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.

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.

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.

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.

Relativity in Our Mind

Stumbled upon a celebrated behavioural economics study conducted by Amos Tversky and Daniel Kahneman (father of BE and one of my intellectual gurus these days) today. It goes in the following manner. Suppose you have two errands to run today. The first one is to buy a new pen, and the second one to buy a suit for work. At a stationery store, you find a nice ‘Cross’ pen for Rs 1,200. You are set to buy it, when you remember that the same pen is on sale for Rs 1,000 at another store 15 min away. What do you do? Do you decide to take the 15-min trip to save Rs 200? Most people faced with the dilemma say that would take the trip to save the Rs 200.

Now you are on your second task: you are shopping for your suit. You find a luxurious grey pinstripe suit for Rs12,000 and decide to buy it, but then another customer whispers in your ear that the exact same suit is on sale for only Rs 11,800 at another store, just 15 minutes away. Do you make the second 15-minute trip? In this case most people say that they would not.

But what is going on here? Is 15 minutes of your time worth Rs 200, or isn’t it? In reality, of course Rs 200 is Rs 200- no matter how you count it. The only question you should ask in this case is whether the trip across the town, and the 15 minutes it would take, is worth extra Rs 200 you would save. Whether the amount from which this Rs 200 will be saved is Rs 1,200 or Rs 12,000 should be irrelevant.

Yet most of us would choose to value Rs 200 discount on the pen more than the same amount of discount on a more expensive item. Behavioral economists have a name for this irrationality- its called ‘Relativity’. What it means is that our decisions are influenced by the context in which they are taken. In our example Rs 200 discount on the pen looked attractive because the amount is significant relative to the price of the pen. Whereas the same amount of discount is insignificant relative to the price of the suit (16.7% and 1.67% discount for the pen and suit respectively).

This is also why it is so easy to add Rs 2,000 to a Rs 500,000 wedding catering bill, when the same person will clip coupons to save Rs 40 on a Rs 250 medium Papa John pizza. And also for the same reason your happiness is not a function of how much you earn rather it is a function of how much your wife’s sister’s husband make (apparently there is a theory that has spotted this particular relationship metric!!).  It was for good reason, after all, that the Ten Commandments admonished, “Neither shall you desire your neighbour’s house nor field, or male or female slave, or donkey or anything that belongs to your neighbour”. This might just be the toughest commandment to follow, considering that by our very nature we are wired to compare.    

Incentivising Work Outs Using BE

I guess most of us feel the need to exercise as we grapple with our steadily growing waistline. Sometime we even have a go at it by going for a run or enrolling ourselves in the neighbourhood gymnasium. If you belong to the former category, most people (like me) the ‘josh’ lasts couple of days or weeks at best, before excuses start gaining their hold. An aching shin bone, sprained calf, no time, long hours- so on and so forth. Some of us feel that the gym is the better option. Why? - Because we pay a fee at the gym and chances are because of this economic penalty we get ‘locked in’. Or more simply put we feel that we need to get the value out of the economic penalty that we have paid up front.  Now consider the situation when we pay a daily fee as we use the services of the gymnasium; I would assume many of us would not trust ourselves that we would continue going to the gymnasium. We would think that bunking a day would be costless simply because we will not pay for it. Now this goes against the sound economic principle of ‘time value of money’, according to which payment made at an earlier point should be costlier than payments at a later point. This cognitive bias can be explained by behavioural economic theory of loss aversion. Loss aversion signifies our higher sensitivity to losses than equivalent gains. In this case we feel that we will discipline ourselves by arousing our sensitivity to losses- the value against the gymnasium fee.

Two Harvard economics students, Yifan Zhang and Geoff Oberhofer, lean heavily on behavioural economics to motivate gym-goers to workout. The concept, Gym-Pact, employs what Zhang calls “motivational fees” – members pay more money when they do not exercise.

