Predictably Irrational: by Dan Ariely

Predictably Irrational: The hidden forces that shape our decisions.

By Dan Ariely

 

A book review by Duncan Brett

Dan Ariely is a psychologist and professor in Behavioral economics at Duke University in the USA. He has written a few books, but this is his big hit. He runs an online course on the book on Coursera, an online open university that is simply fantastic.

You can find it at https://www.coursera.org/course/behavioralecon

Behavioural Economics is a study of psychological, emotional and other factors on the economic decisions of individuals. While standard economics assumes we are all logical rational decision making beings, behavioural economics sees us as often irrational and seeks to measure how we actually behave rather than how we are supposed to behave. Think of it as opposition to the idea of the rational man. We think irrationally and are subject to ‘decision illusions’ which influence our thinking and decisions. This irrationality is more pervasive than most of us realize.

Despite being irrational, we are highly predictable.

The book highlights some of our main irrationalities and calls for us to be more aware of them. It provides real food for thought if you want to try understand why people act the way they do.

If you work in marketing or marketing research, then at least a basic understanding of these traits is essential.

Ariely has a light and humourous writing style, so it makes for easy reading on fairly complex topics. He experienced a personal tragedy when a magnesium flare exploded leaving 70% of his body with 3rd degree burns.

The book is full of references on how this has shaped his perspectives. It is also laden with experiments on unsuspecting students. Each chapter covers an irrational behaviour liberally illustrated with experiments.

The replicability of many studies in behavioral economics has been called into question, and I am not sure how the field will pan out in the end. I find however that many of the examples intuitively make sense to me, and there is more than a grain of truth to them.

Below is a tour of a dozen behaviours covered in the book.

1. The truth about relativity reminds us that context matters.

Subjects would go to another shop to save $7 on a pen, but would not do the same to save $7 on an expensive suit, even though it was the same amount.

This is because we do not have internal value meters, so we need to look for relative advantage in both physical and emotional things. While relative comparison helps us make decisions, it has a dark side that drives jealousy.

Our brains don’t like to work so we tend to focus on the most easily comparable option when looking for relative advantage. Relativity also explains why decoys work in marketing.

Ariely illustrates a practical application of this with an advert from the Economist. Option 1 offers digital subscription for $59, option 2 offers print and digital for $125. In experiments 68% chose the digital. He then manipulated the offer to include option 3, print only for $125. Now 84% chose print and digital. Print and digital now sounds like a much better deal.

2. The fallacy of supply and demand, and the idea of anchors.

This is based on the principle that humans need context, so something needs to act as an anchor. The anchor can be completely arbitrary but, once established, can be exceedingly difficult to shift.

We tend to make subsequent contextual decisions coherent to the anchor. Thus this initial arbitrary anchor can have far reaching consequences into the future and the whole category. This is the principle of arbitrary coherence. The reason anchors work relates to a phenomenon called herding, we see others doing something, so we follow suit. However, we also self herd, where we believe something on the basis of our previous behaviour. You remember your decisions and act on them again. Every time you do it, it reinforces the habit.

We could even go further, the sensitivity we show to price changes may largely be a result of our memory of prices paid in the past, and our desire for coherence with past decisions, and not a reflection of our true preferences.

Think about this in relation to pricing. The anchor is critical; if you are more expensive than the anchor you will forever be expensive. An anchor can apply across a category, so you competitors may be setting the anchor.

Ariely notes that to become an anchor, we need to contemplate a purchase at that price, from then on we always refer back to the initial anchor.A price tag on its own is not enough.

For the economists amongst you this does tend to mess with the laws of supply and demand, especially when you think that the supply side of the market is furiously throwing out anchors over the demand fence.

There are lots examples on anchoring both experimental and real world in the book. Salvador Assael created the market for black pearls and their expensive price by anchoring them next to diamonds and rubies. Starbucks showed how it is possible, but very difficult to shift an anchor by reframing their coffee away from the Dunkin Donut experience to one of a continental coffee shops, effectively creating a new category long the way.

Ariely showed how even the last 2 digits on your social security number can act as an anchor in an auctioning experiment.

Loewenstein showed that when people moved cities the price they were prepared to pay for housing remained anchored in their past city.

3. Zero is something special. I suppose it’s no surprise. Getting something free feels very good. Zero is not just another price it is an emotional hot button, a source of irrational excitement.

The difference between 2 and 1 cent is nothing, but between 1 cent and free is huge. We have an irrational urge for free even when it’s not what we really want.

