Behaviour & Economics: A Start

2016-04-26 15:58

Nice Phone? Long-Term Commitment!

Never underestimate your ability to convince yourself of anything.  If it is one thing behavioural economics teaches a person, it’s to have no doubt how talented we are at convincing ourselves how smart and deserving we are.  And that means making money off you is a lot easier than you think.

Like pickpockets who purposefully put up “Beware of Pickpockets” signs to get you to subconsciously pat the pocket your wallet is in; behavioural marketers know exactly which buttons to push.  And the smarter you think you are, the easier it gets.   Take a self-proclaimed sceptic and any half-baked behavioural economist will be grinding that organ in no time.

Behavioural economics is the study of how people make real-world decisions.   In the real-world we decide we want something, and we exchange something of value, usually money, for that thing.   How we come to wanting that thing, and how much we are prepared to pay for it primarily depends on three things.   Biology.  Psychology.  Sociology.

The biology is relatively straight forward.  We need to eat.  We buy food.   It’s the psychology and sociology that makes it interesting – that give brands their equity so to speak.   Traditional economic theory is based on the premise that we humans act in a rational manner.  With lots of information and in our own best interest.  We know this to be patently untrue.  This where the psychology and sociology get messy, and where marketers rub their hands with glee.

Listening to the radio, there’s that insurance company that advertises car insurance ‘for good drivers only’!  One thinks, “Yeah, that’s me.  I’ve never had an accident; I must qualify”.   Classic behavioural marketing – to the psychologist this is a blunt appeal to “The Better Than Average effect”.  Study after study confirms that something like 75% of us really, really believe we are better than average drivers.  I on the other hand, would gladly bet that you are not.  Obviously I’d make money if we could prove it (that's just maths).  But that ad appeals to your “personal narrative bias” – the one in which you are the hero in the movie constantly going on inside your head!  So the advert appeals to your ego; ignoring the far more likely truth: that you have never having had something as random as a traffic accident is more luck than skill.  Those same insurers will tell you there's only two types of drivers, those who have had an accident and those who are going to have an accident.

How we frame information is important too.  The way in which marketing information is presented makes a big difference.   Is that lean beef you eating 90% lean or 10% fat?  It’s called the “framing effect”.  Call now and if we can’t beat all the broker-front-end-fee-loaded insurance quotes in the market, we’ll pay you R400.  In other words, be your own broker and we’ll just adjust your premiums.  Easy-peasy in a commoditised, scale-driven industry like car insurance.  What about “framing” your insurance quotes on a comparison website?  Yes, you get the “best” premiums but ever thought who pays the costs of all those radio ads?  You do.  Still you get the benefit of competition instead of the self-interest of a broker selling you something they get the best commission out of.   Clearly the psychology of a possible R400 cash payment or cheap comparisons ‘frames’ the purchasing decision.  What you should be looking for from an insurance company is competitive premiums and a good claims ratio.   Then you know you getting value for money.

Remember how rational we were when we signed that gym contract?  The social pressure to look good, or at least be able to tell others in our group ‘we go to gym’ aside; two interesting psychological hooks are at play here.  “Present bias” which manifests when we respond to the urge for immediate gratification.  Like consumption spending on our credit card or signing a two-year gym contract that offers a rate of R199 per month for the first 6 months before ramping up to R700 for the last 18 months.   But we want to get fit now.  And we’ll keep it up.  And R199 per month is a hell of a deal.  And we’ll be earning more money next year so we can afford to pay R700 for a gym membership we're unlikely to be using, right?  Enter ‘Projection Bias’ which suggests we expect our current feelings, attitudes and preferences to continue into the future and underestimate the effect of possible change.  So if you are a marketer – design a special introductory offer, with an unnecessarily long contract period, and ‘trap’ the unsuspecting consumer into a hopelessly complicated contract.  Just be aware, the Office of Fair Trade in the U.K. successfully challenged minimum length gym contracts the High Court in 2011.  The court ruled that such contracts are significantly detrimental to consumers.  In fact, they are designed with no other purpose than trapping people in unfair contracts.  One has to ask what business are they in?  Gym?  Or financial contract trapping?

And let’s not even get started on the abuse and excess profits made by selling mandatory life insurance (at often much more than 10x actuarial valuations) on retail credit products.   The new banking regulation is all about justifying your behaviour going forward, check out the FCA website on Behavioural Economics. It’s all about “conduct” and “culture” in the banks these days, which is my game.

So where does that leave us when buying stuff?   Simple.  Always ask yourself if you’re being impulsive.  Great phone? Two-year commitment. Really worth it?   Take a day or two longer to decide.

One thing behavioural economics taught me:  If you can accept that you are not as smart as you think you are, then you probably are smarter than average.  All biases notwithstanding.

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