The students are trying to tackle a particular economic challenge: because gym fees are paid up front, there is little future economic penalty for not working out. In effect, you’ve already paid the maximum economic penalty. Gym-Pact addresses this issue by linking your economic penalty/reward to your weekly workout schedule. For example, members currently pay up to $25 per week when they fail to exercise at least three times and $75 for dropping out of the program. Conversely, members who hit the gym at least four times per week pay nothing.

What Zhang and Oberhofer did was change the factor of motivation for the gym-goers. Whereas in the standard gym payoff scenario the motivation is loss aversion, in Gym-Pact the motivation is straightforward- reward for work out.

Hopefully Gym-Pact will get more people to the gym than before.  However, one wonders what will happen to Gym-Pact’s revenue if its members never default!!

BE and Marketers' Tool Kit

The art of selling, as a body of knowledge, is quite like folk art form. Much of it is not formally documented and passed down through societal intuition. This knowledge or intuition often works very well for the marketers. Behavioural economics in the last few decades has thrown some light in practices oft used but less understood.  Behavioural research on decision making in psychology, marketing, economics and related fields is substantially advancing our understanding of how and why many established marketing principles work. To the extent that these advances deepen our understanding of consumer behaviour, that’s a win for everyone.

In this article we will talk about some interesting and obvious tools that every marketer should have up his sleeves. These are used but randomly by companies. A systematic focus and strategy would help marketers win their customer over time over and over again.

1.       Make a Product’s Cost Less Painful

In almost every purchasing decision, consumers have the option to do nothing: they can always save their money for another day. That’s why the marketer’s task is not just to beat competitors but also to persuade shoppers to part with their money in the first place. According to economic principle, the pain of payment should be identical for every buck we spend. However, the reality is quite different.

Marketers know that delayed payment option can increase customers’ willingness to buy. One logical explanation is: the time value of money makes future payments less costly than immediate ones. But there is a second, less rational basis for this phenomenon. Payments, like all losses, are viscerally unpleasant. But emotions experienced in the present—now—are especially important. (For the same reason many of us avoid meeting our bosses when things are not moving at work and try pushing the encounter for later)  Even small delays in payment can soften the immediate sting of parting with your money and thereby remove an important barrier to purchase.

Another way to minimize the pain of payment is to understand the ways “mental accounting” affects decision making. Consumers use different mental accounts for money they obtain from different sources rather than treating every rupee they own equally, as economists believe they do, or should. Commonly observed mental accounts include windfall gains, pocket money, income, and savings. Windfall gains and pocket money are usually the easiest for consumers to spend because they are least valued. Income is less easy to relinquish, and savings the most difficult of all. Marketers can be effective by understanding the sources of money with their customers. For example banks can develop algorithm to identify regular income and windfall gains and pitch financial products to customers.

2.       Power of Default Option

Evidence abound that presenting one option as a default increases the chance it will be chosen. Defaults—what you get if you don’t actively make a choice—work partly by instilling a perception of ownership before any purchase takes place. Sometimes when we’re “given” something by default, it becomes a part of us—and we are more loath to part with it. A McKinsey study reveals the following- an Italian telecom company increased the acceptance rate of an offer made to customers when they called to cancel their service. Originally, a script informed them that they would receive 100 free calls if they kept their plan. The script was reworded to say, “We have already credited your account with 100 calls—how could you use those?” Many customers did not want to give up free talk time they felt they already owned. The spin of default option turned the decision on its head!!

Defaults work best when decision makers are too indifferent, confused, or conflicted to consider their options. That principle is particularly relevant in a world that’s increasingly awash with choices—a default eliminates the need to make a decision. The default, however, must also be a good choice for most people. Attempting to mislead customers will ultimately backfire by breeding distrust.

3.       Paradox of Choice

More choice does not always lead to higher utility as many economists believe. In absence of a default option, marketers must be wary of generating “choice overload,” which makes consumers less likely to purchase. In a classic field experiment, some grocery store shoppers were offered the chance to taste a selection of 24 jams, while others were offered only 6. The greater variety drew more shoppers to sample the jams, but few made a purchase. By contrast, although fewer consumers stopped to taste the 6 jams on offer, sales from this group were more than five times higher.

