Copyright: 2008
Publisher: Harper Collins
ISBN: 006135323X
Dan Ariely tells a fascinating story of pain at the beginning of his book, Predictably Irrational: The Hidden Forces That Shape Our Decisions. As a youth he was involved in an accident that left 70% of his body badly burned. During his recovery he explains that he began to view the ordinary and everyday experiences that he used to experience as though he were an outside observer. He began to analyze the "why" behind daily decision making. This led him to an interest in the field of behavioral economics and what he refers to as JDM, Judgement and Decision making.
Decoys
Ariely starts into his exploration of human decision making by looking at the Decoy Effect. Humans are incapable of placing a value on something without a reference point. We use relative value when making economic choices which makes us susceptible to certain marketing ploys.
For instance, The Economist, a well known periodical had a subscription offer that Ariely came across while surfing the web. They offered the "web only" subscription for $59.95 and the "print only" version at $125.95. Then they had a third offering of both the web and the print versions together... for $125.95. Clearly, the web and print offerings together at the same price as the print only is the better offer. Right?
Ariely decided to do an experiment with this data. He surveyed students in his classes to find out which subscription would have the most appeal. A large number predicably chose the great deal of essentially getting the web only version for free along with the print version. The next part of the experiment was the interesting part though because Ariely removed the "print only" subscription and offered simply the two options, namely, web only at $59.95 and web + print at $125.95. This time the results were quite different. Even though in the earlier experiment virtually no one had signed up for the now missing "print only" subscription, its absence now made a difference in the results. Now a large number of students took him up on the much cheaper offer of $59.95.
The point of this experiment was that the print only subscription was a decoy. It was intended to give us a point of reference. We don't know how much the print only is worth or the web only. But we do know that if we can get both of them for the same price as the print only... then obviously that's the better deal because we are getting one of them for free. The decoy causes us to have a frame of reference for our decision... a frame that is chosen by the marketer and not our experience.
FREE is not just another price point
Another experiment that Ariely performed involved one of my favorite things, chocolate. He and his colleagues set up a table in an area busy with foot traffic. They offered two prices of chocolate. The higher priced truffles were $.15 each... arguably a bargain if you are a chocolate lover! The lower priced chocolates were simple Hershey's kisses at $.01. Unfortunately for chocolate lovers they were only allowed to buy one or the other... not both.
Because $.15 is a good price for a fine truffle, predictably more shoppers elected for the finer chocolate (no offense to Hersheys!) This is what the experimenters expected but what happened next they were not able to explain so readily. In the second part of the experiment, the price of both chocolates was lowered by $.01. Thus the truffles were now $.14 and the Kisses were FREE. Even though the value proposition was exactly what it had been before, now the Kisses went like crazy!
After several other experiments that controlled for things such as the hassle of searching for change etc, Ariely and his team found that chocolate lovers (and indeed all of us) are in love with the price of FREE. Making something free changes the equation and quite often can cause us to value the exchange differently. Thus offering a FREE pair of socks with the purchase of one, we can be persuaded buy a pair of socks that we might not otherwise be interested in buying.
Imprinting and Anchoring
First impressions are important. When we first see a particular brand of watch (or chocolate) the price we see associated with it when we first begin contemplating a purchase becomes the reference point for that brand. Ariely is an entertaining as well as thought-provoking author and he tells the delightful story about Tahitian Pearls. When they mottled gray pearls first hit the market, no one wanted them because they were different (and compared to smooth milky-white pearls they were ugly!) The early marketers took a step back and decided to try again.
Contacting a well-known jeweler in New York city they persuaded him to display a strand of these pearls in a shop window along with a collection of high priced and quite beautiful jewelry. In addition they took out large glossy print advertisements that similarly displayed the pearls in this context. Soon after, Tahitian pearls began to appear around the necks of the finest and wealthiest in New York and around the world.
The principle of relative value came into play. The new purchasers now had a context or an anchor for valuing the pearls. Now that they knew that these pearls belonged in the company of expensive diamonds and other beautiful jewelry, they were willing to pay a premium for these previously unknown jewels.
Irrational Motivations
What are some of the reasons we value things irrationally? Here are a few:
- Attachment bias (we value what we own more than if we didn't already own it)
- Loss aversion (we focus on the risk of loss - see prospect theory)
- We assume other have the same perspective as we do
Attachment bias is an interesting one. Ariely goes into detail with a great example about Duke students and their value of tickets of basketball games, both after owning and before owning. The disparity is stark and the reasons given were quite intriguing. The book is worth the read if for no other reason than gems like this story!
One thing I noted as I was reading this book was that ownership bias can be costly when it comes to the ownership of ideas. When we have an idea that we believe is our own, we tend to value it more than we would if the idea belonged to someone else. Understanding this is key to having an open mind when discussing ideas in a collaborative environment.
Death By Options
Ariely launches this section with the story of Sun Tzu burning the ships behind his men to eliminate the possibility of retreat. When you eliminate options, you begin to approach the decision process of the remaining options differently. An important skill in decision making is the ability to eliminate options as you move forward.
The author's team did a number of experiments to show that we are in love with options. In one, students played a quite simple game on the computer in which they were offered three options in the form of "rooms". After choosing a room, clicking in that room would earn you a random number of pennies. Each room had a different payoff range and most students could quickly determine which was the best paying room and they would use all of their limited number of clicks in the one room. The cost of switching a room was just one click but once students found the right room they would still stay in that room clicking.
Next, the experimenters changed things up. They made it so that the door to a room would only stay open if you clicked on it every so often. So if you clicked 12 times in one room, they other doors would be closed and you could no longer click in them. This should be no problem since most students could figure out in less than 12 clicks which room offered the best payoff and rarely ventured back into the other rooms anyway.
Oddly though, even though it cost them a click to keep the other doors open, students couldn't stand the thought of those options going away. Even though they knew they would not be clicking in them any more, they would still waste clicks in order to keep those options open. Even after the experiment was changed so that it actually cost the students a few pennies to keep the useless options open... they still couldn't help themselves. They had to keep the options open, even though they weren't going to be using those options any more.
How many times in business do we make the costly decision to keep options open even though we know they aren't good options and we have decided not to pursue them. We often decide to "make sure we can still go down that road" even though we aren't ever planning on going down that road. Sometimes we need to just let go and move on with the good options and forget about the others.
Conclusion
This book is a fascinating book and well worth the read. I found some of the social explorations to be insightful into the liberal mindset. Many liberals have argued that free markets don't always work. Ariely explains clearly why these thought processes exist even in the face of much evidence that they do indeed work. Ariely argues that the markets can't fix irrational behavior since they rely on rational behavior to work. It is worth noting however that markets can correct for irrational behavior over time. Each of the examples that Ariely gives where irrational behavior might cause market failure can be extrapolated over time and you can easly see how competition can correct for irrationality. Overall the book is very though provoking and a great read.