Monday, 26 October 2009

The future of creative thinking

Sharing a summary of implications of behavioural economics for marketing and us agencies. Most of the specific examples are borrowed from the books listed at end of doc. The rest i hope is orginal. And thanks to Rory and the IPA for encouraging me to to dust off the old economic text books and take a second look at them.


Behavioural Economics

- A marketing perspective -


What is it?

Traditional economic models and assumptions don’t explain why people or consumers do what they do. Behavioural Economics has evolved to help us better understand how economic and consumer decisions are made. And increasingly behavioural economics is being used to explain anything and everything from why people don’t put enough money into their pensions to why it is difficult to get taxis on rainy days (and it is not because they are busy!)*

Behavioural economics is the study of why consumers and economic agents do what they do, especially when what they do is seemingly less than rational.


What is wrong with traditional economic thinking?

Traditional economics is normative in approach. It is rational and deductive, in other words you have to be very good at higher level maths, and a PHD helps.

It utilises two key assumptions.

- Perfect information or knowledge. All possible outcomes and corresponding rewards of an action are known in advance

- Every agent looks to maximise their ‘utility’ or profits at all times over the long term time horizon. I.e. they are rational.

If you adopt these assumptions then it follows, for one, that all stock markets would be efficient, they would assimilate information immediately and there would be no bubbles or ‘sentiment’. [this is a vast over-simplification but don’t worry about it]

Behavioural economics is different to traditional economics, it is built on observation. And observation shows we behave very irrationally. We display brand preference and establish purchasing habits. We spend today and save tomorrow. We smoke. And buying a Porsche is hardly a rational decision.


Why all the excitement now?

We have seen a vast increase in the availability of information, near perfect. Technology has provided us with tools to make more rational choices and as marketers we can increasingly measure what we do and observe behavioural clues (increasingly on line) – but still consumers behave in what we could refer to as irrational ways.

* See last page


Behavioural economics is intuitive

No one believes for a second that we make purely rational choices all the time or reappraise our purchase, health and educational choices on a regular basis ‘in order to maximise our utility’, but the assumption has always been that everything would even itself out over time across the population.

But we see people buying the same detergent their mother always bought. We do follow other people across the road without looking. We do consistently refuse to put enough into our pension. We have unsafe sex, none of this is rational but it makes sense. We do things with our right side of the brain. So clearly we can be rational, habitual as well as intuitive.

What makes behavioural economics doubley fascinating for us is that it is interested in how we can change this behaviour with what Thaler and Sunsten call ‘Nudges’.

Here are a couple of examples (from controlled experiments, not real life). They are taken from Nudge and Predictably Irrational.

Rome or Paris

Say a travel agent offers a weekend break to Paris or Rome; the Rome trip comes with breakfast inclusive. A certain proportion will select Rome, the rest Paris. However if you offer Paris, Rome without breakfast and Rome with breakfast no one selects Rome without breakfast, no surprises there; but there is a significant increase in those who now opt for the Rome with breakfast option over Paris. The Rome with breakfast option has become more interesting by virtue of the existence of a choice no one chooses, namely Rome without breakfast. Everything as they say is relative.

Population of Burundi

If you ask an (uninformed) group how many people live in Burundi they will come up with a figure. The average guess may or may not be close to the actual number. However if you ask them to estimate the population to the nearest Million and tell them that another group estimated 3 Million you will get a very different response. Try it.

And a real example:

Teenage pregnancies

Teenage mothers were given a $1 for every day they did not become pregnant with a second child. The birth rate dropped significantly even though the state benefits would outweigh the relatively insignificant $1 per day contribution. This is what they call a nudge, think of it as an incidental stimulus that modifies behaviour.


The language of behavioural economics

Behavioural economics has its own terminology. Here are the more commonly used.

Choice architecture: The way we present options determines your choice. Kids sweets at the check out or make up at the front of the store are examples.

Loss aversion: this reflects our tendency to prefer avoiding losses to acquiring gains. Experiments have revealed we are infinitely more annoyed about losing £10 as we are gaining £10. This has implications for how we present price rises, direct debit charges and incentives.

Status Quo bias: people will only change a habit or established behaviour if the incentive is significant.

Gambler’s fallacy: the balls have no memory! In other words just because it has not come up red for the last three spins it does not mean the next spin of the wheel is any more or less likely to come up red.