There are two problems when marketers present great number of choices to customers. First, these choices make consumers work harder to find their preferred option, a potential barrier to purchase. Second, large assortments lead to a heightened awareness that every option requires you to forgo desirable features available in some other product. And this will reduce the experienced utility of the chosen option. Reducing the number of options makes people likelier not only to reach a decision easily but also to feel more satisfied with their choice.

4.       Positioning Your Preferred Option Carefully

How marketers position a product, can influence the buyers immensely. Consider the experience of the jewellery store owner whose consignment of turquoise jewellery wasn’t selling. Displaying it more prominently didn’t achieve anything, nor did increased efforts by her sales staff. Exasperated, she gave her sales manager instructions to mark the lot down “x½” and departed on a buying trip. On her return, she found that the manager misread the note and had mistakenly doubled the price of the items—and sold the lot. In this case; shoppers almost certainly didn’t base their purchases on an absolute maximum price. Instead, they made inferences from the price about the jewellery’s quality, which generated a context  specific willingness to pay.

The power of this kind of relative positioning explains why marketers sometimes benefit from offering a few clearly inferior options. Even if they don’t sell, they may increase sales of slightly better products the store really wants to move. Similarly, many restaurants find that the second-most-expensive bottle of wine is very popular—and so is the second cheapest. Customers who buy the former feel they are getting something special but not going over the top. Those who buy the latter feel they are getting a bargain but not being cheap. Sony found the same thing with headphones: consumers buy them at a given price if there is a more expensive option—but not if they are the most expensive option on offer.

Another way to position choices relates not to the products a company offers but to the way it displays them. Our research suggests, for instance, that ice cream shoppers in grocery stores look at the brand first, flavor second, and price last. Organizing supermarket aisles according to way consumers prefer to buy specific products makes customers both happier and less likely to base their purchase decisions on price—allowing retailers to sell higherpriced, higher-margin products. (This explains why aisles are rarely organized by price.) For thermostats, by contrast, people generally start with price, then function, and finally brand. The merchandise layout should therefore be quite different.

Marketers have long been aware that irrationality helps shape consumer behavior. Behavioral economics can make that irrationality more predictable. Understanding exactly how small changes to the details of an offer can influence the way people react to it is crucial to unlocking significant value—often at very low cost.

Social vs Financial Motivation

Read an interesting experiment conducted by one LBS prof on behavioural economics. He randomly picked up 80 post graduate students and divided into three different groups of roughly the same size. These three groups were assigned very similar and very boring tasks individually. The first group was informed that they will receive no payment for their work. The second group members were to get only 50 cents for their work and the third 5$.

After the day of work, it was observed that people worked very hard when they were paid nothing and worked almost not at all when they were paid 50 cents. When they were paid 5$ they worked hard again.

What was happening here? Turns out that people live in two separate markets. The first one is the social market in which we do favours to people. The second is the financial markets in which we work for labour. When people were offered nothing, they thought they were doing a favour and they worked hard. When they were paid 50 cents, they did not think that they were cooperating in the experiment and getting 50 cents on top of that. Instead these 50 cents replaced their social motivation with the financial motivation. What happened as an outcome was- they were paid very little and they worked very little. The third group worked more because they were paid more.

I think this experiment packs in a whole lot of lessons in public policy, governance and development sector

Pre-Mortem to avoid Post-Mortem in Strategic Decision Making

We see it all the time. A project plan finalized after much back-slapping ending in smoke. A plan adopted by the top management and supported by key decision makers are not full proof. One reason is that people are reluctant to speak up about their reservations during the planning phase. People generally find it risky to raise impolite or politically incorrect objections to a plan proposed by their bosses and embrace the safety of silence. By making it safe for dissenters who are knowledgeable about the undertaking and worried about its weaknesses to speak up, we can improve a project's chances of success.

Research conducted  by Deborah J. Mitchell, Jay Russo, and Nancy Pennington, from Wharton, Cornell and  the University of Colorado respectively, found that prospective hindsight - imagining that an event has already occurred - increases the ability to correctly identify reasons for future outcomes by as much as 30%. This method of prospective hindsight has an interesting name – pre-mortem, which helps project teams identify risks at the outset.

