What to do with decision theories?

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This post originally appeared on RWConnect on 4th March 2014

In my last post, I explained three broad theories of human decision-making which different psychologists put forward as alternative explanations for the discoveries of behavioural economics.

decision ahead - proceed slowlyHeuristics and biases assumes that we’re basically meant to be rational but some design flaws get in the way; adaptive toolbox says that there’s no such thing as rationality, we just use a collection of ad hoc mental tools to solve problems as best we can; and information processing viewpoints propose an underlying mechanism in our minds, which act as a sort of imperfect computer to make decisions based on the information the world throws at us.

In this article I won’t try to answer which model might be better, but let’s say you’ve decided which one best fits the consumers you’re studying. What should you do next?

Each of these models gives you a way to understand how customers are making the decision to buy, or not to buy, your (or your client’s) product. Each of them also challenges the traditional, unstated, powerful assumption that most market researchers make about consumer decisions.

You may be one of the rare marketers who does not make this assumption. While others do not know they are making it. But the assumption is revealed every time a questionnaire asks a respondent how much they like something, and every time an interviewer says “Tell me why you bought that.”

What is this hidden assumption? It is this: that the decision process is based on consumers buying products that they like, because of the attributes of the product, and knowing why they do so. In other words, that it’s an economically rational process. All three parts of this assumption are disproven by behavioural economics. The three models each give an alternative description of the decision and buying process, and this process is where researchers can focus their efforts in order to make behavioural economics work for their clients.

The heuristics and biases model says that the basic economically rational process is still the right framework, but consumers make errors of judgement in deciding how much they like things. If you follow this model, you should still look at product attributes but you should also look at how they are communicated and what context they are in, because this affects the value that consumers place on them. By understanding these context effects, you can learn how to emphasise the attributes on which your client’s product is strongest, which contexts it will do best in, and how to segment consumers by their biases and contexts. A methodology for analysing this process can be based on listing product attributes, enumerating the contexts in which the product (and its competitors) will be seen, and using a cognitive biases list as a checklist for how consumers might be influenced to put a higher or lower value on each attribute.

If you use the adaptive toolbox model, you will need to instead think of how consumers might make a good-enough decision about this product category – how they will satisfy themselves that the product they are choosing is OK and meets most of their needs. There are a number of standard heuristics or rules of thumb that consumers typically take to do this. One is to pick the one most important product attribute and focus on that (this might be price, or something category-specific like miles per gallon). Another is to copy what their friends or peers are doing. A third is to do what they did last time, if there were no significant negative consequences. You can find out which rule consumers are using by observing them, asking them (in the right way!), or testing their behaviour in a controlled experiment which is designed to distinguish between these rules. When you know the rule(s) they use, you’ll know the basic parameters about how to design product communications, how to position and price the product and how to change consumer behaviour for the better.

Finally, the information processing model says that consumers make their decisions by gathering information in pursuit of a goal. To analyse this process, you would start by understanding what information the consumer already has – this both forms a baseline to ask what new information they will seek out, and influences the goals they choose to satisfy. In this model, other drives such as emotions and preferences are seen as specific types of information. Then consider the capabilities of the consumer to gather information, the sources they use, the way they interpret and combine new facts with existing knowledge, and some basic parameters like how quickly they can read and interpret information, and their rate of consumption of social or other media. You can then quantitatively and qualitatively determine which (and how many) products each consumer might consider. You can also use the same framework to estimate which contextual, product or communication factors they are most likely to focus on when making their final choice.

Whichever model you use, the tools of traditional market research can fit into it. These new frameworks give a new way to think about the consumer and how to understand them, but they do not in themselves provide new methodologies. Qualitative approaches, survey research, concept tests, panels, eye tracking, ethnography and all the rest can fit as important tools into any of the three models. However, by starting from an understanding of how the consumer thinks – informed by behavioural economics research – you’ll have a more powerful and effective way to use those tools and achieve business results for your clients.

Leigh Caldwell is a consultant and writer on pricing and cognitive economics and partner at The Irrational Agency

How Behavioural Economics Points to Something Deeper

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This post originally appeared on RWConnect on 28th November 2013

lightbulb-headReaders of this blog are likely to be already familiar with many of the experimental results of behavioural economics (BE). Discoveries such as anchoring, hyperbolic discounting, loss aversion and other cognitive biases are now quite well-known in the market research world. Each of them comes with its own tricks for how to influence consumers, or pitfalls to look out for when designing questions. (those who are less familiar can find out lots more about them from some of the leading BE books:Predictably Irrational by Dan Ariely, Thinking Fast and Slow by Daniel Kahneman or Basic Instinctsby Pete Lunn).

These experiments and their associated influence tricks are the most visible aspect of behavioural economics as a field. And they’re useful too – but only in specific circumstances. Most research projects don’t have a specific need for an understanding of hyperbolic discounting or loss aversion. To put this into practice in market research, we’d like to have a clearer set of rules about what BE says about consumer insight.

