Monday, February 21, 2011

Social vs Market Norms in Business Ecology

In one of the earlier posts, I mentioned about two different markets in which we humans operate -social market and financial market. The rules in these two places are vastly different. In the financial market we are cold, calculating utility maximizers. Whereas, in the social market our transactions are fuzzy and not governed by clear lines of loss and gain. For example contributing to an NGO makes us feel warm and nice, and we do not expect to be paid for our efforts and time. Financial loss in some situations makes us happy, as in the case of charity.

Now it is important to remember that rules of the two markets should not be mixed. When social and market norms collide, trouble sets in. Take sex as a case in point. A guy takes a girl out for dinner and a movie and he pays the bill. They go out again, and he pays the bill once more. They go out a third time, he is still springing for the meal and entertainment. At this point, he is hoping for at least a passionate kiss at the front door. His wallet is getting perilously thin, but worse is what is going on in his head: he is having trouble reconciling the social norm (courtship) with the market norm (money for sex). On the fourth date he casually mentions how much this romance is costing him. Now he’s crossed the line. Violation! She calls him a beast and storms off. He should have known that one can’t mix social and market norms- especially in this case- without implying that the lady is a tramp. He should have also remembered the immortal words of Woody Allen: “The most expensive sex is free sex.”

On a more serious vein, we can also examine company- customer or company-employee relationships that often are at the crossroads of social and market norms. Whoever started the movement to treat customers socially had a great idea. If customer and company are family, then the company gets several benefits. Customer loyalty pays companies in more than one way. But companies pouring crores in marketing campaigns to create social relationship – or at least an impression of social relationship – do not seem to understand the nature of a social relationship, and in particular its risks.

For example, what happens when a customer’s cheque bounces? If the relationship is based on market norms, the bank charges a fee, and the customer shrugs it off. Business is business. While the fee is annoying, it is acceptable nonetheless. In a social relationship, however, a hefty late fee – rather than a friendly call from the manager or an automatic fee waiver – is not only relationship-killer; it’s a stab in the back. The consumers will leave the bank angry and spend hours complaining to their friends about this swindler of a bank. No matter how many cookies, heart tugging visuals, mushy slogans a bank provides one violation of the social exchange means that the consumer is back to the market exchange. It can happen that quickly. If you are a company it is advisable to remember that you can’t have it both ways. You can’t treat your customer like family one moment and then treat them impersonally – a moment later when this becomes more convenient or profitable. This is not how social relationships work. If you want a social relationship, go for it by all means; but care to remember that your behaviour needs to be consistently social.

A similar mix up is happening in company-employee relationship in today’s world. Companies see an advantage in creating a social exchange. After all, in today’s market we’re the makers of the intangible. Creativity counts more than industrial machines. The partition between work and leisure has likewise blurred. The people who run the workplace want us to think about work while we’re driving home and while we are in the shower. They’ve given us laptops and blackberries to bridge the gap between workplace and home. Companies try to create an environment through social exchanges in order to make workers loyal, passionate and innovative. In treating their employees – much as in treating their customers – companies must understand their implied long term commitment.  If employees promise to work harder to meet a deadline, if they are asked to get into a plane at a moment’s notice to attend a meeting, they must get something similar in return- something like support when they are sick, or a chance to hold on to their jobs when the market threatens to take their job away.

Although some companies have been successful in creating social norms with their workers, the current obsession with short term profits, draconian cost cutting, increasing the variable pay in the salary package and layoffs threatens to undermine it all. In a social exchange after all, people believe that if something goes awry the other party will be there for them, to protect and help them. These beliefs are not spelt out in a contract, but they are general obligations to provide care and help in times of need.  Social relationships deliver great things; however it demands responsible corporate behaviour.