A pre-mortem is the hypothetical opposite of a post-mortem. A post-mortem in a medical setting allows health professionals, police and the family to learn what caused a subject's death. Everyone benefits except, of course, the patient. A pre-mortem in a business setting comes at the beginning of a project rather than the end, so that the project can be improved rather than autopsied. Unlike a typical critiquing session, in which project team members are asked what might go wrong, the pre-mortem operates on the assumption that the patient has died, and so asks what did go wrong. The team members' task is to generate plausible reasons for the project's failure.

A typical pre-mortem begins after the team has been briefed on the plan. The leader starts the exercise by informing everyone that the project has failed spectacularly. Over the next few minutes those in the room independently write down every reason they can think of for the failure - especially the kinds of things they ordinarily wouldn't mention as potential problems, for fear of being impolite. For example, in a session held at one start up Education Company, an executive suggested that a project to attract the issues of armed forces had failed because interest waned when a particular executive was transferred. Another pinned the failure to a changes in the policy in Army.

Next the leader asks each team member, starting with the project manager, to read one reason from his or her list; everyone states a different reason until all have been recorded. After the session is over, the project manager reviews the list, looking for ways to strengthen the plan.

In a session regarding a project to make state-of-the-art computer algorithms available to military air-campaign planners, a team member who had been silent during the previous lengthy kickoff meeting volunteered that one of the algorithms wouldn't easily fit on certain laptop computers being used in the field. Accordingly, the software would take hours to run when users needed quick results. Unless the team could find a workaround, he argued, the project was impractical. It turned out that the algorithm developers had already created a powerful shortcut, which they had been reluctant to mention. Their shortcut was substituted, and the project went on to be highly successful.

One of the objections to this method is that it may lead to situation where objections cloud the original plan and the project is abandoned. Here the argument is that if the objections are indeed too strong may be the project is worth abandonment. However, experience show that in 78% of the time original plan is modified for the better and not abandoned.

What pre-mortem does and does it pretty cleverly - it incentivizes dissent. It also places creative objections on the table to a plan or project. This allowance of dissent and objections ‘robustifies’ the decision making process. It also reduces the kind of ‘bash on regardless’ attitude often assumed by people who are overinvested in a project. Moreover, in describing weaknesses that no one else has mentioned, team members feel valued for their intelligence and experience, and others learn from them. The exercise also sensitizes the team to pick up early signs of trouble once the project gets under way. In the end, a pre-mortem may be the best way to avoid any need for a painful post-mortem.

Acknowledgement - This article is inspired by the works of behavioral economist, Gary Klein who is the inventor of the term pre-mortem.

Behavioral Distortions in Strategy

Behavioral economics focuses on the irrationalities of so called ‘Homo Economicus’. Though a relatively new branch of economics that has evolved over close to four decades, behavioural economics has gained currency in our understanding of what goes on behind economic decision making process. Executives shaping the strategy of corporations recognise the importance of introducing the concepts of behavioural economics into the strategic decision making process. There have been significant volume of academic and empirical research that show that there are cognitive biases- systematic tendencies to deviate from rational calculations,  influencing our decision making process at an individual level and consequently at a broad corporate level. Some of these biases creep into the ‘system’ even when we are aware of its presence. There are tools prescribed by researchers and academicians that can help eliminate these biases to a great extent and render decision processes robust if not error free. The impact of behavioural economics on the strategic positioning of a company and the strategic choices that it makes is not fully understood though currently as a research area it enjoys a lot of attention. Cognitive biases apply to issues like resource allocation, market entry or exit decisions, mergers and acquisitions, a key technological choice, a new product launch.  The strategic positioning of a company is the outcome of such decisions. Therefore, at one level behavioural economics impacts the strategy and competitive positioning of a company in a very direct manner. Understanding and measuring that impact would allow executives to take improved strategic decisions.