There is a more powerful way to look at the empirical discoveries of BE. As well as standalone discoveries, they are also a set of clues to deeper and more important underlying insights about how people think and decide. These general lessons are applicable in many different situations – and can lead us towards finding the specific biases, limitations, heuristics or methods of influence that apply to our own consumers.

The drawback is: there is no single theory of how people make decisions. Scientific psychologists, working backwards from the results of experiments, have come up with a number of alternative frameworks. They aren’t mutually exclusive – think of them as different, valid, ways to look at the world. As a researcher or marketer, you may want to understand more than one of these models in order to decide which one to use in a particular project.

In this article I’ll briefly look at three of the leading theories of decision making. Each of these can be useful in understanding how consumers think about, and hopefully how they decide to buy, your clients’ products.

The first is the information processing model of Payne, Bettman and Johnson. This theory says that when we make a decision, we have to process the information available to us by using a series of smaller individual steps. The steps include small tasks such as estimating how good a product is, comparing two different products, or choosing to look for more information before making the decision. When confronted with a choice such as which car to buy, we decide on a strategy, gather and process more information until we’re ready to make the decision, and then choose one of the options.

Payne and Bettman also propose that while doing this, we are governed by “meta-motives” or goals that we want to satisfy during the decision-making process itself. There are four possible meta-motives:

  •  maximising decision accuracy
  •  minimising cognitive effort
  •  minimising negative emotions such as regret or anxiety
  •  being able to justify our decision to others

Different people focus on different meta-goals, so in order to appeal to the widest set of consumers, your clients might want to communicate in several different ways to match these four decision-making styles.

A second theory is the fast and frugal heuristics approach of Gerd Gigerenzer, Peter Todd, Ralph Hertwig and other researchers in the “ABC” school. This theory says that we have a toolbox of standard mental shortcuts which we use in different situations. For instance, in evaluating products we might use the “Take The Best” rule, which say that we first compare the available products on their most important feature; if one is clearly the best product on this dimension, that’s the one we buy; otherwise we move onto the second most important feature, and so on. Collectively, these shortcuts are known as the adaptive toolbox and they are thought to have been developed by evolutionary pressures as near-optimal solutions for tricky or dangerous environments.

The third model is the modified expected utility (or subjective expected utility) approach, which says that we take a generally “rational” view of our decisions – roughly estimating our expected outcome from each option, and picking the one that seems best – but subject to some modifications or approximations such as avoidance of risk. Under this theory, we mostly avoid risky options, those which might lead to a negative outcome or those whose outcomes are ambiguous, and therefore act in a relatively conservative way. The prospect theory model of Kahneman and Tversky is an example of this approach.

Other models include decision field theory (Busemeyer and Townsend), which says that we gradually “drift” towards a decision as we randomly consider various aspects of the different options available to us; decision by sampling (Neil Stewart), which suggests we compare options with randomly selected experiences from memory and see whether they appear to be better or worse than those memories; and ACT-R (John Anderson), which is less a theory of decision processes than a model of the structure of the mind, and is often used to simulate various different decision approaches and find which best matches the behaviour of real individuals.

Sometimes “theories” that we hear about, such as “nudge theory” are not general theories as such, but collections of techniques for influencing decisions. Nudge theory, as well as most of the experimental observations of behavioural economics, is compatible with several of the above models.

Any of the above frameworks can be used to understand more about how your respondents make decisions either in a real purchase context or during your research process. However, instead of a list of dozens of cognitive biases, you now have several competing decision making frameworks to choose between – a partial improvement but still no clear answer. So in future posts, I’ll suggest ways to unify these into a practical approach you may be able to use in your daily work.

Leigh Caldwell is a consultant and writer on pricing and cognitive economics and partner at The Irrational Agency

Globally irrational or locally rational?

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This post appeared originally on RWConnect on 28th November 2013

Why we need to understand cultural context when applying behavioural economics

The increase in research in markets such as Asia and Latin America makes understanding the impact of cultural context on consumer decision making more important than ever before. While quantitative researchers have long accepted that survey research is affected by culture through phenomena such as acquiescence bias or extreme response styles, cultural differences have far more diverse and wide-ranging implications for marketing and market research.

Behavioural economics is being enthusiastically adopted across the market research industry all over the world. Researchers everywhere are applying insights from decision making science and embracing the concept that we’re all a little bit irrational. But are we irrational in the same way?

We’re so WEIRD
Much of the research on decision making that is in the public realm has been conducted almost exclusively in Western countries and especially in the US. This means that we are implicitly assuming that these cognitive biases are universal and function largely in similar ways in different cultures. However, 96% of samples in psychological studies come from countries with only 12% of the world’s population, which means that a randomly selected American is 300 times more likely to be a research participant than is a randomly selected person from outside of the West. These countries are commonly referred to as WEIRD (Western, Industrialised, Educated, Rich and Democratic), which makes them vastly unrepresentative as a sample in psychological research.

Even though cross-cultural research into decision making is still in its infancy, a growing body of evidence suggests that behavioural economics as a field will hugely benefit from it as differences between cultures help unpack the deeper foundations of behaviour. Given the emphasis of many cognitive decision making theories on the impact of immediate context such as framing or priming, it’s surprising how little culture is taken into account. While social psychology has a wealth of knowledge on how cultural context affects us, theories in cognitive psychology rarely consider culture as a factor due to implicit assumptions about the universality of cognitive processes: according to these researchers, what we think about may vary, but how we think is always the same.

