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BEHAVIORAL ECONOMICSand the customer journey

Colin Strong & Kiriaki Koutmeridou

Behavioral Economics

BEHAVIORAL ECONOMICS:Visual illusions as a metaphor for rationality

If by looking at the picture [1] on the left you think that the vertical table is longer than the horizontal one, then you are victim of a visual illusion.

A result of evolution, a large part of our brain is dedicated to vision and we make use it most hours of the day. Yet our intuition fools us in a consistent, persistent way. If we make these repeatable, predictable mistakes in vision, what’s the chance that we don’t make even more mistakes in something that we are not physically ‘designed’ to do?

Let’s take financial decision making, something we don’t have a specialized part of the brain for. What is worse? With visual illusion it is easy to demonstrate the mistakes (take a ruler and measure the two table tops). With ‘cognitive illusions’ it’s much harder to demonstrate the mistakes. We don’t have an easy way to ‘see’ them.

A field that increasingly recognized in providing insights into understanding this is Behavioral Economics. This field, popularized by a range of writers including Malcolm Gladwell to Daniel Khanneman, has built a strong following among a range of professionals concerned with consumer behavior not simply from a commercial perspective, but right through to what this means for shaping public policy.

Behavioral Economics is the idea that people don’t always make strictly rational decisions. This is not to say that we are always destined to make the wrong decision; patently we don’t. Within the limits of our brainpower and our ability to process all relevant information to the problems we have to solve, we are able to function effectively for the majority of our needs. But because this is done by using simple rules of thumb (in other words, making shortcuts and not always using optimal (strategies), we occasionally get things wrong.

So how can the understanding of consumers that Behavioral Economics gives us assist in the design and marketing of products and services? The answer is in many different ways, but here we have picked out some important principles that are relevant. This is by no means an exhaustive list but provides a useful starting point for thinking about how to apply Behavioral Economics to your business issues.

BEHAVIORAL ECONOMICS:

Why is Behavioral Economics so useful?

For market researchers, Behavioral Economics offers an approach to understanding human behavior which accepts that economic theories and approaches will not deliver the whole story about the factors that influence consumers’ economic behavior.

On its own, Economics is based on the premise that people make rational decisions and that market forces will resolve everything in the most efficient way.

Yet Behavioral Economics increases the explanatory power of Economics by providing it with more realistic psychological foundations.

Implications of Behavioral Economics for Market Research

Behavioral Economics is not meant to be a separate approach in the long run. The hope is that behavioral models will gradually replace simplified models based on stricter rationality, as the behavioral models prove to be tractable and useful in explaining hidden drivers behind our behaviors and making surprising predictions.

We are exploring ways in which we can make approaches more ‘Behavioral Economics friendly’.

Behavioral Economics confirms what we already know about research design and can provide the explanatory framework which is difficult to access by surveys alone.


RULE 1:Don’t overload consumers with too much choice

We generally believe that we like choice; the more choice, the better, and we assume that our desire for choice and our ability to manage it is unlimited. Indeed, decisions for products as part of a large range, such as mobile devices, can often be extensive as it is generally considered to be a positive idea to cover as many consumer preferences as possible.

In fact, the reality is that consumers often struggle with the number of options available to them, as illustrated by the classic ‘jam sandwich’ study. This research involved setting up an ‘exotic jams’ tasting booth at a high-end grocery store in California. On one occasion there were 6 jams at the tasting booth, while on another occasion 24 jams were displayed. Consumer reaction and subsequent purchase was tracked with compelling results; despite the initial appeal of the wider choice of 24 jams, in this case only 3% of consumers actually purchased a jar. In contrast, of the consumers browsing the tasting booth when only 6 jams were available, a staggering 30% went on to purchase a jar.

Consumer product company Proctor & Gamble has since made use of these findings, reducing the number of versions of Head & Shoulders shampoo from 26 to 15. Sales subsequently increased by 10%.

Technology is a category that has many examples of this with ecommerce sites offering a huge number of categories and sub-categories, with too many options in each of these categories and overly complicated ways of customizing products. Clearly, the content needs to be simple and organized in a straightforward way for consumers to stay and use the products.

Case study: The history of consumer electronics is littered with companies that have boasted extensive ranges of devices, all absorbed with the commercial desire to cover as much as the market as possible to generate revenue across the board. Of course, this can result in choice overload. Consumer electronics company Apple have gone to the other end of the spectrum by having an extremely minimal product range, to the extent that the new version of the iPad is referred to as exactly that, ‘the new iPad’, not even giving it an upgrade number as has been common practice in the past.


RULE 2:Consider the positioning of your most profitable options

Prior to making a purchase choice, consumers generally review the market and begin to identify their preferences. Behavioral Economics research has shown that it is increasingly clear that preferences are actually very malleable and influenced by all manner of context effects.

A good example of this is a classic experiment which offered people a choice of two cameras. One was an upmarket camera boasting various special features; the other was a much cheaper, basic model. Broadly equal numbers of people were interested in each camera.