Ariely hypothesizes the answer lies in the fact that free has no perceived downside. Humans are intrinsically afraid of loss. The real allure of free is tied to this fear. There is no visible possibility of loss when we choose a free.

Amazon illustrated this with free shipping, marketers do this with buy 1 get 1 free, free DVD’s with this hifi, and his experiments show us how people switch from preferring the 15c Lindt chocolate over a 1c Hershey bar, to a free Hershey bar over a 14c Lindt.

4.Two sets of norms drive our relationships. Social norms are fuzzy, soft and driven from our social nature and need for community. Market norms are harder and transaction based, implying a cost-benefit exchange.

These two norms explain why we will often do things for free, as a ‘favour’ but refuse to do it if a small payment is added. So lawyer refused to participate in a programme to help the needy for $30/hour, but were quite willing to do so for free.

When the two norms collide it is usually the social norm that disappears and once gone it will take a long time to come back. A kindergarten school found this out to their cost when they instituted fines for parents picking up toddlers late. Parents viewed the fine as worth it for late collection and the number of late collections rocketed. When they dropped the fine, the number of late collections stayed high.

A non-monetary gift tends to keep the transaction in the social norm, but if you explicitly introduce the price it knocks the social out and brings the market norm in. So while it is fine to bring a bottle of wine for dinner, don’t boast about the price.

In fact just thinking about money, can make us more market norm oriented, more self reliant, but also more selfish and less likely to help. Social norms are cheaper and often more effective as a motivator, but the backlash from violating them is much bigger.

Ariely gives some food for though to those in the world of business. You can cultivate a market or social norm, but you can’t have it both ways.

Companies spend a lot of money positioning themselves as social partners or friends, but when they violate the norm, it is not just business to the customer, it is backstabbing and has an amplified effect. Think of the bank promising to be your friend, and see what happens to that friendship when you default.

The same applies to employees. Companies get employees to go the extra mile working overtime, weekends etc… This creates a social norm, part of a family. It then gets violated with retrenchments et al, thus destroying all company loyalty.

In research you may want to think that a gift or thank you to respondents may be more effective than a small monetary incentive. That is until your competitor offers cash, and drives the social norm effect out for everyone.

5.The influence of arousal. Ariely shows us that Dr. Jekyll and Mr. Hyde lives in all of us. We are unable to predict how we will react when aroused, and we do not learn from experience either. Our emotions grab us and make us view the world from a different perspective.

In our cold, rational state we answer very differently to our hot aroused state. Ariely tested this on male students on sexual issues when cold and when aroused. Our mood states and the different answers they lead to give food for thought about questionnaire design.

6. The problem of procrastination and self-control. If we are aware of this we can help ourselves by using tools to precommit. Not everyone understands their tendency to procrastinate. And those that do often do not understand the problem completely.

Ariely uses an education experiment to show us how pre-committing to goals can help overcome procrastination.

In vehicles a motor plan is a form of pre-committing. He asks whether we can’t extend this to other areas, like healthcare or finance.

He tells us he took the idea of a self-control credit card where you could place spending limits on different categories to a major bank, who listened to him, told him the idea was fantastic and hurriedly showed him the door.

7.The high price of ownership. Once we get our hands on something we don’t want to let go.

The endowment effect predicts that when we own something, we start to value it more than others do. We have three quirks which prevent us from making accurate decisions about ownership; we tend to fall in love with what we have, we tend to focus on what we will lose rather than what we will gain, and we assume others will see the transaction from the same perspective that we do.

Ownership itself also has peculiarities – the more work you put into something the more feeling of pride and ownership you have. Ariely calls this the “IKEA Effect”

Even worse, we can begin to feel ownership before we actually own something. This can be a problem if you are at an auction. It also explains why trial promotions and money back guarantees work so well. Once we have it, we don’t want to lose it.

8. Keeping our options open distracts us. We are driven to keep our options open even when it doesn’t make sense. Usually we’d be better off making a choice and sticking with it.

In a modern democracy we are not faced with a lack of opportunity, but rather an abundance of it. Yet we cannot stand the idea of closing doors on alternatives. As our options shrink we stop focusing.

While having alternatives can be a good thing, it can also be a problem because it can paralyse us. We start focusing on the similarities and differences, which are usually quite minor and don’t take into account the consequences of not deciding, which can often be quite big. Think about spending weeks trying to decide between 2 digital cameras, when they are basically the same.