Strategic decisions involve some fact gathering and analysis. It relies on the insights and judgment of a number of executives (a number sometimes as small as one). And it is reached after a process—sometimes very formal, sometimes completely informal—turning the data and judgment into a decision. Though companies vary in processes - there are some key elements in robust decision making processes generally observed. These elements are:-

1.      1. Assessment: forecasting demand and competitor reaction, assessing own capabilities, and tailoring the evaluation approach to the specific decision etc.

2.     2. Process: Gathering all critical information for the decision makers, giving floor to dissenting voices, comments from people from unrelated fields etc.

3.       3. Focus on targets: Resource allocation, aligning targets and incentives, fixing short term and long term goals etc.

However, such well-crafted strategy is often found wanting in terms of delivery of satisfactory outcome. Such failures result in loss of initiative and resources. It would be a worthwhile exercise to explore the biases in executive decisions and its impact on overall strategy of the firm. And also quantify the financial benefits of processes that ‘debias’ strategic decisions and help corporations to strategically position themselves more accurately and effectively.

Strategy is often the game changer; right strategy taking a corporation to a position of eminence and the wrong one causing downfall. It can be safely said that strategy is a result of a complex decision making process fraught with irrationality and biases. Understanding and correcting these biases will have enormous impact on the competitive positioning and success of a corporation. 

Irrationality and Our Optimism

All of us will be quite unanimous about the statement that optimism is a great human faculty.  It is an inner force that drives us to venture into the unknown, pulls us from the depths of despair and sometimes gives us the raw energy to pull on when things are tough. Expressions of optimisms that conjure up the indomitable human spirit abound in our literature. Often in our lives we use quotes brimming with optimism to egg others on. We have seen that the perspective of optimism turns the table around. I have a personal favourite here- Thomas Edison at the age of 67 met with a disaster-the factory that he built over the years was completely gutted in a terrible fire on a chilly New Jersey night. Next morning, Mr Edison looked at the ruins of his factory and said this of his loss: “There's value in disaster. All our mistakes are burnt up.  Thank God, we can start anew.” This is an enviable perspective that gives birth to fresh enterprise.

But optimism sits squarely on the right side of realism on our mental continuum. For all the virtues of optimism, there is an unmistakable play of cognitive bias from which it is almost impossible for us to escape. Optimism often leads us towards beliefs and opinions which are not rational. For example almost all of us believe ourselves in the top 20 per cent of the population when it comes to driving, pleasing a partner, or managing business. Even drivers laid up after an accident caused by them, genuinely refuse to accept that they have poor driving skill. Almost all of us are irrationally optimistic about our health and lifespan- all of us like to think that we will live long. In business optimism not only generates unrealistic forecasts, but also leads managers to underestimate future challenges more subtly – for instance, by ignoring the risk of a clash with an incumbent competition while entering into a particular segment. Those who are in sales would know that over-optimism tends to produce over-commitment. Over-optimism may create organizational biases as well- for example when the management takes an optimistic business call, dissenting or doubting voice is equated with disloyalty.

Collective optimism can also lead to large-scale disasters. Over-optimism of a very large number of people about their repayment capacity on mortgages led to the housing bubble and recession in the United States. Irrationality and optimism are at the very heart of any economic bubble. Now a very relevant question is – what is the remedy of irrational optimism? Can we escape from it? A raft of research in psychology and behavioural economics indicate that as individuals we are very ill equipped to handle irrational optimism. Corporations are slightly better off. By putting the right set of processes and safeguards, they may be able reduce or discourage over-optimism. One of my intellectual heroes of our time, Nassim Taleb in this latest book “How to live in a world that we do not understand” underscores this very point of future uncertainty and irrational optimism thereby. He suggests ways to adjust to some humility about how much we understand the world we live in. Thinking small, taking two insurance policies and reminding ourselves morning and evening that we don’t know much about the future and having some discipline and quality control over the decisions we need to make may help cure the irrationality around optimism.

However, let’s not forget that optimism can be a very good thing, contributing towards success and happiness in life. However, in many important areas of our lives we tend to be irrationally optimistic. In times of uncertainty and rapid changes, we should be wary of irrational optimism, be it for ourselves or our organization.