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The Muller-Lyer illusion

However, research has shown even fundamental cognitive functions such as how we perceive colour can significantly differ based on the cultural context you’ve grown up in. Similarly, perception of seemingly simple optical illusions such as Müller-Lyer arrows have been shown to vary across cultures and even age groups.

Through the looking glass of culture
When talking about culture, we often refer to aspects such as values, attitudes, social norms, beliefs and traditions. However, despite long-standing debates within academia, no commonly accepted definition of culture actually exists. Instead, researchers tend to focus on certain aspects of culture depending on their area of interest and the phenomena they are investigating.

On a general level there is a wealth of evidence that economic, social and linguistic environments strongly shape people’s behaviour, motivations and preferences: for example, a study investigating time discounting (i.e. whether we value immediate rewards more than those in the future) in 45 countries found that differences at country level related to wealth and education as well as cultural factors such as individualism, the importance of tradition and whether time was conceptualised as linear or cyclical. However, without a unifying framework of conceptualising culture research such remains too scattered and almost makes it harder to grasp the bigger themes underlying cultural differences. A more effective way of understanding culture’s impact on how BE biases work differently in different countries is to look at some measurable differences between cultures which doaffect how a person’s cognition works while they make decisions. While other frameworks exist, one of the most powerful ones is a person’s self-concept.

“Me, myself and I” vs. “All together now”
The most widely analysed dimensions of culture are individualism and collectivism. Often discussed in the context of Geert Hofstede’s Taxonomy of Cultural Differences, these dimensions have received a lot of attention both among academics and practitioners. In a nutshell, individualism is characterised by detachment from relationships and community with the individual seeing himself as relatively independent from others, whereas collectivism is characterised by the importance placed on relationships, roles and status within the social system, with the individual seeing himself inseparable from his network of social relations.

However, at the level of the individual, these cultural mindsets affect how we see the world through organising the information we have about ourselves, directing our attention to information that is perceived to be relevant, shaping motivations and influencing how people appraise situations that influence their emotional experiences. These self-concepts can be placed on a continuum between two poles: independent and interdependent selves. Independent self-concepts are typically more prevalent in individualistic countries, whereas interdependent ones tend to be more common in collectivistic ones, although variation exists within countries.

Those termed independent define themselves through internal attributes such traits, abilities, personal values and preferences, and see behaviour as being under the control of the individual, arising from internal attributes such as preferences (e.g. what you buy reflects your identity). Conversely, those termed interdependent define themselves through relationships with others and don’t necessarily see behaviour as a reflection of internal traits but situated in a specific context – your preferences might radically change depending on what social circumstances you are in.

This has profound consequences for some of the fundamental concepts in consumer psychology such as cognitive dissonance: if you see your behaviour reflecting your true self, which is ideally consistent across time and circumstances, holding two or more conflicting ideas will make you feel uncomfortable. However, if you instead assume that your preferences merely reflect the current social circumstances and can therefore change from one moment to the next, conflicting ideas will not pose a threat to your identity, which means the concept of cognitive dissonance exerts much less power on consumers in e.g. East Asian cultures. As cognitive dissonance, often seen as irrational, is commonly used in advertising, understanding the extent to which it is prevalent in the cultural context is crucial to efficient marketing communications.

I am what I buy… or am I?
Whether or not we see ourselves as separate individuals or intertwined with others is also important in understanding consumer choice. Is choice an individual endeavour, reflecting our internal attributes or one that takes other people into account and says little about the chooser? In Western cultures, choice is seen as an act of self-expression: uniqueness is desirable and choices are a way to paint a portrait of yourself for the outside world, so we vary our choices in an attempt to gain a sense of “specialness”. In behavioural economics, this is termed as diversification bias where we seek variety in both what and how we choose which may sometimes lead to seemingly irrational behaviour. However, the majority of the research on this effect has been conducted in Western countries and specifically in the US where personal choice is almost one of the key cultural values.

When choice is an act of self-expression, it becomes hugely important for the individual, and the psychological impact of either lack of choice or failed choice is larger, which leads to strategies such as variety-seeking. However, in in collectivistic cultures choice is often an interpersonal task which means the success or failure of making a choice that portrays oneself in the most positive light is not as big a concern. Subsequently, recent research has shown that the diversification bias is weaker in these cultural contexts.

Self-concepts also affect the strength of another well-known behavioural economics concept: theendowment effect, where simply owning an object enhances its perceived worth, and owners value objects substantially (and irrationally) more than potential buyers do. Because owning an object activates an association between it and the self, the Western focus on self-enhancement means this association automatically boosts the object’s value. Therefore, the strength of the endowment effect is influenced by the degree to which self-enhancement is culturally valued, with recent research suggesting that the effect is indeed stronger in a Western context. In practice this means that sales tactics such as free trial or “bait and switch” may be less effective in these non-Western contexts with weaker endowment effect combined with weaker cognitive dissonance.

