Why you Should Take Business Advice from Psychologists, not Economists
This article was originally published on RetailSector.co.uk
A detailed look at how psychology affects consumer decisions and the ways retailers can utilise this knowledge to improve sales.
In 1980, economics students at Harvard walked out of a class and refused to return. They were striking to protest their belief that the standard economics they were being taught had an inherent bias which affected students, their universities, and society at large.
What was this inherent bias? And were they right to believe in it?
Years later, psychologists revealed that the claim made by the protesting students could be supported by scientific research; that much of economics is built upon the assumption that humans are perfectly rational creatures, yet we are in fact perfectly irrational.
The claim that humans are perfectly rational beings implies that they have unlimited time and resources to dedicate to the decision-making process. However, as Thaler, a psychologist who authored the best-selling book, Nudge, points out, we are not ‘homo economicus’ but rather mere homo sapiens who lack such powers. Instead, we use our ‘adaptive toolbox’ to make fast and frugal decisions. These tools include heuristics, biases and rules of thumb, which unfortunately make our decisions – and therefore us as humans – highly fallible.
It wouldn’t be far-fetched to claim that you’re relying on one of your biases right now, the bias of selective perception, which evaluates this article and is silently protesting against my claim that humans are less-than-rational. Therefore, I will try to backup my views with proven examples of the most common biases that we use such as context effects, loss aversion and anchoring in everyday life, and show how these heuristics affect our decisions.
If people are really as rational as neoclassical economics assume, they should be perfectly aware of their preferences and should not be under the influence of context. However, several experiments prove otherwise. The first example is that of the framing effect. A 2008 study published by Sharpe, Stealin and Huber investigated people’s choice of soft drinks. They manipulated people’s choice by either removing the smallest option or adding an extra one.
The findings revealed that when an extra soda of larger size was added, instead of choosing the smallest soda, which used to be the middle option, people again went for the middle option, although this was now bigger than their original choice. When the 12oz option, which was originally the smallest available soda,was not present, only 4% of people decided not to buy a drink and 94% went for the next largest drink. The findings of this study has important applications for marketing strategies. It shows us that the way options are displayed or framed can greatly affect people’s consumer choices.
Another bias that we are often controlled by is that of loss, or risk, aversion. The bias demonstrates that people perceive losses to be more painful than corresponding gains. Tversky and Kahnemann successfully demonstrated this in a controlled psychological experiment. One group of people were given $1,000 (£752) and asked whether they would prefer a 50% chance to of winning $1,000, or to be guaranteed $500 (£376). Another group was given $2,000 (£1505) and asked whether they would prefer a 50% chance of losing $1,000 or to be guaranteed a loss of $500.
If all that mattered to the participants was the amount of money they walked away with, then both problems would be seen as identical. However, the findings showed that for humans, this is far from the reality. In the first group, participants choose the guarantee of $500, and in the second group, the large majority of participants preferred the gamble. Again, the implications of these findings, which have been replicated hundreds of times in other controlled experiments, are far-reaching.
Loss aversion implies that a negative performance on a particular attribute can have greater impact on overall satisfaction and repurchase intentions than positive performance has on the same attribute. Therefore, being disappointed by a product has more implications for future consumer behaviour than having the current expectations of the customer exceeded.
Another bias that we all fall victim to is that of anchoring. Anchoring occurs when we are subconsciously affected by the numbers that we have seen first. This then affects our subsequent decision-making. An experiment by Wansink, Kent and Hoch (1998) nicely illustrates this effect. In their experiment, the researchers showed that when presented with the statement ‘on sale – six cans for $3’ versus ‘on sale – 50 cents’, consumers will purchase more, according to the conditions of the first sale. This is because the number six subliminally suggests that they should buy a higher number of goods. Such insight allow figures and costs to be manipulated in such a way that ensures the behaviour of customers is guided in appropriate directions.
What was certainly not in doubt when the Harvard students struck in 1980 was the fact that we are highly social creatures. As such, much of our perception of the world is influenced by social norms and the actions of our peers. In an experiment conducted by Wood, Brown and Maltby (2012), researchers aimed to investigate people’s perception of their drinking behaviour as compared to that of their peers.
The experimenters found that people’s judgements about the risks associated with their drinking are not influenced by the amount of alcohol that they consume, but by how their consumption ‘ranks’ among how much they perceive others to be drinking. In other words, they construct a mental sample of relevant examples and rank themselves within that sample. They then estimate how their drinking levels differ from the average.
If I were a Harvard economics student in 1980, I believe that I, too, would have walked out with the Harvard students to strike against neoclassical economic theory. It did not incorporate what the students intuitively knew then, which is now known to be scientifically sound – that our behaviours and decision-making are driven not by conscious self-control, but rather by subconscious cognitive biases and heuristics.
We are not the omniscient, rational economists that Harvard professors of the past assumed us to be. Today, these findings have important applications for how businesses and marketing strategies should be run and developed. This knowledge is easy and accessible to you and your business if you look for it. Don’t act like an economist stuck in the past – harness the power of psychology and offer a more persuasive customer experience.