Another study was then undertaken with the same two cameras but this time with the addition of an even better, more feature-packed camera. In this scenario, the camera that was previously a photographer’s dream is now the middle-range option. However, in this new context, the camera improved its market share with more than 50% of respondents choosing that item. The camera (which still has the same features as it had in the previous context, as well as the same price) won over more customers as it now looks like a good compromise - a deal hard to pass by.

So consumers’ preferences are clearly governed by the context of options that they do not choose, a finding that has implications for how technology brands seeks to position their products in the market both relative to competition and indeed within their own portfolio

Case study: An interesting example is the effect of a decoy option on preference for The Economist subscription renewals. Participants for this were shown a combination of 3 options:

(1) Online only for US$59

(2) Print only for US$125

(3) Print and online for US$125

The first group saw all 3 and unsurprisingly no body picked option 2 and 84% chose option 3. So what is the point of option 2? Well, when it was removed for the next group the number of people choosing option 3 dropped to 32%. Option 2 effectively acted as a decoy making the print and online subscription seem far more attractive than when it was absent.


RULE 3:Help consumers make fast and frugal decisions

Consumers struggle to juggle a large number of variables at a time. One study illustrated this well by looking at the way in which magistrates (a court official in UK courts) make decisions concerning whether to allow defendants to have bail (go free until their next court appearance) or whether to retain them on remand (keep them in jail until their next court appearance). Although magistrates are instructed to make their decision based on a wide range of different variables, in the vast majority of cases the researchers found that it was ultimately only one or two pieces of information that influenced the decision (in this case the advice of the prosecution).

This ‘fast and frugal’ means of decision making is a useful, adaptive skill we adopt in an attempt to simplify the otherwise complex myriad of everyday decisions we may have to make. This is pertinent for many companies which often provide consumers with a large amount of information concerning the variety of features that their proposition may offer. The ‘fast and frugal’ rule means that it is critical to understand which features consumers focus on when making their purchase decisions.

Case study: Work we’ve undertaken has explored how consumers make decisions about the purchase of new televisions. As the TV market is evolving with the introduction of some disruptive new features, consumers may be inclined to balance these with other more well-known facets such as price

and brand. However, our initial study has indicated that the vast majority of consumers only use one piece of information to generate a shortlist - price. More work is underway to examine if a larger number of features are used when comparing TVs within the same price range. Nevertheless, in the meantime this is a sober finding for television manufacturers.


RULE 4:Encourage consumers to take ownership of your services

Once consumers make a purchase and own an item they revalue it, resulting in a reluctance to give it up or exchange it for any other item. An example is a study where participants in three different groups were offered a choice between the same two goods, a coffee mug and a bar of Swiss chocolate. In the first group, upon completing a short questionnaire, students were asked to choose between the two goods. The result was a roughly equal split in preference.

Meanwhile, all students in the second class were given the coffee mug at the beginning of a session as a reward for completing the same task. On completion of the task, the students were shown the bar of Swiss chocolate that they could immediately receive in exchange for the mug. The students in the third class were offered the opportunity to make the opposite, having been given the chocolate bar first. In each case, the majority of students chose not to make the exchange.

This neatly illustrates how consumers, once in possession of an item, will endow it with a greater value than they otherwise would have done.

This effect is so strong that it extends to situations where people just imagine owning an object, a pseudo-endowment effect. This has been repeatedly shown to affect people bidding for objects on online auction sites. If someone becomes the highest bidder they begin to start concretely thinking about possessing their desired item, leading them to pursue the item more aggressively if they get outbid. This has been proven to occur on a range of products from cars to furniture.

The implications for companies is to give consumers a sense of ownership of their purchase

Case study: An area in which the endowment effect has been put to great use is in the offering of free trials. People are disproportionately affected by loss compared to what they might gain. This partial ownership changes our perception, so instead of gaining a product at the point of purchase we are effectively losing one, making it hard for us to give up what we just had. A great example of this is online retailer Amazon’s free trial of its express delivery service Amazon Prime. Their limited trial makes customers focus on what they will lose if they cancel their subscription.


RULE 5:Focus on providing memorable moments

Studies have shown there to be a difference between what consumers have actually experienced and what they remember experiencing. This is a subtle but critically important distinction that has significant implications for the way in which brands manage customer experiences.

A significant, if rather wince-inducing, study from the early 90’s looked at the experience of patients undergoing a colonoscopy. At that time, this was a treatment which was administered without the benefit of anesthetics and was thus considered to be very painful. Patients were asked to report their pain levels every 60 seconds, a demonstration of real commitment to the cause of research! When the patients were asked to report their retrospective evaluation of the treatment, researchers found that the average or total amount of pain was much less important than the peak pain experience or the level of pain that occurred at the end of the operation.

This finding is crucial for brands which must ensure that the in-life management of their customers has some key positive experience, particularly towards the end of the life cycle.