In an emphatic example of closing doors, in 210BC Xian Yu, a Chinese general, burnt all his ships and smashed all the cooking pots. His troops could fight their way to victory or die, there was no plan B which led to a 9 battle winning streak.

9.The effect of expectations. Expectations matter influencing nearly every aspect of our lives, the mind gets what the mind expects. If we believe beforehand something will be good, generally it will be good and when we think it will be bad it will be.

Expectations also shape stereotypes, as a stereotype is a way of categorizing information. It also changes our perception of things, which helps to explain why two people can see the same facts but interpret the results completely differently.

In experiments in a beerhouse (how cool is that), Ariely and his cohorts asked patrons whether they preferred Beer A: Budweiser or Beer B: MIT brew (Budweiser & 2 drops of balsamic vinegar). If people knew beer B had vinegar they universally hated it, but without knowing they tended to prefer the sexier sounding Beer B. Strangely enough it didn’t make such a difference if you told them about the vinegar after the fact. You have to have the expectation in advance. This principle explains why we think wine in fancy glass tastes better. Or how a detailed and delicious description of food on a menu can lift expectations and consequently the appreciation.

If you tell people upfront that something will be distasteful, the odds are good that they will end up agreeing with you, not because of their experience but because you have set their expectations.

These expectations influence how brands grow, because providing information can heighten someone’s anticipated and real pleasure.

Neuroscientists using MRI’s showed that by knowing the drink was Coke made subjects enjoy it more, even though they preferred Pepsi in blind tastes.

10.Placebos work and expensive ones work better. Placebo comes from the Latin “I shall please”, by the 14th century it was being use to describe sham mourners, and by 1785 it had come to be regarded as a marginal form of medicine. They run on the power of suggestion. They work because people believe in them. They work very well in fact.

Ariely set out to explore if the price of the placebo made a difference too.

In an experiment he showed how a $2.50 painkiller, is much more effective than a $0.10 one, even though it was the same drug. So add some marketing hype and we can really begin to believe the potion makes us cleverer, smarter, faster and because we believe it we really are. Or maybe not.

It is tempting to think of a placebo as just psychology but it represents an amazing reality of the way our mind controls our body.

Now, the placebo effect does create an ethical dilemma for marketers, since it appears hype really can improve efficacy and satisfaction, but when it stretches to outright lying, where do you draw the line?

And if you think marketing has problems, what about medical. It is full of placebos’ some of which really work.

Take Dr Cobb, a cardiologist in 1955 who suspected that internal mammary artery ligation did not actually do much, despite its popularity. He decided to perform the real surgery on half his patients and faked it on the other half. Amazingly the placebo-operated patients reported the same level of short-term relief as the real operations, although neither showed long term efficacy.

There is a big moral dilemma in placebo trials in surgery, but a big cost in not running them too.    

11.We are all dishonest (but just a little bit). We need to think of ourselves as good, honest people (most of us anyway).

Ariely demonstrates the majority of people cheat when they get a chance, but just a little bit, and not as much as they could. The amount of cheating is not related to the risk of being caught. It relates more to the fact that we need to think of ourselves as honest good people and have an inbuilt fudge factor that allows us to justify a little cheating, but no more.

Turns out society is not squeaky clean with a few bad apples, evidenced by the fact that insurance fraud and office fudging costs society more than robberies.

However when we are given a moral reminder at the point of temptation people generally don’t cheat at all. It doesn’t help to do it as a once-off, the effect is not long lasting. The moral reminder does not need to be big either.

So if you are getting people to do something or answer something, getting them to swear to do it honestly before they start. Each time. Keep reminding people of the benchmark of ethical thought at the point of temptation.

12. Cash makes us honest. When we remove ourselves a step from cash then it becomes easier to steal, it’s less real somehow and so easier to rationalize.

Students happily took a coke from a fridge, but no-one took 1$ bills. In all Ariely’s honesty experiments (where people were asked to say how many of 20 problems they had solved in exchange for reward) only 4 of 2,000 participants cheated the whole way (solved all 20). Yet, when tokens which could later be exchanged for cash were used, the magnitude of cheating doubled and more than 5% cheated the whole way.

Ariely regards this as one of his most worrying discoveries, with huge implications as we move further and further away from cash in society today.

There are elements of all the above dozen irrationalities that are worth factoring in for marketing and research activities. (and many more besides) If you want to read more, he has written two further books, The (honest) truth about dishonesty, and The upside of Irrationality. There are also a number of other authors on the topic. I’ll be summarizing their thoughts in due course.

 

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