Fifty shades of irrationality
Understanding the potential cultural influences on thought is crucial for everyone attempting to accurately describe and predict consumers’ decision making.  Insights from behavioural economics might well be applicable in different cultures, but we need to have highly nuanced sense of the specific characteristics of each cultural context and its impact on consumer decision making to ensure effective applications. As behavioural economics professor Dan Ariely notes, the biggest challenge for the field in the next 10 years is understanding the generality of the findings so far and to what extent the effects discovered carry over in different contexts. As market research gradually abandons the error of rationality and adopts more principles from behavioural economics, let’s make sure we don’t entrench a new mistake: universality.

Elina Halonen is a founding partner of the Irrational Agency and editor at InDecision blog.

What’s life like on the other side of the behavioural fence?

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Last week we co-hosted (along with Hunting Dynasty) an event to celebrate the second anniversary of the London Behavioural Economics Network. To mark the special occasion, we invited two illustrious speakers to discuss life on both sides of the behavioural fence: commercial and academic. Representing the academic side, we had George Loewenstein from Carnegie Mellon University and for the commercial side, there was only one option – Rory Sutherland.

2014-04-23 20.17.23

Thanks to Brian Tarran from the Market Research Society, we can share with you a transcript of the event (link to our video at the end of this post). Brian also wrote an excellent review of the event which you can read on Research Live.

 