Sunday, February 13, 2011

Winner's Curse and the Cost of Ownership

Consider yourself in the shoes of Siddharth Mallya. Your team fared reasonably well in the last season of IPL, finished third overall, smelt blood but couldn’t quite make a kill. This time you are hungry for the trophy and you don’t want to take a chance. Pack in firepower in your arsenal, no matter what it takes. You want to retain that Virat Kohli; he rocked with his willow last summer wearing your shirt, you want him real bad this time too. So as the auction progresses in salubrious Bangalore, you fork out $1.8 million, an amount other bidders think preposterous, and you bag Kohli with the fall of hammer. Even though you have retained Kohli in the auction, you probably have ended up overpaying for him. Clearly the market (the other bidders) didn’t see Kohli’s value at your price. So your win was rather costly. Economists have a name for this phenomenon – ‘winner’s curse

Now move over Siddharth Mallya. Let’s get closer to ourselves. Think about the last time you entered an e-bay auction. Suppose you make your first bid on Friday morning, for a wristwatch, and at this point you are the highest bidder. That night you log on, and you are still the top dog. Ditto the next night. You start thinking about that elegant watch. You imagine it on your wrist; you imagine the compliments you will get. And then you go online again an hour before the end of the auction. Some dog has topped your bid! Someone else will take your watch! So you increase your bid beyond what you had originally planned.

Let me tell you, auctions are not the only time when we end up paying more than we want to pay for something. In daily life we miscalculate the value of transactions very often. We do it as a buyer as well as a seller. These miscalculations can be explained by invoking a mental faculty that we have – a sense of ownership. Much of our life story can be described by the arrival and departure of ‘things’ that we own or relinquish ownership of. We buy clothes and food, cars and homes, for instance. And we sell things as well- homes and cars, and in the course of our careers, our time.

Since so much of our lives is dedicated to ownership, wouldn’t it be nice to make the best decisions about this? Wouldn’t it be nice, for instance, to exactly how much we would enjoy a new fancy mobile phone, a 4wd SUV or a Prada shoe, so that we could make accurate decisions about owning them? Unfortunately, this is rarely the case. We are mostly fumbling in the dark.

Lets look at a very common situation of selling a car. Even before you put your ad or contact a dealer, you begin to recall trips you took. You were younger, of course; you just started your married life. The memories of those romantic drives wash over you and you feel an ache in your heart every time you look at the old faithful. You set a price that is high but reasonable to you as your heartache can’t be just for nothing. However, the prospective buyer during his inspection tends to only notice the dent in the bumper and the black smoke from the exhaust! He quotes a ridiculously low price for your beloved.

When it comes to buying we are no better. Often we start owning things before we actually do so. We see M S Dhoni sitting in front of an Amrapali Villa with lush greenery all around him, and we imagine ourselves there. We imagine our kids running around in the carpet grass lawn right in front of our dream house. The trap is set, and we willingly walk in. We become partial owners even before we own anything. Companies know this concept too well and advertisers use it as a mainspring.

There is another way that we can get drawn into ownership. Often companies have ‘trial’ promotions. For example dishtv offers a free premium platinum package for new customers for the first three months (it’s not actually free though- the rental is cleverly built into the initial price). We like the television experience and tell ourselves, we can always go back to a downgrade because at the end of the day we only watch channels that we can count on our fingers. But once we try the platinum package, of course, we claim ownership of it. Will we really be able to downgrade? Doubtful. Most likely we won’t be able to deal with the idea of letting go of something that we got used to. Letting go is often harder than we can imagine.

Another example of the same hook is the ’30-day money back guarantee’. If we are not sure whether or not we should get a dinner set, the guarantee of being able to change our mind later may push us over the hump so that we end up getting it. We fail to appreciate how our perspective will shift once we have it at home and how we will start viewing the dinner set – as ours. It’s difficult to imagine how a dinner set can ignite an emotion of ownership in us!

The bad news is there is no known cure of ownership bias. Only thing is to try to view all transactions as if we were non-owners, putting some distance between ourselves and the item of interest.

Friday, February 11, 2011

The Riddle of Experience vs Memory

Everybody talks about happiness these days. There is a huge wave of interest among many people including researchers to study happiness and what makes us, we human beings happy. But in spite of this flood of work, there are few cognitive traps that almost make it impossible to think straight about happiness. It applies to lay people like us and to scholar as well. Turns out that scholars are as messed up as anybody else.

