Richard Thaler won the 2017 Nobel Economics Prize for integrating psychology with economics. He has played a crucial role in the development of behavioral economics over the past 40 years, which has had a significant impact on economists, researchers, business, and government policy-making.

Behavioral economics incorporates insights about human behavior from psychology to show how we really make decisions and why we behave the way we do. We try to make rational decisions, but we have limited cognitive abilities, self-control, and willpower to do so.

Why should you care about behavioral economics?

"I think the most important impact [of my research] is the recognition that economic agents are human and economic models have to incorporate that." --Richard Thaler​

Gallup research shows that companies applying behavioral economics principles outperformed peers by 85% in sales growth and more than 25% in gross margin during a one-year period. 

Applying behavioral economics to your business strategy will help you align your services and processes with what people value and how they actually behave. This is very much in the same vein as design thinking: understanding human behavior and emotion will help you design and deliver outstanding customer products, services, and experiences. Behavioral economics and design thinking both put people at the center of strategy.

Behavioral Drivers 

Biases influence how we see the world and help us make quick decisions in daily life, but they can also blind us to new information, and inhibit us from considering valuable options when making important decisions. You can design actions to counter these.

1. Status quo bias

Default options are powerful because we tend to accept the status quo. For example for many 401(k) pension plans, the default option is not to join.When an automatic enrollment was adopted in one company, enrollment of new employees jumped to 90% immediately and increased to more than 98% within 36 months. (Thaler)

Action: Design well-structured default or no-action-required options to your services to make it easy for people to choose.

2. Loss aversion bias

Consumers are more willing to take risks in order to avoid loss than to pursue a gain. The psychological pain of losing $100 is twice the amount of the pleasure of gaining $100. 

Action: Create scarcity via 'act now or lose out' messages. These are more effective than offering added benefits for purchasing. (Upfront Analytics) Offer free trial periods. This helps users develop ownership of your product and decreases the likelihood of returns when the trial is complete.

3. Sunk Costs Bias

Fear of loss makes it hard to give up on a project, new business, etc, even when we have invested resources that can't be recovered. It traps us into thinking that since we've already spent money on X, we should keep spending money on X, keeping us stuck in bad investments.

Action: Examine your assumptions about X and explore alternatives.

4. Choice overload

When we are given too many options, we suffer from choice-fatigue or decision-making paralysis. Studies show that offering fewer choices to consumers can increase sales. 

Action: Make it easy for customers to choose.

5. Framing Effect

Basing a judgment on whether a choice is presented as a gain or as a loss, rather than on objective criteria. Negative messages carry negative associations, and positive messages carry positive associations. 

Action: Create "yes" emotions: A photo of a happy/attractive person had the same demand effect for a bank as a mortgage-rate cut of 100 basis points." (McKinsey)

6. Salience

People respond to messages that are easy to process and remember. Regular information on energy usage and price increases drives energy consumption down more than twice as effectively as yearly updates (McKinsey)

Action: Show consequences or benefits: Alain Samson Phd, says, "A technological device can be framed as being 99% reliable or having only a 1% failure rate, thereby emphasizing either positive or negative information."  Older people find positive information more salient. 

As Thaler notes, "If you want to get people to do something, make it easy. Remove the obstacles." To learn more, read his book Nudge: Improving Decisions About Health, Wealth, and Happiness.

Published on: Oct 19, 2017
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