George Loewenstein: Why is it that British electrical outlets have a switch on them? If you don’t have anything plugged in, why bother to turn it off, and if you do have something plugged in, why bother to turn it off?
Rory Sutherland: I’ve always seen it as a failing of other countries that you don’t have a switch. But there may have been also, bizarrely… if you go back to the early days of electricity, there was a considerable fear that if you left the switch on with nothing plugged in the electricity would leak into the room. So it might have been a device by the electricity boards to prevent people from being paranoid.
GL: I’ve read in various places that you studied classics at Cambridge and taught classics. Now, I don’t want to rake the coals on any deep regrets that you feel about leaving teaching, but I’m wondering if you’ve gained any insights from your career in advertising that would apply to education?
RS: A classical education is one of those things that works obliquely. It’s also worth asking: is a large component of education signalling, rather than value? Your level of educational attainment correlates very well with your career outcome if you get a paid job. It doesn’t correlate at all with people who are self-employed. This raises the question: is there a large amount of education that is effectively a spiralling, competitive credentialism? We don’t have any evidence that people with OxBridge firsts are better employees than people with firsts from Leeds. There’s no real empirical evidence that your degree class predicts your level of value to your company. There’s an aspect, which I know is a very cynical one, who argue that this is in a sense a peacock’s tail thing; basically it’s a three-year long IQ test combined with proof of commitment.
GL: Take something like drop-outs, or students not studying as hard as you’d like them to. Are there any lessons from behavioural economics or the marketing world that would discourage and encourage those people?
RS: There are some interesting questions about education. Does it disproportionately privilege certain personality types, those that are particularly well-suited to the system they find themselves in. One of the interesting things about an ad agency is that, as a place to work, it is a complimentary mix of skills. You need the beard-stroking Oxbridge intellectuals dotted around the place, but what you find in the most successful ad agencies is that the people who make up the management of that organisation tend to come from an extraordinary mix of educational and social background. That’s not just a politically correct, nice thing to have, it is a source of competitive advantage.
GL: That’s a nice segue into a question I was going to ask, about the new master’s programmes that are beginning in the UK, focusing on behavioural economics. Is this the kind of training that you would value at Ogilvy, or are you looking for the pot-smoking… what was it?
[laughter]
RS: They are not mutually exclusive, of course. You can have an MSc in behavioural science and a severe pot habit.
[laughter]
RS: One of the strange things is, you would think that advertising agencies and clients are full of behavioural scientists and psychologists, devising the next evil way in which to mislead people into buying stuff. I must admit, I was rather hoping to find that kind of thing when I went into the business myself. I always assumed I’d be able to turn some strange corner and find a room full of people attaching electrodes to rats. That room does not exist. But the reason private enterprise looks like it’s good at behavioural science is that it stumbles on things by accident. It happens to produce things that work. Capitalism is sort of semi-Darwinist: if you stumble on something that is disproportionately successful, it makes money, so you tend to expand that particular area. Now, some time after the early Mad Men era, the links between academic psychology and advertising and marketing were actually quite strong. This was in the late-50s, early-60s, when there were various people dotted around ad agencies with possibly fake, possibly genuine Viennese accents, who claimed to have met Sigmund Freud. These people came up with ideas, like how ‘plink, plink, fizz’ would create a social norm around using two Alka-Seltzer rather than one. They came up with lines like, ‘How else can a month’s salary last a lifetime’ for DeBeers, which was an extraordinarily good piece of framing in terms of anchoring what a man should spend on a commitment device for his future wife. They stumbled on these things by accident, but they made no effort whatsoever to codify it. What the business world is very good at is stumbling on successes by accident, but it’s terrible at making sense of them. We had all the information to create a science of behavioural economics back in the 50s and 60s, but we squandered it because nobody tried to make sense of it.
GL: How do you use behavioural economics in your practice? Can you give an example of a campaign that wouldn’t have happened without behavioural economics.
RS: The most important thing about behavioural economics is the widespread awareness among clients and agency people that these things are important. Before, in modelling and attempting to predict consumer behaviour, we tended to rely on the two pairs of broken binoculars: neo-classical economic assumptions, which are quite seriously wrong in some areas, and market research. Enormous business and government decisions are based on these two flawed lenses. Neo-classical economics tends to assume that psychology isn’t matter – which, as a result, creates an imaginary fantasy world of perfect information, perfect trust and perfect efficiency where marketing and advertising needn’t exist. But there are loads of things for which there is no rational reason. Stripy toothpaste, say – let’s get really trivial. There is no rational reason for stripy toothpaste because once you put it into your mouth it all gets mixed up. Nobody in market research would ever say that toothpaste should be stripy. No neo-classical economist would argue that there was any benefit to it. But someone stumbled on this idea that it’s much easier for people to believe a toothpaste does three things if there are three different visible components. That kind of thing, just understanding something that would never have emerged from research or neo-classical economics – those kind of things can make the difference between triumph and disaster. If all I do is get people to understand that, and get people to accept that it is worth testing things that don’t appear to make any sense to test, that’s all you have to do.
GL: The stereotype of advertisers and marketers is that they are playing on motives like power, sex, fear and so on. Is that true, and to what extent is behavioural economics capturing the motives that really drive people to purchase products?
RS: I’m very uncomfortable with the use of the word irrational, because an awful lot of behaviour that is currently seen as irrational is meta-rational or evolutionary rational. It’s the product of evolved psychological instincts that may or may not be useful in the modern world. For example, people’s willingness to pay a premium for a famous brand is rational if you understand a bit of reputational game theory, which is that someone with a valuable reputation has more to lose from selling a bad product than someone you’ve never heard of. There are lots of mechanisms that we employ instinctively, actually make very good sense. I also think loss aversion, in evolutionary terms, needs to be better understood. Rationality is always about maximising something, but I would argue that any sensible evolved system is not going to care about whether something is good or really good, but it would desperately care about the chances of something being fatally terrible. If you look at it from the absence of bad, rather than presence of good, an awful lot of human decision making makes an awful lot of sense. The idea that rationality means getting the best of something… I mean, you can go to a Michelin-starred restaurant and spend the afternoon on the bog, but say what you like about Maccy D’s but you don’t get ill there. Satisficing is what most people do all the time to the extent where, when people don’t satisfice there’s probably something going wrong. When people maximise, it tends to be in competitive situations where people are thinking as game theorists.
GL: But sometimes what appears to be maximising, isn’t maximising at all. I had a colleague who always tried to maximise the gain from any kind of negotiation and it was a disastrous strategy…
RS:… Because no-one would negotiate with him?
GL: That’s right. Another case is, if you always want to get the parking spot closest to the theatre, you’re going to waste a lot of time looking for a parking place. I’m actually a big believer in satisficing, but really a believer that satisficing can be a form of maximising. On the idea of loss aversion being connected with having evolved, it would have to be a very crude kind of evolution that produced that effect, because we’re loss averse over very small amounts: like gain $10/lose $10, or gain $15/lose $10 – most people are going to turn that down. But $10 has no prospect of killing you, so you would have to say it’s something we learned through evolution and then generalised inappropriately.
RS: Do you accept the claim that some psychologists make that the term behavioural economics steals for economics credit that is owed to psychology?
GL: There are a lot of psychologists who are annoyed at economics, and are annoyed at behavioural economics specifically. A lot of the work on changing health behaviours, for instance, was first done by psychologists, didn’t get a huge amount of attention, and then behavioural economists started doing it, and have gotten a tremendous amount of attention since then. Psychologists are, rightfully in my opinion, bothered about that. In fact, a lot of psychologists have started rebranding themselves as behavioural economists and getting more attention. I think they are right to have a grudge, but I guess you could tell us that it’s all a matter or marketing, and behavioural economists are much better at the marketing game.
RS: I got into this weird Twitter row, and Nicholas Christakis, I think, had the last word on the question when he said, “Look, there is a branding problem with psychology, which is very simple: the president of the United States cannot have a council of psychological advisors – but he can have a council of economic advisors”. On the other hand, for reasons I don’t fully understand, economics has completely disproportionate influence in business, and especially in policy making, out of all the other social sciences. Part of my theory is that economics is the one academic discipline where it is ok to be greedy. My brother is an astrophysicist, and if he went off to work in a high-frequency trading firm for two years and make a fortune and then try to get back into astrophysics, his career would be dead because he’d sold out. Economics, because it preaches self interest as a virtue, getting two-year gig at Citibank for £300,000 a year is positively career enhancing. Is that a valid theory?
GL: I think there is a good reason why economists are so tied into policy, because a lot of economics is oriented towards policy. But I actually want to pick up on a little piece of what you talked about, which is greed. When economists talk about greed they misuse the term. For an economist, greed is self interest. But when lay people use the term, they are using it in a very different sense. For a lay person, greed is self interest taken too far; to the point where it is destructive. So, it’s fine in my opinion to be self interested, but the danger is where you take it too far.
RS: We do have a social epistemology, and our idea of the good life is probably massively informed by what we think other people’s idea of the good life is. So, I think the extent to which we decide individually is a really interesting question. Although we’re consciously determined to see ourselves as individuals, I think our vision of what’s good is massively driven by our assumptions of what other people think.
GL: Exactly, and I recently co-authored a paper on mattering maps. When you’re in a particular situation, let’s say a social group, there’s typically something that matters more than anything else. Among academics it might be publications. If you are a musician it might be how well you play a piece. But one of the interesting features of mattering maps is they can change so abruptly as a result of whatever social milieu you’re in. So, I couldn’t agree more with you, that whatever we’re seeking at any given time is completely socially determined. The think we have some kind of free will about is how we’re going to seek it out. But we don’t really have a lot of control over what we’re seeking.
RS: We won’t get into free will and determinism here, because that’s probably a bit heavy. But a final thing: there is this attack on behavioural economics that it is just a collection of findings, or anomalies – that it is stamp collecting for psychologists. Critics say, ‘Where is the unifying theory?’ But if you’re dealing with psychology, human behaviour, human health – any of these complex emergent phenomena – is there ever going to be a unifying theory?
GL: Let me just say that something I’ve noticed about Brits is that you find pretension toxic. And what you don’t realise is that Rory is actually making fun of me with this question…
[Laughter]
RS: No, I’m not!
GL: …because I was having breakfast with him and I told him that I was working with Nick Chater on a theory of everything. I actually meant it a little bit tongue in cheek, but not totally. So Rory’s making fun of me. But, ok, the first thing is that it’s kind of surprising as a behavioural economist to be questioned about the desire for a unified theory, because we’re always being attacked by traditional economists who say, ‘We have a unified theory and you’re just a bunch of disparate findings’. My view is that traditional economics is not nearly as unified as it claims to be because whatever phenomenon the economist is looking at, the utility function metamorphoses to deal with the phenomena that’s important to them. But I do think that a unifying theory, even a unifying mathematical theory, can be a beautiful thing. And, that’s what social science is all about: trying to take disparate social phenomena and come up with a unified account. That’s when I get a chill up my spine, when disparate things come together. So my aspiration is for behavioural economics to be grounded on a unified theory, or maybe a few unified theories.