Self serving bias: Simply put I deserved my promotion, he was lucky. We look through the world through our very own goggles.

Money illusion: Economists refer to sticky downward pricing. People won’t sell their house at a nominal loss even if every other house is going down in value; we prefer to wait for our house to go up in nominal terms even if inflation has reduced the real value of the house.

Anchoring: The Burundi example is a classic illustration of this. Our responses often over rely on one piece of information.

Inequity aversion: Cut off his nose to spite his face if he thinks you are getting more than your fair share!

Herd behaviour: Individuals act in a group without thinking, believing that not everyone can be that wrong.

Calender effect: The classic one being the New Year resolution. Days and events in the calendar change our behaviour. Are you nicer at Christmas?

Hyperbolic discounting: Within reason – people state a preference for money now over a little bit more in a month’s time. However if they are given the same offer but it is delayed for 12 months they are happy to wait the extra month for the extra amount. So why the change in preference? This explains our attitudes to pensions.

Paradox of choice: Give me a choice of two or three things and I can hopefully decide what I want. Give me 27 (insurance services) and I am lost. This partly explains the existence of middle men and aggregators.


The good news

Most of us are regularly doing or have ‘done’ some behavioural economics within our roles as marketers. In many ways it is what we have done intuitively, behavioural economics is applied marketing.

  • Prize draws and incentives. Don’t miss out (rather than make sure you get).

  • Holiday companies. Book early to avoid disappointment. .

  • Application forms. Just tick this box and we will do the rest.

  • Loyalty programs utilising inertia.

  • Amazon. People like you also purchased.

  • RRP.

  • Leisure brands. You deserve it.

  • Bigger red buttons.

  • Pill packets with dates

  • Telecoms. Different calls packages with various free minute options to reframe the choice around incremental value.

  • Insurance brands. Automated renewal

  • Savings (or credit cards). “With just a £1 a day ...”.

  • Smoking cessation products.

And you could probably add semiotics and any re-positioning projects. Even our very own moments of truth are examples of utilising behavioural economics. Essentially behavioural economics explains what we, as marketers, have been doing for a while but importantly it gives us a framework and a language to do more of it, more often as part of ‘what we do’.


The big implications of behavioural economics

1. Perhaps more than we thought people are doing things without rationalising the decision. This challenges the traditional communications model of change attitude, then change behaviour. We know that if we make products and services more available or simpler to use they will be adopted. Perhaps communications should increasingly be used to reinforce the purchase and encourage inertia rather than change behaviour. Inertia, availability, group behaviour, options, comparisons are much more important marketing tools than we realised.

In other words getting them to do (respond, buy) first; worry about attitude later. Direct marketers take note.

2. The consumer may be making an active decision when and when not to be rational. For example, habit is fine when you are doing the weekly shopping. But if you love running you are going to take a bit longer choosing a pair of trainers and maybe the same applies when you buy a car.

Time is precious and sometimes we can’t be bothered to look around. So intuition and inertia are rational choices if the cost of error i.e. choosing the wrong product is deemed to be insignificant or the cost of acquiring the necessary knowledge to make the ‘correct’ purchase is perceived to be high. So if the consumer is less involved in the category, the chances are there is a greater opportunity to use the tools of the behavioural economist. This would apply to utilities and commoditised markets.

3. Agencies need to encourage their clients to let them focus on the problem, not the medium. How we solve it should not really matter. How we get paid for it will though.


Some final thoughts

- If we can influence choice literally by how we present the options what happens if the choice architect is unethical. (and is not paternalistically libertarian)

- Marketing and communication agencies are probably in the best place to utilise this thinking, how do they charge their clients way of thinking – about them?

- How do we structure our behavioural economics story or even our approach? When do we engage our client?


Want to know more? Then read

Nudge

Undercover economist

The economic naturalist

Predictably irrational

Freakonomics

Black Swan

*The taxi example: Taxi drivers make more money in wet weather faster. So once they have reached their target, it is off to the golf course. Makes sense when you think about it.

1 comment:

  1. v useful summary - going to use it!

    ReplyDelete

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Just curious about marketing, psychology, economics, business, irrational behaviour, people, models, communications, advertising, market imperfections, b2b marketing. I work in the marketing communications industry for OgilvyOne.