heuristics and irrationality
Heuristics help explain why we make irrational decisions on a day to day
basis
They are experience-based techniques for problem solving, learning and
discovery
People often make decisions based on approximate ‘rules of thumb’ and
‘mental shortcuts’
The range of heuristics that help
describe irrationality
Behavioural Economics
in marketing practice
Some examples
Irrational value assessment
Consumers make inferences about value using cues such as price and overall
look and feel
E.g. Wine
Dominated alternatives
Options can lack appeal if consumers have no reference point for the status
quo in the same product category
Option 1
Print only - $56
Option 2
Print + online - $125
Dominated alternatives
Options can lack appeal if they have no reference point for the status quo
in the same product category
Option 1
Print only - $56
Option 2
Print + online - $125
Dominated alternatives
Decoy options can provide a reference point for consumers to make a
particular option seem more appealing
Option 1
Print only - $56
Option 2
Print + online - $125
Option 3 (decoy)
Online only - $125
Dominated alternatives
Decoy options can provide a reference point for consumers to make a
particular option seem more appealing
Option 1
Print only - $56
Option 2
Print + online - $125
Option 3 (decoy)
Online only - $125
Attribute priming
Merely emphasising a particular product attribute can make it more
desirable
Memory Processor speedvs.
Decision paralysis
Be weary of choice overload
6 jam choices 24 jam choices
The power of free
Just the sight of the word ‘free’ can release large quantities of dopamine
How, as strategists, can we harness behavioural economics to
help us achieve our goals?
So…
A process for addressing irrational
behaviour
•Understand the
consumer and the
decision making
processes
•Determine key
heuristics and
influences
Map the
context
•Ideate possible
actions
Select the
nudge •Identify possible
constraints
•Agree areas where
actions can be
implemented
Identify
the levers
•Prioritise actions
and test for
effectiveness
•Refine and
optimise
Experiment
and refine
Stage 1, understand the decision
PROPERTIES OF THE DECISION
1. Is the decision important to the individual or does it receive little attention?
2. What moments or events motivate an individual to act on the decision?
3. Is it an active or an automatic, passive choice
4. How many options are available? What is the default option if an individual decides
to do nothing?
5. What are the incentives? Which ones are most prominent, which ones are not?
6. What are the associated costs?
INFORMATION SOURCES
1. What knowledge or expertise is needed to make a decision?
2. How is information knowledge communicated to the individual? (visually, verbal, text)
3. Does the information flow sequentially? What information is presented first, last?
FEATURES OF THE INDIVIDUAL MINDSET
1. Are the benefits of making a good decision delayed or felt immediately?
2. Is the decision usually made when the individual is in an emotional state?
3. Does the decision take willpower or self-control?
ENVIRONMENTAL FACTORS
1. Is the decision made in isolation or in a social environment?
2. Is the decision influenced by what is in the media or by expert opinion?
3. Are peers a major source of information
Then map the decision making process
and identify where bottlenecks occur
Recognise the
importance of
retirement savings
Allocate money
Open retirement
account
Select investment
fund
Monitor investor returns
Re-allocate as required
In this example, often the key challenge is triggering the need among younger adults
Think about what may cause the
bottlenecks
BEHAVIOURAL INFLUENCES
Status Quo An individual’s inertia to change even if that change would
be advantageous
Endowment effect The inclination to value and pay more for an item that is
already in possession than one that has yet to be attained
Loss aversion A tendency to be more attuned to losses than gains
Conformation bias A predisposition to accept information that is confirmatory
to one’s opinions rather than contradictory
Mental accounting Money being allocated to several accounts (eg clothes,
entertainment) rather than being fluid
Will power We only have a certain amount of willpower and its needs to
be replenished periodically
Hyperbolic discounting To value benefits that are reaped now more than those reaped
in the future. Similarly costs that are paid in the future
are not felt as deeply as those paid now
Choice overload Too many choices for decision making it hard to evaluate and
decide
Information overload The presence of too much information, preventing evaluation
and a good decision
HEURISTICS
Availability bias Information that comes readily to hand is used to make a
decision rather than a comprehensive set of facts
Representativeness The use of similar attributes to judge a situation
Anchoring and
adjustment
To assess based on a comparison to a pre-determined
normative number
Social proof Where a decision is influenced by the group and the desire
to conform
A process for addressing irrational
behaviour
When choosing the best course of action, consider:
- Prioritise the actions that resolve bottlenecks that
are further up stream in the decision making process
- Reach. Self-imposed nudges such as pre-commitment may
not reach as many people as automatic enrolment. Though
it may be in their best interest, an individual may not
want to make an upfront commitment
- Automatic enrolment may not work as the default option
may not suite everyone
- The longevity of the nudge’s impact
- Wherever possible test the nudge against a control cell
to measure impact and
The four dimensions of addressing
irrational behaviour
MINDFUL MINDLESS
ENCOURAGE DISCOURAGE ENCOURAGE DISCOURAGE
ACTIVATING
A DESIRED
BEHAVIOUR
EXTERNALLY
IMPOSED
BOOSTING
SELF-
CONTROL
EXTERNALLY
IMPOSED
SELF-IMPOSED
The four dimensions of addressing
irrational behaviour
MINDFUL MINDLESS
ENCOURAGE DISCOURAGE ENCOURAGE DISCOURAGE
ACTIVATING
A DESIRED
BEHAVIOUR
EXTERNALLY
IMPOSED
Simplifying tax
rules to make
tax filing
easier
Placing signs
reminding people
not to litter
Advertising that
most people are
recycling to
increase
recycling
efforts
Including
neighbourhood
average energy
consumption on
bills to reduce
power usage
BOOSTING
SELF-
CONTROL
EXTERNALLY
IMPOSED
Simplifying
application
processes for
college grants
to encourage
higher level
education
Installing car
dashboards that
track petrol
usage
Automatic
prescription
refills to
encourage
medicine taking
Placing
unhealthy foods
in harder to
reach places
SELF-IMPOSED
Maintaining an
exercise regime
by agreeing to a
small penalty if
a gym session is
missed
Avoiding drink
driving by
ordering a
scooter driver
Joining a peer
savings group to
encourage saving
Using a water
pebble that
times your
shower then
reduces shower
length after
that and uses
traffic lights
to indicate time
left
BE in Action
Hands up who thinks to themselves it’s a cheap price just because it ends in 44. It must be cost price right? By comparing you with others it triggers a reaction that it
otherwise hard to achieve despite being all of ours goal – to be more green and save money
http://www.thefuntheory.com/speed-camera-lottery-0
Bringing it all together
- People make 10,000 decisions a day
- As strategists we might hope that the ones that
relate to what we do are rational. But they often
are not.
- But if we accept that, understand it and apply
structures thinking based on a deep understanding
of the consumer we will become much more effective
Any
questions?