 

For a video of the event, click here.

To sign up to the next London Behavioural Economics Event: meetup.com/London-behavioural-comms-monthly-informal-drinks/

Join the LBEN Facebook group: https://www.facebook.com/groups/londonBEnetwork/

Consumers are irrational – a myth

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[Transcript of my talk from NewMR: Explode A Myth. The accompanying slide is here and you can listen to the recording of the talk and Q&A here]

 

If you’re the type of person who tunes into NewMR events, you can hardly have missed the library of behavioural economics books that have poured out of the typewriters of various academics in the last few years. Nudge, Thinking Fast and Slow, and Predictably Irrational have hammered into us the idea that we’re all irrational. We don’t make choices in our best interests and we’re always making mistakes. We don’t even know what we want. How can we be trusted to make our own decisions in life! We’re idiots!

Even the name of my own agency, the Irrational Agency, plays up this idea.

Today I’m going to tell you all this is nonsense. Consumers aren’t irrational at all. Not that they’re rational either…and thank goodness for that.

The fact is: if we really did behave the way economists say we should, we’d all be dead. The only people who make decisions in the way economists tell them to are people with specific types of brain damage. These people cannot use their intuition or feelings to make choices – they have to calculate all the costs and benefits of every decision they make. As a result, they can’t make any practical decisions in life: not even whether to get out of bed in the morning. They end up unable to live outside of an institution.

We’ve all probably experienced this on a small scale – they call it “analysis paralysis”. Any time you’ve found it really hard to make a decision between two options, and you’ve put it off and thought it over and worked it out and still been no closer to deciding – you’ve been in this mode. And eventually you probably picked one path or the other, and chances are it worked out OK.

Imagine you weren’t in a comfortable office (or living room) in a modern economy, but instead in a threatening environment, with only just enough food to survive on, and a wide variety of creatures waiting to kill you. In other words, imagine you were your great-great-great-great-grandmother 300 generations back. Now imagine you stopped to calculate and weigh up the potential costs, benefits and associated probabilities of every decision before making a choice. It wouldn’t be long before you ended up as lion food.

Any “rational” person – rational in the sense that economists would like us to be – would quickly be eaten out of the gene pool. Only those who are willing to make decisions quickly, find shortcuts and do what’s “good enough” would have survived. And those people are your ancestors, and mine, and the ancestors of the people who buy our products.