One among these traps is the confusion between experience and memory. Basically the confusion is between being happy in your life and being happy about your life or happy with your life. These two are very different concepts and both get lumped in the notion of happiness. This can be illustrated by an example in which one person describes about her experience about a musical rendition. She said she had been listening to a symphony and it was an absolutely glorious music. At the end of the recording there was dreadful screeching sound. And then she added quite emotionally – “it ruined the whole experience!!” But it hadn’t. What it had ruined was the memory of the experience. She had had the experience. She had had the experience of twenty minutes of glorious music that counted for nothing because she was left with a memory. The memory was ruined and the memory was all that she had gotten to keep.

What this is really telling us is that we should be thinking about our experiences in terms of two selves. There is an ‘experiencing self’ who lives in the present, knows the present, capable of reliving the past, but basically has only the transient present. It is the experiencing self that the doctor approaches when she asks ‘does it hurt when I touch you here?’ And then there is the ‘remembering self’ that keeps score, maintains the story of our life. It is what the doctor approaches when he asks ‘how have you been feeling lately?’ or ‘how was your trip to Egypt (pre or post Mubarak)?’ These are two very different entities and getting confused about them is part of the mess about the notion of happiness.

The remembering self is a story teller. That really starts with the basic response of our memory. We don’t tell a story only when we set out to tell a story; our memory tells our story. What we get to keep from our experience is the story. Let us explain this with an example. This is an old study that was conducted on actual patients undergoing colonoscopy (which used to be a painful procedure till 1990s when these tests were conducted, thankfully they are no longer as painful). The patients were asked to report their pain every 60 seconds. Here are the two patients and these are their recordings. If you are asked who out of these two patients suffered more, you would not take a moment to answer. Clearly patient B (the lower one) suffered more. Her colonoscopy was longer and every minute of pain A had B had that and more. Now there is another question.  How much did these patients think they suffered? And here is a surprize. Patient A had a much worse memory of the pain than patient B. In case of A the story is worse because her colonoscopy ended with the pain at its peak. These patients were asked about their experiences immediately after the procedure and much later too. It was much worse for patient A than B in memory.

Now this is in direct conflict between experiencing self and remembering self. From the experiencing self-point of view, clearly B had a much worse time. Now what you could do with patient A (and actually it was done) is to extend the colonoscopy by keeping the tube in without jiggling it too much. That will cause the patient to suffer, but just a little, and much less than before. If you do that for a couple of minutes, you have made the experiencing self of patient A worse off and the remembering self of patient A a lot better off. Because now you have endowed patient A with a much better story about her experience.

What defines a story (that is delivered by our memory)? The main factors that define a story are changes, significant moments and endings; endings are very very important. In our example, quite evidently, the ending dominated. The experiencing self lives its life continuously. It has moments of experience one after the other. You can ask what happens to these moments. The answer is really straight forward- they are lost forever. Most of them don’t leave a trace. Most of them are completely ignored by the remembering self. And yet, somehow you get a sense that they should count. What happens through these moments of experience is our life. It is a finite resource that we are spending while we are on this earth. And how to spend them should be relevant. But that is not the story the remembering self keeps for us.

The biggest difference between experiencing self and remembering self is the handling of time. From the point of view of the experiencing self, if you have a vacation, and the second week is just as good as the first, then the two week vacation is twice as good as one week vacation. That’s not the way it works for the remembering self. For the remembering self the two weeks’ vacation is barely better than one week vacation because there are no new memories added, you have not changed the story. And in this way time is actually the critical variable that distinguishes the experiencing self from remembering self. Time has a very little impact on the story.

The remembering self actually does more than remembering and telling stories; it is the one that takes decisions. Consider a patient who had two colonoscopies with two different surgeons and is now deciding whom to choose for the third procedure. He would surely choose the surgeon with whom her memory is less bad. The experiencing self has no voice in this choice. We actually don’t choose between experiences; we choose between memories of experiences. And even when we think about our future, we don’t look at it from the point of experience. We think of our future as anticipated memories. We can think of it as a tyranny of the remembering self and remembering self dragging experiencing self through experiences that the experiencing self doesn’t need.