Case study: The clear lesson here is to create positive peaks and positive endings. The former could be a surprise free gift. Meanwhile, a positive ending might be extending a subscription for a short while. Many companies aim to deliver on these. A good example is food-delivery company Abel and Cole which regularly puts tasty surprises in its vegetable boxes. We suspect that the often low value items, such as an avocado, have a disproportionately high impact on consumers and are, therefore, a great means of driving customer loyalty.


RULE 6:The power of memory cues

Advertising is hugely dependent on memory to guide subsequent decision making and behavior. Given the time delay between consumer’s exposure to advertising and their opportunity to purchase the advertised product, there is a need to improve consumer’s memory at the point of purchase. The placement of advertising retrieval cues (verbal or visual information from the ad) has been shown to trigger recall and increase advertising effectiveness. Research has demonstrated that retrieval cues can lead to more favorable brand evaluation and can effectively increase likelihood of purchase.

Are all cues the same?

The use of retrieval cues is not a panacea. Cue effectiveness to prompt brand recall is highly determined by the cue’s ability to bring to mind only that specific brand. However, within product categories, there is a substantial overlap of information leading to the use of the same advertising cues. Used at the point of purchase, those shared cues will not be beneficial to a specific brand as they will prompt memory for other, same category, brands as well. What is the solution? To identify the most effective advertising cues for each brand and avoid cues that are also related to competitors.

Case study: We have undertaken work exploring the most effective retrieval cues. We began by exposing consumers to TV advertising in a low involvement way. Subsequently, after a time lag of week, the participants were presented with a variety of advertising cues. Results indicated that not all cues were successful in prompting brand recall. Only advertising cues that were distinctive and unique to the brand were able to retain the memory for that brand and the product characteristics. Advertising needs to increase the use of information that is distinctive and unique to a specific brand and use that information alone as a retrieval cue in the retail environment.


RULE 7:Encourage social norms

Most pricing strategies are governed by market exchange norms and establish a money-market relationship between the seller and consumer. Participating pricing is a new pricing mechanism where the consumer has complete control over the price they pay. This promotes a social-market relationship governed by social exchange norms, like norms of distribution or cooperation. Previous research has shown that this strategy increases consumer’s intent to purchase. Consumers are strongly motivated by concerns of fairness and reciprocity [2]. People help those who are kind to them and punish those who are unkind [3].

Companies increasingly try to create shared value by developing profitable business strategies that deliver tangible social benefits. This is creating major new opportunities for profit and competitive advantage at the same time as benefiting society by unleashing the power of business to help solve fundamental global problems. However, Corporate Social Responsibility activity can be treated with scepticism and suspicion by the customers. Introducing a participating price model can promote the establishment of a Shared Social Responsibility that could reinstate the trust to the seller and encourage purchasing behavior.

Case study: A field study was conducted at an amusement park. Fairgoers riding a roller coaster were photographed during the ride and then decided whether to buy the photo or not. In one condition, the photo had a fixed price of US$12.95. In the other condition, participants were free to pay what they wanted. Participants in both situations were told that half of the revenues would go to charity.

Total sales suggest that Shared Social Responsibility promoted by the ‘pay what you want’ model is substantially more profitable (US$6224) compared to Corporate Social Responsibility (US$2331)

As stated at the outset, Behavioral Economics is in many ways an exercise in making explicit many of the mechanisms that we have implicitly understood but struggled to generalize. For example, we knew that if an item was running out then people would see it as a sign of popularity, being more likely to want to purchase it themselves. But what we have failed to recognize is the contexts in which this operates, how powerful it is, who it influences (or not) and so on. Behavioral Economics extends our understanding of consumer behavior and allows brands to avoid common pitfalls.

We strongly believe that Behavioral Economics has real benefits for brands wishing to enhance their consumer insights. It can be particularly powerful when integrated with existing survey work to fully embrace a rounded understanding of the consumer context. If you wish to find out more, please don’t hesitate to get in touch.


GfK’s Research Centre for Behavioral Economics

GfK’s Research Centre for Behavioral Economics was established in 2012 as a joint initiative between GfK and academic institutions. Together, we undertake primary research using leading-edge market research techniques combined with the latest Behavioral Economics thinking to generate fresh thinking on business challenges.

References

[1] Based on illustration found in - Shepard, R.N. (1981) ‘Psychological complementarity’. In: Kubovy, M. & Pomerantz, J.R. (eds) Perceptual organization, pp. 279–342. Hillsdale, NJ: Lawrence Erlbaum Associates.

[2] Andreoni, J. and Miller, J. (2002) ‘Giving according to Garp: an experimental test of consistency of preferences for altruism’, Econometrica, vol. 70, no. 2, March, pp. 737-753.

[3] Rabin, M. (1993) ‘Incorporating Fairness Into Game Theory and Economics’, The American Economic Review, vol. 83, pp. 1281-1302.

To find out more about Behavioral Economics, please contact the author:

Colin StrongGfK NOP | Ludgate House | 245 Blackfriars Road | London | SE1 9UL United KingdomT +44 (0)20 7890 [email protected]

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