This isn’t just a matter of whether our brains are big enough, or if we just happen to be a bit too stupid and slow to calculate the right answers. It’s mathematically impossible for any imaginable creature to calculate all the pros and cons and predict the future consequences of their actions and weigh them up and make decisions, every minute or every second of the day. If you dedicated all the computers in the world, programmed by the smartest programmers, helped by all the people in the world and gave them a hundred years to calculate in exact terms the best sandwich for you to order today: they wouldn’t even be able to do that. There is so much information in the world; it’s such a complex place, and everything influences everything else; that nothing and nobody could process it all, even if given aeons to do it in. And certainly not in time to dodge that lion. It’s simply not an option.

So instead of calculating everything, we use heuristics. Heuristics, contrary to the impression given in some books, are not flawed or error-prone ways of thinking. They are brilliantly designed techniques to let you make a good-enough decision in less than a second, 99.9% of the time, without even being aware you’re doing it. The only reason we can navigate the world in a practical way is because we have these heuristics to make our decisions for us.

The heuristics are what let us choose products we know we’ll like. They’re what help us to drive to work safely, or talk to people without having to calculate and plan out every individual sound that every word will be made up of. It’s heuristics that tell us what brands we can trust and let us know we’re not being ripped off by a high price.

And that one time in a thousand that the heuristics don’t give us the right answer? Well that’s a better hit rate than any computer algorithm you can think of. Sure, algorithmic step-by-step calculations can give us the right answer to a small number of carefully defined mathematical problems: and there’s no harm in learning those situations so you know when not to use a heuristic. I wouldn’t recommend using a heuristic to calculate your tax bill. But don’t start believing the heuristics are wrong, or bad, or useless. And above all, don’t let them tell you consumers are irrational. Not even someone who runs an agency named after irrationality. (Sometimes I wish we’d just picked a nice acronym like GFK or TNS. But there you go.)

Don’t let your fantasy of that unattainable, perfect calculating machine be the enemy of recognising what a brilliant object your brain is, to have found its way past those lions on the savannah, through all the dangers of history, and past the supermarket till without buying the National Enquirer.

Consumers aren’t irrational, but you might be irrational if you think they are.

IA partner interviewed on leading psychology blog

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This week our partner Leigh Caldwell was interviewed by InDecision – a blog aimed mainly at academic researchers in the field of psychology of decision making. Every so often they feature  a practitioner applying the science in the commercial world and previous interviewees have included e.g. Rory Sutherland from Ogilvy Change, Matthew Willcox from advertising agency Draftfcb and behavioural finance expert Daniel Egan from Betterment. (Original interview here.)

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This week in our practitioner series we’re featuring Leigh Caldwell who is a behavioural economist and founding partner of pricing research consultancy Irrational Agency. He’s been applying decision making research commercially since the mid-2000s, making him quite an early adopter of this discipline, and is also active in academic economic research, working in the emerging field of cognitive economics. He has founded and run several businesses in technology and professional services, and recently condensed his experience in pricing and marketing these businesses into a new book The Psychology of Price. He is also the sub-editor for our upcoming interview series on applications of decision-making psychology in economics and public policy.

Tell me about your work: how does decision making psychology fit in it? I see my work as scaling up. I start from decision-making research that applies to individuals, and expand it into an understanding of how groups of people, companies or markets or whole economies, operate.

As a consultant, I do this for companies who want to know how to design a pricing or marketing strategy while taking into account consumer psychology. As a researcher, I do it with economic theory, building models of how markets work and how economies experience growth or recessions.

To do either of these jobs calls for mathematical models – models of how people behave which strike the balance between being psychologically realistic, but simple enough to work with. Old style economics went too far down the simplification route; but modern empirical psychology doesn’t produce simple models. So my work involves figuring out just how much simplification is enough, then doing the mathematics to expand it to an economic scale.

This field as a whole is called cognitive economics. Its goal is to build models of the economy that are based on a realistic foundation of how people really make decisions, and to bring an understanding of positive psychology into economic modelling – how people get utility or happiness from non-material goods, by modifying their cognitive state. It tackles questions like: what determines whether a company invents a new product or competes in an existing category? Why do companies make profits when economics says all profit should be competed away? Why are people unemployed? Why do people invest and save and borrow in the way they do? When people can get psychological benefit from intangible things, why do they still rely so much on material possessions? These are all really important questions which traditional economics can’t answer. Cognitive economics uses the discoveries of decision-making psychology to figure out why these things happen.

How did you first become interested in decision making psychology? I was running a business, a software company, and had been trying to work out for years how much money I should charge for our products. I could tell that my customers weren’t making decisions through rational cost-benefit analysis, so I wanted to know what else was going on. The same pattern showed up when we built software – whenever people started using it, they insisted on ignoring the “correct” processes and used it in whatever way they felt like. The Sheldon Cooper in me was frustrated by all this irrationality. I had to figure out what was going on!

I had read lots of marketing books with some foundations in folk psychology – anything from Dale Carnegie to Ries & Trout – but none of them seemed very scientific. As a mathematician and programmer with an economics background, my natural approach was to try to build a predictive model of people’s behaviour and figure out what was going on. When I started looking into the psychology research, I found out that there were plenty of researchers examining the same kinds of problems…but no coherent structure for how to apply the discoveries either to economics or business. That was where I discovered my niche. I decided to start applying this science, first in my software business and eventually set up a new business selling pricing advice. Having got involved along the way in academic research in order to find these answers, it seemed natural to keep working both on new research and on business applications.