The two selves bring two different notions of happiness. Two different concepts of happiness, one per self. We can ask questions related to happiness of the experiencing self (that can now be measured). If you ask questions about the happiness of the remembering self, it is a completely different matter. The happiness of the remembering self is not about how happily a person lives, rather it is about how satisfied or pleased a person is when she thinks about her life. For example a happy person, when asked to rate her life, says that her life was not fulfilling because she never went to college.  

The distinction between the happiness of the remembering self and the experiencing self has been recognised in recent years. There are now efforts to measure these separately. The main lesson that we have learnt is that remembering self and experiencing are really different. You can know how satisfied a person is with her life and that really does not tell you much about her experiences in life and vice versa. Just to get a sense of correlation between the two, (which is about .5) we can draw an example. For example if you are going to meet somebody and you are told her father is six feet tall- how much would you know about her height? You would know something about her height but there will still be a lot of uncertainty about her height. You have that much uncertainty about her experiences if I tell you that she has rated her life 8 on a scale of 0 to 10.

Who thought understanding happiness could be such a complicated business!! 

This article is inspired by a talk delivered by Prof. Daniel Kahneman, winner of the nobel prize in economics in 2002.

Monday, February 7, 2011

Healthcare and Behavioral Economics

We all know that exercise is good for health, but how many of us actually do. All smokers know that they are doing a great disservice to their own health, but this awareness fails to prevent them from smoking. The big three – cancer, heart diseases and obesity are to a large extent the result of the poor health choices that we make. In fact, in a 2008 paper entitled Personal Decisions Are the Leading Cause of Death, Professor Ralph Keeney of Duke University estimates that every one million of the 2.4 million deaths in the U.S. in the year 2000 could be attributed to personal decisions. Furthermore, those deaths could have been avoided if alternative choices were made. Specifically, Professor Keeney found that 46% of deaths due to heart disease and 66% of cancer deaths could be attributed to personal decisions. These numbers are shocking and alone should serve as a wakeup call for changing behaviour. Poor compliance of treatment protocols by patient is a major cause of death and contributes to very high cost of healthcare. For example, research shows that missing an appointment with the doctor in the US has an average cost of 700$. Why then, is the healthcare industry not making more progress? Why are citizens still making irrational decisions that they intuitively know will lead to bad results? The science of behavioral economics can give us some insight into decision-making processes and, more importantly, help us to better understand how to influence those processes to encourage individuals to make better choices about their health.

Considering healthcare, imagine if BE principles could be applied to help stroke patients follow their treatment protocols more closely. In most cases after a stroke, doctors prescribe a blood thinner to help reduce the chance of recurrence from 24% to 4%. Despite the fact that taking this drug significantly reduces the chance of additional brain damage, many patients do not take their medicine! Researchers Kevin Volpp, George Loewenstein et al., created a small scale experiment to see if they could combine three incentive ideas drawn from BE to change this sad state of affairs. In a paper entitled “A Test of Financial Incentives to Improve Warfarin Adherence,” (warfarin is a blood thinner) the researchers used: (1) small, quick, frequent rewards, (2) a small chance at a big reward, and (3) the regret of missing a payoff in their clever design. In one test group, each day 20 patients were entered into two lotteries. All participants had a 1 in 5 chance at a $10 prize, and a 1 in 100 chance of a $100 prize. An electronic pillbox in their homes recorded their behavior. The daily lottery was conducted and patients were notified if they won. If they had not taken their pills correctly, they were told they would have won, but regretfully they had not complied with the drug regimen so they received nothing. Noncompliance dropped from 22% to under 2% for the entire three months of the study.

Think about how cost effective this type of incentive can be. For $3 a day, it is possible to significantly improve drug adherence and in all likelihood decrease strokes and improve wellness. What is remarkable to me is that a well-designed $3 payoff was a more powerful motivator than a 20% decrease in the likelihood of an additional stroke. Investments in such creative solutions that reflect how people really think, as opposed to how they are supposed to think, could create a huge, measureable, humane, and rapid return for patients and all of us.