What type of research do you find most interesting, useful or exciting? Like everyone, I’m entertained by the range of provocative topics people study in this discipline: the psychology of online dating, whether people called Michel are more likely to buy Michelin stock, or how easily people can be manipulated into saying the opposite of what they apparently believe – there’s always something fun.

But I’m always more interested in foundational work. This field is full of ad hoc papers, with lots of experiments focusing on individual standalone phenomena. Those are all fine in their own right, but they are hard to apply to real world problems. You need to do a new experiment every time you want to investigate anything. Theoretical work that unifies a spectrum of different results into a smaller set of principles makes it easier to solve new problems. That kind of work is what really fascinates me.

Do you see any challenges to the wider adoption of decision making psychology in your field? There’s resistance from the economics side of the discipline – many economists insist that people are fundamentally rational, even if they make occasional mistakes in their decisions. Their idea is that all the mistakes basically cancel out, or disappear once consumers learn to overcome them. That is part of why I want to turn all the disparate effects in this field into a unified theory: to find out whether our general cognitive limitations have an impact on the efficiency of markets or on whether societies end up rich or poor.

From the business side, the issue isn’t any direct resistance, just a lack of rigour and knowledge. Businesses are often run on superstition more than on evidence. The barrier here is inertia: a concerted effort will be needed to persuade companies and governments to take up these ideas. Fortunately, capitalism provides an incentive to make that effort – there are big rewards awaiting the agencies or consultancies who can win that role as a bridge from science to business.

How do you see the relationship between academic researchers and practitioners? Tenuous.

Two other interviewees in this series responded to this question with the word “symbiotic”. That’s true, but it’s also idealised. In reality, the culture – or to be technical, the habitus – of these two worlds are so different that it’s hard for them to work together. So far.

Academics mostly agree that it’s a good thing to make their work relevant for business or public policy applications, but many of them don’t have a clear idea of how to do that. (Business schools are a major exception – I’ve been impressed by the decision-making research conducted in the top business schools.) However, academics who are hired as consultants often struggle to make their work have an impact. Consultancy needs to be followed up by strong and simplified implementation steps in order to work, and academics rarely enjoy distilling their work in that way. Then again, that’s true of most commercial consultancy too.

Businesspeople are more skeptical of the potential for collaboration. No pharmaceutical company would deny the importance of rigorous biochemical science in creating their products, but it wouldn’t occur to most of them that decision-making science is relevant to their marketing and pricing too. I don’t think this means they’re anti-academic or anti-science, just that they don’t understand it and so it is easier for them to rely on gut feeling and intuitive judgment in this area. Quite a lot of my commercial work ends up being about translating scientific concepts into business language, and then demonstrating why business should be more open to using scientific methods and knowledge.

Mostly, the interface between the two worlds is limited to popular science books, a few intrepid people from marketing agencies who visit academic conferences, and the occasional consulting contract for a professor somewhere. I would love to be part of changing this. Right now we have two separate worlds and a few people who occasionally cross the border between them.

Imagine we could create a continuous spectrum instead: at one end theoretical academic research on mathematics or abstract models, then empirical research testing hypotheses, then an “engineering” discipline who knows the science and also how to implement it in business, through to marketing departments who use what the engineers have developed, all the way to operations or finance departments who could become aware of how to incorporate consumer psychology in the service they deliver and the way they bill for it. That would transform the practice of both business and academia.

How do we get there? Maybe we all need to apply some decision making psychology to understanding our own barriers and how to change our own behaviour.

What advice would you give to young researchers who might be interested in a career in your field? The areas I work in get their richness and value from the interplay of three disciplines: marketing, empirical psychology and economics. Researchers who are interested in pricing and other business applications will want to understand how people work in business as well as the scientific process of psychology and the modelling and mathematics that comes into economics.

For example, if you’re an economist and haven’t done empirical psychology work before, try getting involved in some pricing experiments at a business school so you can see how that works. If you’re a psychology researcher who hasn’t worked in a company, try working with a small business to try to redesign the pricing of their products or services. To get a feel for practical applications in pricing, you might also want to take a look at Priceless by William Poundstone (or my book). And if you’re a practitioner who wants to bring more science into your work, go along to some academic conferences or seminars just to get a feel for how people work.

Sometimes people are worried that they won’t understand the science (or the economics) or the maths will be too difficult. Try it anyway and just understand as much as you can. People in other fields aren’t any cleverer, they just speak a different language – the people who work in that field learned it, and you could learn it too if you wanted to.

Practical applications aside, if you’re interested in cognitive economics research, you will have to have an independent spirit. There are not many people working in the field yet, so you probably won’t find a supervisor who specialises in it. You can get in touch with me and I can help you identify a list of papers to start with, and then see what kind of research question you’re interested in. I think cognitive economics will be an increasingly important field and this is a good time to get into it; but it is always more challenging to work in an emerging field because the directions of research and the conventions aren’t clear yet.